3 Reasons to Create Strategic Vacancy

Episode Sumary

Today’s episode is about the case for strategic vacancy. Why would we want to create vacancy? Strategic vacancy is always planned and it has a purpose. Usually the purpose is to increase rents (we’re talking about rental property). We’re always looking to increase rents but rent is not always about price.  There are three reasons to create strategic vacancy.  They are:

Episode Transcript

[00:00:24] Sometimes rent is about the services rendered to our customers and potential customers. If they (our customer) finds a  better value across the street, even if the price is the same or if our prices are a little bit less, our customers may gravitate across the street because they see greater value.

[00:00:45] When we're creating vacancy it's usually for a purpose and that purpose is very often to create some form of differentiation between our product and what others in our marketplace are offering. When I say it's not always about price, and if we're talking about rental property, particularly residential rental property, then every place has four walls and a door. Beyond that there's always things that we can do to differentiate between ourselves and our competitors. In so doing we want to create vacancy so that we can increase that differentiation and it may be more than just fresh paint. Sometimes the changes are more like new "everything." It may be new appliances, new flooring, new fixtures, new windows. It can be a lot of things that create differentiation and therefore create more value and attractive more customers or a higher quality customer.

[00:01:54] Most time changes are something in between. We're not necessarily doing a complete rehab but we are implementing things that allow us to attract that customer from our competitors and tracking those changes in rents in real time allows management to ascertain what those upgrades should be.

[00:02:17] We're not only just looking to do "stuff" we want to do stuff that makes sense. We want to do things that have a return on our investment.  That means a market survey. Before we create this vacancy, we want to see what we can do to increase rents and determine what changes we can make that will have a positive impact on rental value.

[00:02:42] A rent survey is accomplished before creating vacancy because there must be a plan in place prior to kicking people out for the sake of putting in new floors and doors. We don't want to just do things ad hoc. Anytime there's a plan there's a calendar and whenever we create a calendar for redeveloping units that calendar starts long before we get to the vacancy part and it ends and only at the point where we have the unit re-occupied at a higher rent after the changes, or upgrades made.

[00:03:18] We want to know why we're doing this, what we're doing, what the time line, and of course the cost. And we also want to know what the revenue gap is between what a unit will rent for "as is" versus what it will rent for once upgrades are in place. That's the metric that tells you if it's worth doing. It doesn't do you any good to create a stellar place for folks to live where the rents go up from $924 to $926. There's no reason to do the upgrades, right? But if the upgrade goes from $900 to $1,050 that is a measurable increase in rents. What do we have to spend (on upgrades) to get that measurable increase in rents? Once you have that number in hand then you can make a quality decision on whether there is a value in creating vacancy so that you can make those investments and reoccupy the unit capturing the increased rents.

[00:04:24] Preparing for rent growth; that's the primary reason for a strategic vacancy. That preparation requires you to do your market survey to run the numbers and make sure that you're on track. Here's some questions to ask to see if you are preparing for rent growth.

  • Are you using tools of the trade to see rent growth in your markets and submarkets?
  • Are your managers performing rent surveys to keep pace with competitive assets?
  • Are your concessions and/or premiums attracting the right customer to your assets? You don't want to be collecting just people you want to be collecting quality candidates, quality residents that stay a long time.

[00:05:07] Preparing for rent growth requires a yes response to these questions. Rent survey, knowing concessions and understanding if the quality of tenant that you are targeting is the quality of tenant that's residing in your units. When you creating a community, you create a community of like-minded people. I'm not suggesting they're like-minded politically nor socially. But they are very likely similar with respect to their income and their educational attainment. Without knowing these simple market dynamics, you have no idea of what pending rent growth will be in your assets and you can potentially miss these gains or increases in rents.

[00:05:55] You should know, within your markets, what the rent surveys are and you must know if you are attracting the right type of customer for your asset.

[00:06:07] If you can see rent growth coming your marketplace, if the answer is yes to rent growth potential, then the answer is yes to creating strategic vacancy in advance of that so that you can capture that cash when you've made the changes, when you've made the upgrades, prior to people coming in.

[00:06:31] If your rental survey tells you that your rents are under market, and they're under market substantially then the question is why. Is it just a matter of upgrades? If you do make upgrades to your property. Will that in fact increase your overall income or revenue stream or will it just decrease your concessions? If all its doing is decreasing your concessions then it's a net zero, right? You're not gaining anything by upgrading your property only to have to increase concessions to capture the residents.

Three Reasons to Create Strategic Vacancy

[00:07:11] Here's the three reasons to create vacancy on purpose. These are three that I like you to consider if you're going to create strategic vacancy.

  1. The first is asset renovation. Basically. just upgrading the asset so that you can get closer to gross potential rent or increase your rents so that they mirror market rents and are competitive with other assets within your submarket. Creating asset renovations- I should say implementing asset renovations.
  2. The second is to re-position the asset which may or may not necessarily include a renovation because re-positioning can be a cosmetic facelift; just to the facade, the entry points. It's more than throwing grass seed. Re-positioning can be exclusively marketing or re-branding an asset. That's separate and distinct from renovating the asset. Asset re-positioning can in fact have a real positive affect on revenue. The first reason to create strategic vacancy is for asset renovation. The second is for asset re-positioning.
  3. Third is for the removal and replacement of low quality clients or customers. If you're having significant issues with collections is the only reason because you're selecting the wrong residents? If that's the case that means you're not renovating the property you're renovating your residence selection process so that you can reduce your collections and install people that have a better profile economically. It means selecting resident selection that includes those with higher credit scores and higher income. That leads back to rent growth. That also leads back to competitiveness between your asset and surrounding assets. So, you can't just charge more without cause. You must bring in reasons why people will pay you more. That's why you're doing a rental survey of comparative assets and competitive assets to decide what renovations or what upgrades are needed, if any, to bring your rents higher.

[00:09:32] Once that's done you want to make sure that there's enough people in the marketplace to pay those rents and come over to your asset. Every asset has competitor's. Sometimes it's a zero-sum game and sometimes you can bring in more people, new people, into the submarket based on the type of property and the upgrades that you're offering. You must also know that going in with respect to creating strategic vacancy.

[00:10:02] Are you attempting to steal residents from your local competitors or are you casting a wider net to bring more people into the market because of the quality property that you are presenting to the marketplace? And will that be attractive to those that will compete a little bit further to come and reside inside the property that you've created for their home and home use?

[00:10:28] Those three areas, with respect to creating strategic vacancy; asset renovation, asset re-positioning and replacement of your existing client base with a higher-level client base. By a higher level we usually mean higher income and or higher education (those two often go together).

[00:10:52] I've written two books that have a segment in each that can help you fill out this area even further. The title of the book is Multifamily insight: How to Build Wealth Through Buying the Right Multifamily Assets in the Right Markets.

[00:11:12] Volume 1 and Volume 2 have four categories; Acquisitions, Property Management, Demographics and Market Analysis and Financing. The best area to get further information on creating strategic vacancy and what to do and how to do is in the area under demographics and market analysis. Each book has several dozen pages about the topic, demographics and market analysis, and I think they would be very beneficial to you if you're looking to create strategic vacancies.

[00:11:48] Thanks for listening today. This has been John Wilhoit on Real Estate.

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