Yield of Dreams
Revenue management software may hold big opportunities for multifamily properties.
There has been plenty of buzz during the past several years about the
potential of utilizing revenue management practices in real estate, especially
for pricing apartment rents. Revenue
management, also known as yield management, automatically determines
lease rates based on a specific property's market data: In particular, what
will a tenant pay at this point in time in this market for this amount of
space? Hospitality properties use it extensively to determine room rates, as do
airline and rental car companies.
Using a more structured, predictable process for managing the
challenging aspect of pricing multifamily lease rates holds tremendous appeal.
For example, the gross revenue impact of revenue management on the hospitality
industry is between 3 percent and 6 percent; for airlines it runs between 4
percent and 8 percent. Clearly there is money to be made.
Understanding the Process
First, it helps to understand what revenue management really is and is
not. In simple terms, it is the practice of applying microeconomic supply and
demand management techniques to arrive at the optimal price that yields the
maximum demand at the highest possible revenue value. While a crude
misinterpretation of this is "getting the most money from each and every consumer,"
the underlying subtleties are more compelling, especially in terms of real
Effective revenue management's key mechanism is the ability to precisely
measure consumer willingness to pay, referred to as elasticity. Put another way,
businesses cannot make consumers pay more than they perceive is appropriate;
they are, however, obviously willing to pay less. This approach is relatively
simple to manage in commodity businesses where there is plenty of opportunity
to compensate for errors in judgment by adjusting prices to respond quickly to
demand fluctuations. But it is not so simple in real estate where property
managers can be forced to live with the lingering effects of misguided
transactions for a year or more. Successfully modeling elasticity requires vast
amounts of detailed, historical market data, such as rents and occupancies,
which can be difficult to acquire. Solving elasticity for real estate largely
explains why it has taken so long to arrive.
Surprisingly, the differences between commodities and real estate also
provide the strongest arguments for revenue management's potential. These
differences can be distilled down to two components: value and duration. The
value difference is that real estate transactions are significantly more
expensive than commodity sales; each transaction is worth thousands versus tens
or hundreds of dollars. From tenants' perspectives, the value of choosing where
they will live and spend 20 percent to 30 percent of their disposable income is
considerably greater than where they will sit on their next flight. The
duration difference is that commodities typically are consumed in hours or
days, and the downside of a bad decision is quickly forgotten. In real estate,
the downside of bad decisions is much more durable for both property management
and tenants. The complexities of the time and value dimensions of each lease
decision are nearly impossible to solve effectively by the average person.
Computers and models, on the other hand, excel at these tasks.
Benefits from revenue management manifest in several ways. First, the
obvious - successful practitioners can increase revenues. Gross operating
revenues typically improve by around 2 percent sustainable. Actual results vary
by property, largely driven by a given market's pricing efficiency. Very
inefficient or poorly priced markets generally provide the highest opportunity
and can yield even greater returns.
To put 2 percent into perspective, Camden Property Trust recently
attributed 1.5 percent to 2 percent revenue improvement - or about $6 million
dollars - to its revenue management system in the first full quarter of
deployment. But positive results are not a function of portfolio size. Revenue
management operates at an individual property level since pricing is specific
to the unique supply and demand characteristics of each property and
In addition to higher operating revenues, revenue management contributes
equally to asset valuation. Assets successful at sustaining a premium over the
market command a premium at the time of sale. Also, since these are supply and
demand management systems, supply can be controlled in preparation for disposal
to position the asset for maximum investor appeal. For example, when managing an
asset for long-term hold, the objective will be to maximize occupancy and
operating revenue. However, an asset for sale rarely receives credit for
occupancy over 95 percent but is treated very favorably for extracting premiums
or increases on recently signed leases. Constraining supply to 95 percent in
preparation for sale allows a facility to turn disposition strategies into
Revenue management produces qualitative advantages as well as
quantitative. Demonstrating that all prices offered were established blindly
and objectively before prospective tenants arrive at the site eliminates
subjectivity and human bias from the pricing process and virtually ends
exposure to fair-housing infractions. Removing the "let's make a deal"
component of transactions frees site management and leasing agents to focus on
closing leases, delivering customer service, and tending to other productive
activities. In addition, compliance with home office pricing strategy at the
site is no longer an issue because the objectives are configured directly into
the revenue management system.
The last beneficiary of revenue management is the least obvious -
tenants. Systems are designed to carefully measure the best value, or price, to
offer. This price ultimately is the value established by the tenant relative to
his or her other options in the market. So the rent offered truly has been
tailored to meet the tenant's expectations. Unlike offering a single price,
such as a 12-month lease for occupancy in two weeks, revenue management offers
prospective tenants nearly unlimited move-in, lease term, and move-out options
from which to choose. More options create more flexibility to meet each
individual's unique needs - and more opportunities to close deals.