Technology Solutions

Yield of Dreams

Revenue management software may hold big opportunities for multifamily properties.

By Jeffrey Roper |

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 estate transactions.

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.

The Advantages

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 neighborhood.

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 operating tactics.

Other Benefits

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.