Organic rent growth inputs in a real estate underwriting model have dramatic effects on the returns.

This is the manual input in your underwriting model that reflects the percentage increase your rents will grow each year. Unusually high organic rent growth inputs can be dangerous because it has a compounding effect.

Meaning, every year builds off of the previous year. The organic growth input can easily inflate the projections on paper if used incorrectly.

Let’s take a look at an example using the Next Level B.O.T.E. Model:

• 100 unit property

• All 1 Bedroom units

• Rent is $500/unit

As you can see, a 100-unit property rented at $500/unit will give me a gross potential rent of $600,000. I'm assuming 0% rent growth for the first year after acquisition so my average rent is still $500 for Year 1.

So with a 5% increase every year after, we are saying the 1-Bedroom units will be rented at $525 in Year 2 ($25 increase) and $608 by Year 5 ($108 increase).

In the example above, I'm doing a 10% organic increase in the first 2 years. Since every year builds off of the previous year, by Y5 I'm projecting my 1-Bedroom rents to be $700!

Keep in mind, this is only organic rent growth! This is not counting any rent premium achieved from an interior renovation or value-add strategy. Let's do that now:

In the example above, I'm renovating 50 units in Y1 and 50 units in Y2. Each renovated unit is receiving a $200 rent premium. Additionally, I'm still assuming a 5% organic rent increase every year.

But Year 5, I'm projecting my 1 bedroom unit to be renting at $893! Wow! That's a 79% increase from the in-place rent of $500 when we bought the property! (Of course, these are just example numbers, but you can see the dramatic effect of what a simple input can have on your projections.)

Is that realistic? Is it conservative to underwrite to unusually high rent growth every year? Can those rents be achieved in Year 4 or Year 5?

Conclusion:

As a multifamily underwriter, it's critical to have realistic underwriting assumptions in your analysis. You can see how a simple input like organic rent growth can easily over-inflate your projections (and your investor's returns). Being too optimistic with your projections will set your business plan up for failure.

What’s an acceptable rent growth input? This can highly depend on the market, business plan, and a variety of other factors. Most real estate investors would agree 2% - 4% annually is acceptable.

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• Small Apartment Markets Where Supply is Holding Back Occupancy

📈 Chart of The Week

Small Apartment Markets Where Supply is Holding Back Occupancy

While the U.S. overall has seen moderate occupancy decline in the past five years, some small apartment markets are logging significantly worse performances.

Small Florida markets make up nearly half this list of metros with significant occupancy declines. Inland markets Gainesville and Deltona suffered setbacks around the 400-bps mark in the past five years.

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