The Lease-Up ProcessDec 16, 2020
Steve Olson explains how the Fourplex Investment Group fills a new construction multifamily development with tenants. With multiple investors owning different units throughout a project, a modified round-robin is necessary in order to follow fair housing laws while also meeting the needs of each investor.
We get a lot of questions, sometimes over and over again, about how various components of our business work. One that gets asked a lot, but not as often as it should, is how leasing should be handled.
Imagine you bought an apartment complex and it's got 200 units in it... maybe you syndicated it. You're the managing partner, and you got a bunch of people to bring in money. Each of you bought this thing together. Let's say it was a new construction apartment complex.
After you go through the build process, you'll need to turn around and lease the thing as units get completed, right? These things don't complete all at once—you might get one or two buildings in the complex completed—then they kind of roll through over the subsequent months.
Now it's time to lease it. You can imagine when you're leasing in the middle of construction, or the seasonality component, sometimes you have to do little incentives. Sometimes you have to be a little creative as to how you do that. But it always takes time, even in a really healthy market. The population is growing and there's a housing shortage. When there's huge, huge demand for rentals, it still takes time because you need to find safe and qualified tenants.
Sometimes it goes quickly, sometimes not so quickly. But you need to plan on that. What's interesting is, if you own that $200 apartment complex and you get a couple of leases one week, you'd feel pretty good, right?
But here's the problem you run into a lot.
You have 200 doors, but it's not one owner, right? It's you and perhaps 20 or 30 different individuals, doctors, business people, and IT professionals (whoever), that all own multifamily in this same project. Each of you want it leased yesterday, which is understandable.
How do you navigate that?
How do you make sure that the person across the street isn't getting preferential treatment over you and that your units are treated fairly through that initial lease process? That's the hardest part for new investors. When you get the project fully leased, and there's an occupancy rate of, say, 95%, (this isn't really an issue anymore, because at any given time, we have almost no vacant units), but when you've got 200 of them hitting the market over eight months, no matter how you slice it, you're on the wrong side of supply and demand.
You'll need to stabilize and get through that, which we'll discuss how we do that next.
Mechanics of How a Lease-Up with Fragmented Ownership is Handled
Entrata Farms is one of our projects in Meridian, Idaho. The development is probably halfway through its start of construction. As we post this, in fact, some of the first phase units are now finishing up and the property management team is marketing for tenants on those units.
Phase one is actually a pretty small phase. Those investors came in and they closed on the ground and their construction loans almost 11 months ago. So they've been under construction for the last year. As these units turnover, they'll be ready to rent out to tenants.
Let's talk about how this will be handled. First, we have to remember that we're posting this in December. We can't really landscape effectively in December. So if you're leasing units, it's not a great time of year when you can't also get the landscaping in. That combined with the fact that there's construction happening in the rest of the project means sometimes a property manager needs to do incentives (ie. x amount of dollars off the first 2 months of rent if you sign a 12-month lease, etc.)
This project is in the Boise metro. For Entrata Farms, they're probably not going to need incentives since that market is hot right now. Property is leasing very, very well in that market. But if it wasn't going so well, they'd probably do some aggressive incentives, because the name of the game is to get your properties full and to get rental income coming in ASAP.
We look at this first phase, and we record in December/January. That's when these units are going to turn over. In this phase, the first building is a Duplex (bldg A) followed by three fourplexes (B, C, and D). Once A is finished, more than likely the very first unit completed in this project is going to be right on its heels (B) because that's an attached building. And then you might see a few days later, maybe even a week later, C and D complete.
So now if I count these up, we've got 14 units that have just hit the market. And what's going to happen is the property manager is now advertising the empty units. The first tenant that walks in the door and is qualified, is going to be placed in the very first unit that was completed. And guess what, maybe later that day or later that week, another tenant comes in that tenant gets the second one, and therefore they go into the first door of the second completed unit. Then you can see the third and the fourth.
So now everybody in phase one, which is the only completed phase has a tenant in the first door of their building. So now tenant five walks in the door... you probably see the pattern. He'll be placed into the second door of bldg A. The property manager works around to give everybody their second tenant in that phase. We call that a modified round-robin.
Now, it doesn't always work perfectly like that though. There are fair housing laws that we have to be careful of. Let's say that the sixth tenant walks in and the property manager shows him unit D. But they look at C and decide they like that one better because it's closer to the park. Even though the pattern suggests the tenant should be placed in unit D, the property manager can't and frankly, shouldn't, tell them no. It's a completed unit due to fair housing and investors can't discriminate since the unit is technically available.
So every now and then what happens is a tenant leapfrogs. But most of the time, we can generally stick with that round-robin approach. And it's a pretty good idea for how things tend to flow. So that's what we stick to.
Start of Phase 2-3
We try to get as much done as we can in phase one, but if phase two comes in, then they're in the rotation now as well. So maybe the 12th tenant comes in as phase two is completed. The idea is we're trying to fill the farthest back completed units first because they're the ones that have been incurring fixed costs, like mortgages, HOA fees, and taxes, for the longest period of time.
So what you can see sometimes when this happens is if these phases are delivering through the winter months, which is the slowest time right now, It's not uncommon to see property management sign anywhere from one to maybe five or six leases a week.
You'll see that in the winter, things tend to be a bit slower, and then leases hit a spike typically around March. What happens in March? Tax refunds. Refunds start getting mailed out by the Treasury and people get an unexpected $2,000. At that point, they decide they don't like where they live right now. So they go looking for a brand new rental.
So you'll see a little bit of a spike in March, then it subsides a little bit again. And then usually in late April, things rev up significantly. We were talking about placing tenants in here in December, but come Spring, we're talking 6, 10, 15, sometimes 20 signed applications a week. In fact, in the Boise Metro in the late spring of 2020, we received as many as 60 rental applications per week.
You might kind of slug through the winter and get a tenant, maybe two, but each tenant will help with some of your fixed costs. And then bam, is we hit that prime leasing season, typically, end of April through September, things usually clean things up nicely.
But in any case, it all evens out and through the modified round-robin, we equitably distribute those tenants to help offset that disadvantage in the business model, which is the fractionalized ownership of a FIG fourplex project.