Loss to lease is one of the most essential metrics to understanding and evaluating the potential of a multifamily property.
Simply put, loss to lease can be defined as the difference between actual rent and market rent. In this article, we’ll explain further what loss to lease is, how to understand it, and what it means for the potential of a multifamily investment.
Loss to Lease Meaning
When renting a home or apartment, it’s wise to set the rent based on the going market rate in the area and for that property type. In the event that the market you are in rises in value while your rents fall behind, you’ll find yourself renting below the market value for your property and missing out on potential income.
This “loss” of potential income is loss to lease (also known as LTL). It is the difference between the market rent potential and the actual rental income of a property, typically measured monthly or annually, or sometimes as a percentage.
Why Loss to Lease Matters to Real Estate Investors
Loss to lease matters to multifamily real estate investors for the following reasons:
- Indicates potential revenue upside in a property - if the property is being rented below market rates, then there is room for rents to increase.
- It can help an investor determine where the biggest potential upside is between two properties, should they be deciding between investments.
- Serves as a key metric in underwriting and valuations.
- Suggests opportunities for increasing property value through strategic lease renewals.
When reviewing real estate investment opportunities, it’s important to evaluate the market's going rates and the property's position.
An Example of Loss to Lease
Loss to lease can be calculated with the following formula:
Loss to lease % = (Market rental rate - Actual rental rate) / Market rental rate
Here’s an example: Suppose a unit’s market rental rate is $2,500, but it is being offered at $2,000. The loss to lease percentage is ($2,500 - $2,000) / $2,500, or 20%. Calculated monthly, that is $500, and calculated annually, that is $6,000.
What Causes Loss to Lease?
Loss to lease can occur for a number of reasons, such as:
- Rents increase in the area: When market rents increase but existing tenants remain on older leases at lower rates.
- Concessions made to attract tenants: When properties offer concessions or special deals to attract tenants.
- Lower rents to maintain occupancy: When units are deliberately priced below market to maintain high occupancy.
Loss to lease creates an opportunity for the owner to increase rents and gain higher revenue from the property over time. It may require some work to get there, such as upgrades, but it ultimately allows for the property investor purchasing the property to have some leeway in increasing rents.
Download the Free Investor’s Guide to Multifamily Real Estate
Understanding loss to lease is just one piece of understanding the potential of a multifamily opportunity. There are many other ways you can evaluate a deal’s potential and build confidence in the decisions you make for your portfolio.
If you’re looking to invest in multifamily real estate but are not sure where to start, we recommend downloading our free multifamily investing guide. We wrote it to show you the ins and outs of investing in multifamily real estate. Fill out the form below to get your free guide. In it, you’ll learn:
- The tax benefits of investing in multifamily real estate.
- Definitions of key terms
- How to choose a firm.
- The best markets to invest in.
And more!
