The Impact of Organic Rent Growth on Real Estate Projections

Real Estate Rent Growth Analysis

I’m talking about organic rent growth. 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.

  • 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).

Here’s why you have to be careful: Every year, the rent increase is higher and higher since the percentage increase builds off of the previous year. This is the compounding effect. The increase from Y2 to Y3 is $26 (551-525) but the rent increase from Y4 to Y5 is $29 (608-579).


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.

never underwrite above a 3% organic rent growth and I like to start this after any value-add strategy is complete.

Source: Why Organic Rent Growth is Dangerous

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