The unsung hero of the real estate world is sure enough, the comp. The comparable housing that, based on how someone feels a particular day, represents the best approximation for a home’s value, whether it be selling or renting.
But should it be this way? Absolutely not.
OK, so maybe it’s not time to eliminate the comp from our way of thinking. Comps provide a very valuable service, especially on the sale side of things. The problem mostly arises in the rental side of business when people use comps to determine the “ideal listing price” for their property.
This namely comes down to a few issues:
- Rental listings that are used for comps are aspirational, unlike sold comps
- Rental listings are listed by individuals and companies with a wide range of differing motivations
- Rentals are much more sensitive to finishing touches (think countertops, flooring, appliances) than demographic details (think bedrooms, baths)
- “You only need one”
Let’s talk about these in detail, shall we?
- Rental listings that are used for comps are aspirational, unlike sold comps
Typically, when a home is sold, the data that is used for the comp is the selling price rather than the listing price. On the rental side, however, what a home leases for is not always made public, so many will rely on what the other current listings within the area are. But what happens if one of the selected homes was negotiated heavily before lease signing? What if the operator of that home had a concession available that discounts the effective rent? Any of these things can make it more challenging to price appropriately, especially in markets that are experiencing increased weakness.
- Rental listings are listed by individuals and companies with a wide range of differing motivations
This one is pretty obvious in itself. A mom-and-pop operator’s number one consideration for renting their house is to cover their costs, while minimizing tenant turnover. So it’s safe to say that they may not always be pricing true to market conditions, and may opt to minimize their vacancy by settling for a suboptimal price. But this behavior isn’t limited to mom-and-pops. It’s behavior I have seen from institutional players as well, as they chase KPIs in a particular market, either by pushing rents skyward in an effort to tweak rent growth, or by dramatic cuts to gather occupancy. This, coupled with number one above means that we may never see what actually happens between the potential resident and the owner.
- Rentals are much more sensitive to finishing touches than demographic details
This is a little more subtle, and actually involves a lot more than just the house itself. Large-scale operators of rental homes typically have a variety of additional resources available to them that mom-and-pops who are pricing within the market do not. There aren’t many mom-and-pops with dedicated leasing teams, that can offer robust maintenance that’s available 24/7. Furthermore, from my experience, I’ve noticed that institutional investors in the SFR space tend to give their homes higher-than-average finishes, with granite countertops and high-quality durable LVP flooring throughout the home. On top of all of this, renting is much less of a commitment than owning, and renters expect a potential home to be turnkey, whereas owners may look for something that they may customize to their own liking. All of these combine to allow well-established investors with high-touch offerings the ability to command a premium over the “average”.
- It Only Takes One
I apologize for what I’m about to do, but I’m going to bring back some charts you haven’t seen since High School Economics. But the basic supply and demand chart we all know and love looks something like this:
There are a few problems here. First off, that’s for a robust system, that is to say the price for milk from all providers, and large-scale demand. The second issue is that in the real world, price is offered by the supplier. This is all further complicated by the fact that any one individual house is not a commodity, it’s a much more personal experience for the potential renter. The outside availability of replacement goods and substitute goods affects the decision, but also people are known for falling in love with their abode and making decisions at a level beyond academic-economics-rationality. So assuming every house itself is a one-of-its-kind offer (which we know it isn’t, but humor me), the supply line becomes vertical. This means that at any price below the maximum (shown as the green shaded area in the figure below), you should be able to find someone who is willing to lease the home.
Now, of course, there’s another dimension that we haven’t really discussed: time. Sure, you could spend a year waiting for someone who values your 3-bedroom, 2-bathroom, 1500 square-foot exurb house at $5000/month, but that’s impractical. So, we would need to find an equilibrium point where we believe we will have enough exposure to attract potential residents, but circling back to point three above, a dedicated leasing team will help you build a bigger prospect pool than someone advertising only on Craigslist. If your homes have self-show, the barriers to becoming a resident are even lower. This, on top of the other amenities offered by a larger scale investor, means that “Market Average” is most likely underselling a product for a professional institution.
So, what does it all mean?
It means that the goal of an organization shouldn’t be to simply determine what the “CMA” (Comparative Market Analysis) is, but strategies need to be designed to capitalize on the differentiation that your organization offers potential residents. One easy way to do this is with Forest Revenue’s flagship product: Forest. Forest allows you to customize strategies based on any grouping you wish to imagine, whether it’s based on geographic attributes (ZIP codes, submarkets, markets, regions) or housing attributes (e.g. “All 2 bedroom homes should maintain a 3% premium over the market”). With Forest, you can manage your portfolio as simple or as complex as you need to.
Wrapping it all up
To be clear, we’re still big fans of the comp, but part of revenue management is understanding the market dynamics and how your asset fits within that. The comp gives us signals of directionality of price (I know that if all the houses in the neighborhood are going between $2000-$2200, I can’t be charging $3500 a month, most likely), but the sociological piece of renting a house cannot be discounted. With the capabilities that a full-service SFR operator has, there are plenty of opportunities to capture additional revenue when we look at the current best practice of using comps.