Getting Sticky with Tenants

The venture world takes fearless moonshots, while real estate is more practical and risk-averse. But both fundamentally rely on customers, and real estate investors and landlords can learn from VC in this area.

The Cost of Customers

building is just a product — like an iPad or Amazon Prime — that requires customers to create profit. The prettiest building is worth little beyond the bricks if people don’t find it valuable. Apple and Amazon know their customers intimately, real estate landlords (with some exceptions) doesn’t know them at all. Two concepts — Customer Acquisition Costs (CAC) and Customer Lifetime Value (CLTV) — are prevalent in software and relevant in all businesses. These simple ideas of finding and keeping tenants don’t really exist in real estate, where most landlords assume that 50% of their tenants will leave in a given year. Imagine if Salesforce or Sears Facebook simply assumed that 50% of customers would leave each year and never return?

The Value of Keeping Them

The data suggests that it is true that one-half of renters change homes in a given year. Why? Some move to another city or buy a home. But many leave by choice, a failure of landlords to heed the wisdom that it is cheaper to keep an existing customer than to gain a new one. How much is this worth? Let’s assume that for a typical project, there are 300 units, rents are $2,000 and it costs $750 and one month of downtime to turn over a unit. At 50% annual renewal rate, these turnover costs are $412,000 per year. An increase of the renewal rate to 75% would cut these costs fall by half, to $206,000. An application of a 5% cap rate to these savings result in an increase in property value by $4 million. Is it possible to increase in renewal rates from 50% to 75%? We think so, and that it happens on four levels.

City

More than ever before, cities now need to compete — in a B2C way — for consumers. The migration of talent reflects directly on the assets and costs of each city.

Invest in cities that will have more people arriving than departing, which will create a tailwind. Renewal rates will likely be higher in Raleigh than in San Francisco in 2021 due to the differences in migration.

N’hood

Within cities, neighborhoods compete for people and amenities. In many cases, people get more attached to the neighborhood (people, coffee shops, lunch places) than to the property or the city.

Our research shows that there are objective rental premiums to be located near grocery stores and food halls. Other important neighborhood factors include access to most of daily needs, such as pharmacies and job centers. By investing around these (or adding them), we can create more stickiness.

Building

The building serves as a neighborhood within a neighborhood. The amenities and programming within a building are the “software”. a customer’s engagement in the building’s community is a predictor of renewal, because community creates stickiness.

Research shows not all amenities are equal: rooftop decks and dog parks create large rental premiums while others create none. By creating the amenities and the programming that people actually want (rather than what everybody else does), they will be more likely to stay.

Unit

Where people sleep, eat and work should be a space that they enjoy and don’t want to leave. The unit should be like their iPhone with amenities (fixtures, furniture, lighting, and technology of various sorts) the apps.

Understand why people are leaving and determine mitigants. If they need more space, units can be built more flexibly. Do they need more workspace? Solvable. Are they having children? Solvable. Like allowing people to put their own apps on their iPhone, customizable amenities create stickiness.

It is getting easier to move. Pre-furnished units, deposit assistance, technology and increased transparency into competitors are increasing the liquidity of mobility. This is bad news for lazy landlords and their 50% renewal assumptions, but good news for investors who can better understand what tenants actually want. The answer is not to force tenants to stay through longer leases or onerous breakage costs. Instead, the better solution is to use data to understand where people want to live, which amenities they actually value and deliver a better product, creating happy customers that don’t want to leave.