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Calculating loss to lease and effective gross income.

A Google search for Loss to Lease (LTL) will provide you with a basic understanding of this simple term. Correctly calculating the LTL number and applying it to a pro forma is another matter. Residential property managers are often asked to determine loss to lease as part of the property pro forma. This lets them know possible income that might be reclaimed from management and marketing efforts they are responsible for. Office and retail properties deal with LTL less often. This article will explore the process of calculating Loss to Lease.

In order to ultimately calculate Effective Gross Income, there are three specific items that must be analyzed beforehand. 1) Gross Potential Income, 2) Loss to Lease, 3) Vacancy and Collection loss.

GrOSS Potential Income (GPI) is the maximum amount of income a property would produce when 100 percent of the rental space or units are leased at the full market rental rate in any given market. It also includes miscellaneous income and expense reimbursements. In its strictest sense, GPI is a near fictional number. Actually receiving GPI would be nearly impossible because of ever-changing market conditions and lease contracts which remain stable when market rents change. Given this quandary, the concept of LTL developed.

LOSS to Lease (LTL) is the difference between the full market rent and the actual rent specified in a lease or rental contract. Simply put, if the full monthly market rent for an apartment unit was $800 and the lease contract for that unit specified the monthly rent to be $750, the monthly Loss to Lease would be $50. Having defined LTL, calculating it for your property is the next step. If calculated properly, LTL will have no impact on NOI or Cash Flow. It is merely an accounting function to bring the fiction of GPI into reality. When subtracting LTL from GPI, remember to only apply LTL from the space or units that are actually leased. If an apartment complex has 500 units, and 475 units were leased at $50 below the GPI, the monthly calculation for loss to lease would be 475 x $50 = $23,750.

It would be incorrect to apply the LTL to 500 units because LTL can only apply to units or space actually leased.

Vacancy/Collection Loss: Property can be physically vacant or suffer from economic vacancy. In other words, some tenants occupy space but fail to pay contractual rent. The combination of vacancy and collection loss is also subtracted from GPI to determine Net Rent Revenue. LTL would only be calculated on space or units that are actually leased. LTL calculations are not applied to physically vacant units or space.

To illustrate these concepts, consider a hypothetical apartment complex with 500 total units.

* Full market rent per unit is $800 per month

* There are 25 vacant units

* 475 units are leased at $750 per month

* 25 units are leased but tenants are not paying contractual rent

If calculated correctly, Loss to Lease entries will have no effect on Effective Gross Income collected on a property. Its only purpose is to identify the financial opportunity being missed when full market rents are not achieved on leased units or space.

Effective Rent is another topic that is often associated with Los to Lease. When concessions are applied to long-term leases, the concession may be discounted at a given discount rate to indicate the financial impact of the concession to the stated annual rental rate. Concessions for one-year leases are usually not discounted. Loss of income from concessions is usually not identified in the Loss to lease calculation.

CONCLUSION

In its simplest sense, Effective Gross Income on a property is actually the result of collected lease income, miscellaneous income and expense reimbursements (less vacancy and collection loss). Loss to Lease is a simple accounting method which identifies what opportunities for rental income that might have been missed. Once identified, a good property manager will work to achieve full market rents wherever possible. Correctly calculating Loss to Lease will not change the actual Effective Gross Income on a property.

500 units at the full market rent of $800 per month = $400,000 x 12 = $4,800,000 (GPI)

+ miscellaneous income and expense reimbursements

--475 units at LTL of $50 per month = $23,750 x 12 = $285,000 (LTL)

--25 units physical vacancy = 25 x 800 = $20,000 x 12 = $240,000

--25 units economic vacancy = 25 x 750 = $18,750 x 12 = $225,000

EFFECTIVE GROSS INCOME: $4,050,000

Simply re-stated: 475 units at $750 per month contractual rent = $356,250 x 12 = $4,275,000

+ miscellaneous income and expense reimbursements

--25 units at collection loss: $750 x 25 x 12=$225,000

EFFECTIVE GROSS INCOME: $4,050,000

ERIC STOREY, CPM, (ERIC. STOREY@ZIONSBANK.COM) IS VICE PRESIDENT OF PROPERTY MANAGEMENT AT ZION'S BANK IN SALT LAKE CITY.
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Comment:Calculating loss to lease and effective gross income.
Author:Storey, Eric
Publication:Journal of Property Management
Geographic Code:1USA
Date:Mar 1, 2015
Words:808
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