Over the years I’ve found that the best way to explain to clients how their rental buildings rank compared to competitors is by using charts and diagrams. Once you, as a manager or investor see your building positioned on a chart, you will instantly understand where your building is positioned now and where it could be repositioned in the future. Similarly, once you as a developer see how existing rental buildings are positioned on a chart, you’ll be able to identify what rents and what level of quality you’ll need to ensure your proposed building is ideally positioned. In this post I’ll explain, using examples, how to rank purpose-built rental properties in a housing market and how to show these rankings in charts for maximum impact and understanding.
Before charting market position, you need to rank rental buildings using two data points: rents and quality. Rents are pretty straightforward and my definition is the current asking rents for each unit type for each building. Quality is harder to define and most of the time I think of it as a subjective opinion of “desirability,” but it could also take the form of an alphabetic or numeric ranking system. I’ll discuss these in more detail before explaining how to prepare ranking charts and how to interpret them.
Ranking rental buildings by rents is relatively straightforward and easy to do. Basically, you rank from highest to lowest asking rents. This is complicated by different types of units having different asking rents and whether or not utilities are included in asking rents.
Regarding different unit types, the only solution is to rank each unit type separately, since there are no advantages in combining asking rents for, say, 1 bed and 2 bed units, just to generate a single “rent” to make ranking easier (and there are a lot of disadvantages to doing this, so it should be avoided).
Regarding utilities, some asking rents include monthly electricity or other utilities costs, while other asking rents do not. The solution—and my preference—is to remove estimated monthly utilities costs from asking rents for buildings which include them in rents. In Ontario, the utility cost which is most often included or not included is electricity: for older buildings, which are typically less energy efficient, you can use an estimate of $100 per month, while for newer buildings you can use an estimate of $50 or maybe $75 per month.
Ranking rental building by quality or desirability is much more challenging than simply ranking asking rents. The problem is that everyone has a different opinion of what’s the best building in a market and what’s the worst, and where do all the other fit in between. To some extent, inconsistency in assessing quality or desirability can be reduced by touring dozens (even hundreds) of rental buildings: the more buildings you’ve toured the easier it is to assess the relative quality or desirability of a group of buildings. No matter how much experience you’ve got, it’s still a subjective assessment (and ranking).
Greater rigor can be introduced by ranking buildings based on a set of criteria which score each building based on amenities, features, units, and other factors and which generates an overall ranking mathematically. This approach has the virtues of consistency and repeatability, but setting up the criteria and scoring system in the first place requires a lot of experience and expertise or it could easily generate some weird rankings. Having used a score-based ranking system in my first years working in the industry, I know from first-hand experience that score-based ranking systems are fraught with pitfalls, and these days I tend to think it’s best to keep ranking systems as simple as possible. I think when it comes right down to it most people, if they pay attention when touring a group of rental buildings, will be able to come up with a quality/desirability ranking that can be relied upon and which most other observers would agree with.
The table below summarizes different methods which could be used to rank building quality or desirability.
|alphabetic||A, A-, B+, B, D, etc.||The advantage of using an alphabetic ranking system is that plenty of people are capable of grasping how to use it, especially those who have been in real estate for some time since this was the traditional way of rating buildings. This system also encourages buildings to be grouped into categories which can be applied to multiple housing markets. The disadvantage is that alphabetic rankings need to be converted to numbers for analysis and charting.|
|numeric||1, 2, 3, 4, etc.||The advantage of a numeric ranking system is that it clearly ranks buildings from best quality to worst quality and charting is easy. The disadvantages are that it doesn’t easily allow buildings to be grouped into categories which an alphabetic system does naturally, and by using numbers it implies a level of mathematical or statistical precision which it doesn’t necessarily possess.|
|casual||best, worst, second, third, etc.||This system is how a non-industry person would rank rental buildings when looking for a new place to live. It is too vague to be of much use to analysts, although it’s basically an ‘everyday language’ version of the numeric system.|
|score based||(various criteria with math-based scoring and ranking)||The advantages of a score-based ranking system is that it is consistent and repeatable and can be applied to rental buildings in almost any housing market. It can also be automated, theoretically, which would make it easy to generate market position charts and reports with little or no updates needed (since building quality/desirability doesn’t change often). The primary disadvantage—and it’s a big disadvantage, or rather a big barrier to entry—is that setting it up requires a lot of experience and expertise, plus a lot of testing, and thus is not easy to use or understand for most industry people, including many analysts. An additional disadvantage of score-based ranking systems is that they don’t really allow a subjective element to be incorporated.|
Which system do I prefer? Given what’s possible with score-based ranking systems, I think they’re the most desirable for ranking rental properties for the reasons summarized in the table above. However, I think the downsides of score-based ranking systems, especially their setup requirements, plus their potential to turn up weird rankings if setup isn’t done right, argue against their use. My personal preference is for alphabetic based ranking systems since they are intuitive to use and naturally group buildings into categories (those categories can be applied to multiple housing markets). But for ease of use, especially when it comes to preparing positioning charts, I recognize that numeric ranking systems are the best choice and easiest to understand.
Charting Market Position
How can rankings be shown in charts for? The easiest and simplest way to chart rankings is to use a bar chart with one bar for the quality ranking and additional bars for 1 bed and 2 bed rent rankings. This is the approach I’ve used to prepare the following hypothetical ranking charts.
The first chart (above left) shows hypothetical quality and rent rankings for five rental apartment buildings in a “perfect” market. What do I mean by a “perfect” market? This is a rental housing market in which the best quality buildings are achieving the highest rents, and the lowest quality buildings the lowest rents, with everything in between. This means the market is priced appropriately since all of the buildings in the market are priced according to their quality rankings.
The second chart (above right) shows hypothetical rankings in an “imperfect” market. This reflects reality more than the first chart since in no rental housing markets in Ontario are all buildings priced appropriately for their quality rankings. In this example, Sandy Apartments, the building with the highest quality ranking has the second-highest rent ranking for 1 bed units. This means 1 bed units in this building are under-priced and could, in theory, be increased so they rank highest in this market to reflect the building’s leading quality ranking. Two bed units in this building have the highest rents in the market, so they are appropriately priced. Similarly, 2 bed units in Pebble Apartments are under-priced and could be increased. However, 2 bed units in Shale Apartments are over-priced (third-highest rents) in comparison to the building’s quality ranking (second-highest). This is good news for the owners of Shale Apartments since it means their 2 bed units are over-performing.
These examples show how useful quality and rent rankings are for existing rental housing properties since their owners can see at a glance which units are under-performing and raise their rents. Owners can also see which buildings are performing better and use these competitor buildings as repositioning targets, while developers proposing new rental buildings can do the same.
There are other ways to chart quality and rent rankings which show more information with much great detail, making market positioning a more precise analysis tool, but those are beyond the scope of this post.