Landlords in the hypercompetitive Bay Area are offering incentives to prospective tenants to compete with other landlords and newer rental properties in the city, according to the San Francisco Chronicle.
These incentives include a variety of perks, such as:
- gift cards;
- one month rent-free occupancy;
- free parking;
- free utilities; and
- waived fees and security deposits.
Incentives are most common for new buildings attempting to bring in tenants to reach a stable occupancy rate — standard practice for new investment properties which need permanent mortgage financing to replace the construction loans.
Rent incentives are particularly popular throughout San Francisco neighborhoods, from SoMa to Mission Bay. Their popularity has also grown in several other Bay Area cities, including:
- San Jose;
- Santa Clara;
- San Mateo;
- Redwood City;
- San Ramon;
- Pleasanton;
- Tiburon; and
- Novato.
However, this phenomenon is not unique to new projects, nor is it necessarily for the benefit of prospective tenants. Rents are so universally expensive in the Bay Area that even landlords of existing, older buildings are now offering incentives just to stay in the pricing game.
These landlords often disguise rent incentives as “late fees” — which are rarely paid by tenants, since they are not late fees in the traditional sense.
For example, a landlord enters into a rental agreement with a tenant, establishing a monthly rent of $3,500. The landlord agrees to accept $3,000 as the monthly rent so long as the tenant pays by the first of the month. If not, a preset “late fee” of $500 is triggered. The tenant always pays on or before the first, reducing the monthly rent they actually experience to $3,000 — but the landlord has now established the stated rent as $3,500.
Unlike consumer mortgage lending, no law requires residential landlords to provide a grace period after the due date (usually the first day of the month) before receipt of the rent payment is then delinquent. If one did exist, this type of discount practice would disappear entirely.
Additionally, landlords may negotiate rent incentives in a form of graduated rent, which raises rent periodically on a schedule. Functioning similarly to an adjustable rate mortgage (ARM), monthly amounts start at a teaser discount figure to entice prospective tenants. However, by the end of the lease term, the rental amount may have increased beyond the market rate.
For example, a tenant with a three-year lease agreement for a rental property charging $1,100 monthly on the open market may pay rent of $1,000 for the first year, adjusted upward to $1,150 per month the second year, and $1,300 monthly for the third year of the lease.
However, older rental properties in San Francisco subject to a certificate of occupancy prior to June 13, 1979 are under rent control — which accounts for most rental properties in the Bay Area, given the decades of sluggish construction of much-needed new housing. Under the city’s current rent control restrictions, landlords may only increase rent by 1.6% annually through February 28, 2017.
“Older” buildings in this case more likely refer to those constructed within the last 30 years or so which aren’t as fresh as recently completed projects.
Ultimately, stiff competition among new rental properties in San Francisco pushes landlords to offer incentives with greater frequency, especially as the city’s housing inventory searches for equilibrium with insatiable demand. Landlords believe incentives elevate their properties to compete with newer construction at high prices, but are they really necessary in such an inventory-starved urban market where many residents are desperate to remain living near their workplaces?
Do rent incentives in the Bay Area actually work?
A month of free rent equals an 8.3% decrease in the average monthly rent during the first 12 months of occupancy, according to the Chronicle. So, what’s the benefit for landlords — aside from matching competitors’ ever higher rental rates?
Incentives allow landlords to periodically increase initial rents without receiving backlash from tenants. For example, a landlord increases rents by 9% to establish a higher monthly rent price but combines the increase with an incentive offer of one month free rent. For the second year of the lease, the stated monthly rent increases by a mere 5% on the monthly rate paid during 11 months in the first year.
This first year combination of increased rent and free rent produces the same annual income for the landlord as in the prior year. Importantly for the landlord, it is a less aggressive way to set what appears to be higher monthly rent amounts for the project rather than attempting to make a whopping 13% increase in the second year.
Incentives have always been part of real estate negotiations, and even go so far as to include strangely excessive amenities, like a new car — with the home purchase, of course.
Incentivizing tenants has become a trend, if not the rule, in the overpopulated and exorbitantly priced Bay Area. Widespread incentives reduce the attraction of an “exclusive” prize like six months of free parking. When a potential tenant can get incentives from any landlord, they ultimately choose where to live based on their preferences — not the $100 gift card to the local coffee shop. Thus, the effect of incentives is essentially neutralized by their popularity; the “special deal” loses its luster when it becomes ubiquitous and expected.
Work incentives to your advantage
Though incentives are less functional in competitive markets such as San Francisco — where a severe lack of supply means expensive rental units will likely become occupied regardless of incentives — they have potential to be the deciding factor for tenants on the fence in slower markets. Real estate agents, brokers or property managers may be able to sway a hesitant tenant by offering a customized incentive suited to the tenant’s individual needs.
For example, consider a prospective tenant who responds to a property manager’s listing of a rental unit. The tenant tours the apartment and observes it is located near a busy street and has a small parking lot for which they charge separately per car for parking. The tenant is aware of a neighboring apartment that is charging a similar rental rate. The tenant expresses to the property manager their desire for less expensive parking since they have two cars — like that available at the other complex nearby.
The property manager offers the tenant six months of free parking to ease the burden of parking costs and positively distinguish their apartment from the competition. The tenant considers the offer and agrees, electing to enter into a two-year lease agreement for the available unit. The manager in the negotiations thus reduces the frequency of turnover. [See RPI Form 550]
Agents or property managers faced with a similar situation need to consider which amenities they can offer as incentives to prospective tenants during the bargaining process — without breaking the bank. However, in a fast-paced and hyper-competitive market like San Francisco, there’s no greater incentive than lower rent. The vacuum of past failed construction will bring on lower rent as an incentive when accelerated construction eventually outruns demand once again.
