Several law firms in Seattle are vying for control of a couple of antitrust lawsuits against property management software company RealPage and some large multifamily property owners that use its revenue management software, YieldStar. The lawsuits are brought by two groups: students living in off-campus housing and renters of multifamily residences, who were allegedly forced to overpay for apartments. Some politicians have also written to the Department of Justice and the Federal Trade Commission to investigate RealPage’s software, suspecting it of helping owners collude to fix prices. As easy as it may be for laymen to conclude that software is the culprit for our housing affordability crisis, there is more to the widespread use of pricing tools than meets the eye. And as much as it might go against the current narrative that these software tools are just padding the pockets of large landlords, they are more beneficial to the average renter than one might think.
The whole thing began after an article by ProPublica last year alleged that YieldStar’s algorithm was hurting competition in the rental market. RealPage executives were discussing their software’s ability to help landlords find the best price point for their assets. ProPublica’s authors grabbed onto that exchange as a sort of “gotcha” moment in an effort to push a narrative about price fixing in the multifamily industry. There have also been allegations made concerning so-called “cartel” behavior, a term which has been employed to instill a sense of dread in the minds of the public. But legalese and journalistic etiquette aside, modern revenue management software is a critical tool for nearly every industry and based on that article and these lawsuits, its usefulness is clearly misunderstood by some.
An old industry at a modern crossroads
Revenue management software has its roots in the airline industry, where it was first developed in the 1970s and 1980s. The early days of revenue management involved manual calculations and heuristics, with airline staff adjusting prices based on demand and inventory levels. However, as air travel became more popular and complex, a more sophisticated approach was needed. In the early 1980s, American Airlines became the first airline to develop a computerized revenue management system, known as the Dynamic Inventory Allocation System (DIAS). DIAS was based on a mathematical algorithm that optimized the allocation of seats across different fare classes based on demand and inventory levels. This system was highly successful, and other airlines soon followed suit.
By the 1990s, revenue management software began to expand beyond the airline industry into other sectors. Today the software has become very sophisticated, using advanced algorithms and machine learning to analyze large amounts of data and make accurate predictions about demand and pricing for just about everything. In the hotel industry, it’s used to optimize room rates based on occupancy levels and market demand. In the rental car industry, it’s used to manage fleet inventory and pricing. In sports and entertainment it helps set ticket prices. Amazon uses it to set dynamic pricing with secretive supply and demand algorithms. And in real estate, multifamily apartment owners now use it to figure out what to charge for rent based on market conditions.
Before revenue management software became widely available, multifamily housing investors relied on manual market research, fragmented historical data, and their intuition. Even the largest owners and investors had to depend heavily on brokers to help them understand local markets, including supply and demand, rental rates, vacancy rates, and other economic indicators. Many smaller landlords continue to operate this way using spreadsheets and even physical ledgers, but like a lot of other industries and processes, what used to require laborious effort has now become more automated.
While smaller landlords may be able to juggle data without the help of sophisticated software, the multifamily industry is becoming increasingly consolidated with some owners operating tens of thousands of units. Manual methods don’t scale easily and are limited by the amount of data available and the complexity of the analysis. With revenue management software, multifamily housing owners now have access to the same types of powerful tools that have transformed other industries. The software can help them quickly analyze vast amounts of data across their portfolio and make more accurate predictions about the future.
If someone read that aforementioned ProPublica article, they might think that all the software does is figure out reasons to hike up the rent. But that’s just not the case. In fact, rents have declined nationally four of the last five months according to Rent.com. The website’s most recent report cites increased vacancy rates, new inventory, and a cooling housing market as factors for slow or declining rent growth. As a practice, revenue management offers a holistic approach that takes into account these same factors, among others. Property managers use it to help optimize occupancy rates, manage lease expirations and renewals, schedule maintenance, cut costs, and execute marketing strategies. All of these things help increase revenue and improve profitability while keeping tenants happy and satisfied.
A roadmap for successful multifamily projects
When it comes to multifamily buildings, revenue and profitability are the main driving forces. After all, these buildings are investments that must meet financial benchmarks, outlined in a pro forma, to satisfy their lenders. A pro forma is a financial model prepared by a developer or commercial property owner that estimates potential revenue, expenses, and profitability for a real estate project. It takes into account everything from construction and financing costs to operating expenses and expected rental income. Revenue management software can give multifamily developers and owners a more complete view of their property’s earnings potential. This is critical for making informed decisions about the investment for both for the investor and the lender. Intuition and gut feelings just don’t cut it anymore. You can’t invest in something or sign off on a budget just because it feels right.
To peel the onion back even further, a multifamily owner’s budget starts with “top line” results, which include projected rental income. This information is typically organized on a rent roll, where each unit has its own line item that includes details like its unit number, square footage, bed and bath count, and total rent. When it comes to new developments, this information is compared against a local market analysis to make sure the numbers are reasonable. But for existing or stabilized apartment buildings, the numbers are what they are.
Once the rental income is established, the next major consideration is the stabilized operating budget. This budget includes projected rents and vacancy assumptions at the top, followed by projected operating expenses like management fees, maintenance costs, utilities, insurance, and property taxes. There are high fixed costs in multifamily real estate and owners must cover those expenses no matter how lean they try to operate. Similar to an airplane or a hotel, apartment units when looked at in monthly increments are a perishable commodity. The losses from empty or underpriced units can never be recouped while the fixed costs apply regardless. Subtracting operating expenses from rental income gives us the net operating income (NOI), which is the key takeaway from the operating budget.
Ryan Freedman is a General Partner of Alpaca, a venture capital firm specializing in real estate technology. Prior to Alpaca, Ryan built Corigin, a New York-based private real estate investment firm that develops, owns and operates student housing, multifamily, and condominiums. He told me that you can think of revenue management as supply and demand management. “At one price your building will be 100 percent occupied and at another price it will be 80 percent. Revenue management software simply helps owners make decisions based on their own risk tolerances of how they want to run their business,” he said. Freedman went on to explain how different multifamily owners have different views, capital partners, and debt stacks and will use these software tools in different ways to maximize their business plan. “Some owners with a new building may want to lease it up very quickly and charge less, others may want to optimize for yield management over a twelve-month period,” he added.
Revenue management software makes all of these calculations more accurate through automation. The additional revenue can even lead to innovation, in both the creation of more desirable apartments and new amenities as well as streamlining operating processes. Every department within a multifamily property organization can reap the benefits of this type of software from maintenance, to leasing, to day-to-day management. A culture of data driven operations spills over to other aspects of the business, which makes the overall company more efficient, driving down costs for owners and renters and increasing tenant satisfaction and owner profitability.
Because of revenue management software, today’s renters have options available to them that didn’t widely exist in the past. For example, it used to be that renters were usually only offered a 12-month lease with limited information about pricing. Now landlords can show renters a range of move-in dates and flexible lease terms, which helps them find a pricing option to suit their needs. The use of revenue management software can also help prevent unfair rent negotiations and bidding wars that sometimes happen with manual pricing. This means there is less chance of breaking fair housing rules and discriminating against certain renters. And as for those “cartel” allegations, when multifamily owners are equipped with better tools to analyze their own historical data, they become less reliant on the old method of just looking at competitor’s comps, which is its own form of collusion.
The developers of multifamily property and the software companies supporting them are on the front lines of the housing affordability crisis. And these organizations are some of the very few actually doing anything about it—building more housing and figuring how to optimize its operation. As easy as it is to be appalled that landlords are making more money off of their tenants, it is important to remember that those profits are what drive more investment in housing development. The real barriers to more affordable housing are cities and states with strict zoning regulations that hinder the development of more housing.
The road to affordability must be paved
According to a recent study commissioned by the National Multifamily Housing Council (NMHC) and the National Apartment Association (NAA), the U.S. faces a pressing need to build 4.3 million new apartments by 2035. That figure includes an existing 600,000 apartment home deficit because of under-building due in large part to the 2008 financial crisis. Texas, Florida and California account for 40% of expected future demand and will require 1.5 million new apartments by 2035. “The U.S. has undergone tremendously difficult conditions that have fundamentally altered our nation’s demographics, but one thing remains certain—there is a need and demand for more rental housing,” said NAA President and CEO Bob Pinnegar. “Put simply, we do not have enough housing. The U.S. must build 3.7 million new apartments just to meet future demand, on top of a 600,000 unit deficit and loss of 4.7 million affordable apartment homes. It is time to reverse course after decades of under-building.”
For their part, Florida and Texas are expected to help ease the housing shortage with hundreds of thousands of units under construction right now. According to CBRE, the multifamily housing market is expected to experience short-term relief in some places but not others. This is likely to result in a peak vacancy rate of 5.2% by the end of 2023, slightly exceeding the long-term average of 5.0%. However, the most expensive rental markets are not expected to see significant improvement. CBRE forecasts rent growth of 3.5% for the year, which is down from previous years but still healthy compared to the long-term average.
In California, little progress has been made on housing inventory due to notoriously burdensome regulatory hurdles. To address this issue, some California lawmakers have introduced several new housing bills, including AB 2011 and SB 6, which aim to incentivize the construction of affordable and market-rate housing in abandoned and underused commercial corridors near city centers, job centers, and transit networks. If successful, these bills have the potential to help drive the construction of millions of new affordable housing options for low- and middle-income renters and owners of idle commercial sites across California.
So while all of this spilled ink and litigation about revenue management software may help bring some transparency into multifamily pricing processes, it’s unlikely to result in more housing, the root cause of the problem. To address it we need to assign blame where it is most deserved. Regulators, politicians, activists, and communities of single-family home owners (NIMBYs) have made it extremely difficult to build enough affordable housing, especially in the markets that need it most. This not only causes rents to go up but it also makes it harder for property companies to stay competitive and profitable in such a challenging environment. Housing costs are outpacing income growth and we’re all worse off for it, but trying to punish software companies and multifamily owners is a distraction. The real solution is to continue encouraging multifamily innovation while holding cities and communities accountable for escalating rents driven by a shortage of housing supply.
