For years, real estate companies have been using technology to help them maximize the revenue of their properties. Many multifamily landlords use software created by property management software firms RealPage and Yardi called YieldStar and RENTmaximizer. Both software products use extensive shared rental data to suggest the highest rent price that a residential unit could get in the local market. It quickly became an easy way for any property firm to price their units.
It’s easy to see why this would catch on. Pricing a rental is incredibly important, especially because a small increase in rental prices can add up to a huge boost in a multifamily property’s valuation. Little did landlords know that using such a tool would lead them, alongside RealPage and Yardi, to be the subject of a class action lawsuit around the country. As of last week, RealPage has even had a complaint filed against them by the Attorney General of Washington, DC. The lawsuits claim that enough landlords were using this software that it artificially increased rental rates for entire neighborhoods. They argue that allowing competitors to agree, even unwittingly, to higher prices was, in effect, creating a cartel.
There are a lot of opinions about the validity of these lawsuits; however, one thing is clear: the potential participation by the Department of Justice in at least one of the cases may suggest the validity of claims. According to a Notice of Potential Participation filed on October 12, the United States notified the court that the DOJ is considering filing a Statement of Interest in the case by November 15, 2023.
Under the Notice, the Department of Justice defined the United States’ particular interest in the case, stating that:
“The United States enforces the federal antitrust laws and has a strong interest in their correct application. The government has a particularly substantial interest in addressing the proper application of Section 1 of the Sherman Act to the use of algorithms by competitors to help set pricing. Companies’ use of algorithms in price setting, often in an effort to increase pricing, has become more prevalent in the modern economy. As a result, the issues involved in this case are of increasing significance to the application of antitrust law across the economy.”
In response to the potential legal risks under the Sherman Act, with fines of $100 million per offense for corporations, some landlords are taking significant steps to mitigate their exposure.
According to reports, multifamily REITs such as Essex Property Trust and Equity Estates have been cutting back on their RealPage use ahead of the lawsuits. Equity CEO Mark Parrel even said in an earnings announcement that it was increasing its legal reserves to prepare for the legal battle.
Defendants claim, amongst other things, that they did not control enough of the market share to be able to influence the entire housing stock. But the plaintiffs point to the disproportionate rent increase in markets where YeildStar was used as proof that it “colluded to coordinate pricing.”
The trials are still to come, so we still don’t know if a court will uphold these claims; however, even if the defendants are able to win the case, they already likely wished they had never relied on a software design that shares competitors’ non-public data. The way that these algorithms use private information can be compared to a “guy named Bob.” As Maureen Ohlhausen, former Chairperson of the Federal Trade Commission, explained: “Is it ok for a guy named Bob to collect confidential price strategy information from all the participants in a market, and then tell everybody how they should price? If it isn’t ok for a guy named Bob to do it, then it probably isn’t ok for an algorithm to do it either.”
Besides the threat of litigations, revenue-only optimization might not even be the best approach to pricing rental units. Optimizing for revenue only means focusing on price in a vacuum, not factoring in the other components that are really a function of price—costs, for example. A higher-priced unit might generate more revenue, but if it causes the unit to sit vacant for longer or makes it harder to retain tenants, it could actually be detrimental to the bottom line.
This scenario might actually occur when two Class A apartments are competing for the same tenant. Suppose one building provides luxury amenities like concierge services. In that case, it may gain market share over its competitor simply because the cost of those amenities is not reflected in the algorithm’s price. Despite what the algorithm says, it would be wise for the building with the extra cost of the amenities to charge more to retain its margins and for the building without the extra services to charge less to be competitive.
A higher-priced unit might generate more revenue, but if it causes the unit to sit vacant for longer or makes it harder to retain tenants, it could actually be detrimental to the bottom line. This is where revenue-only pricing might actually be a significant factor in the reason the turnover ratio in apartments is so high. It could be that if a building was priced competitively, inclusive of operating costs, profits could have increased because not only does it outperform its competition on operations but also on pricing and turnover.
This brings up an interesting and more robust approach that has already been researched by academics for the pricing models of hotel profit management. In a study titled “Total Hotel Revenue Management: A Strategic Profit Perspective,” published by a research team at Cornell University, firms are expanding away from traditional revenue management to focus on customer value and strategic profit management. Researchers interviewed industry leaders and solution providers and found “the importance of profit, rather than just revenue, given rising distribution and variable costs.”
“You have to take into consideration all of the components that build to higher rents to find rental prices where marginal revenue equals marginal costs,” said John Cona, founder of profit management software F9Analytics. “Higher prices can boost revenue to a point, but if you have to provide extra services to get that higher rent and you don’t account for it, it may end up being a less profitable decision in the long run.”