Understanding and Adjusting Loss-to-Lease Calculations in Archer

How to calculate and adjust the loss-to-lease within the underwriting model and how to transition from a percentage-based approach to a detailed calculation method that leverages rent roll and market rent data versus percentage based deductions

Step-by-Step Guide

1. Understanding the Loss-to-Lease Calculation

Loss-to-lease is the difference between current in-place rents and perceived market rents (i.e. Gross Potential Rent) at any given point in time. In a normal market with growing month-over-month rental rates, it is generally expected that Loss-to-Lease will be a negative value indicating that leases put in place in the past, which are at a fixed monthly rental amount for a defined duration, will fall below market rents as market rents continue to climb. In markets with declining rental rates, it is possible to experience a Gain-to-Lease where in-place rents exceed the market rent until such time that the lease is renewed or the existing tenant vacates the unit.
The Archer underwriting model follows industry standard calculations and contains two methods for calculating Loss-to-Lease:
- a Simplified Method that utilizes an approximated percentage for loss to lease in each period of the forecast, and
- a Detailed Method which calculate Loss-to-Lease in each period of the forecast by measuring expected in-place rents for all occupied units versus the perceived market rent for those same units
The Detailed Method is only available if the user has supplied a Rent Roll as part of the underwriting process.
The Archer underwriting model will default to using the Simplified Method, however, the user can manually toggle the model to use the detailed method for loss-to-lease calculations by changing the "Forecasting Method" in the "Advanced Rent Scheduling Assumptions" section of the Setup tab.
Please note that if a user has a Global Underwriting Assumptions Profile set up with Archer, and if this profile is utilized during underwriting, the user's inputs on that selected profile may overwrite the default values outlined below.

2. Understanding the Simplified Method for Calculating Loss-to-Lease

The Simplified Method for calculating Loss-to-Lease applies a fixed percentage of loss in each period multiplied by the Gross Potential Rent in that period. The key inputs in for this scenario are:
- Current Market Rents per Unit entered by the user or sourced from the Rent Roll that was uploaded by the user
- Current In-Place Rents per Unit for all occupied units
- Estimated Rent Growth which will govern the growth of market rents in each period of the forecast
- The Loss-to-Lease percentage to apply in each period of the forecast as a deduction (Loss-to-Lease) or addition (Gain-to-Lease) to Gross Potential Rent, with Gross Potential Rent calculated as the market rents for all units multiplied by the number of units assuming 100% occupancy.
The Simplified Method begins with the current in-place Loss-to-Lease as of Time 0 (i.e. the date of acquisition; T=0).
- If the user enters a Rent Roll as part of the underwriting process, this Loss-to-Lease will be sourced from the rent roll as the calculation of total in-place rents divided by the gross potential rents for the occupied units at the time of acquisition.
- If no rent roll is added to the underwrite, this T=0 Loss-to-Lease will be based on Archer's estimates for the property or for similar properties in the same market.
The Simplified Method then utilizes a target Loss-to-Lease of 2.5% by Year 2 as the approximate threshold where in-place rents, which are generally assumed to be based on 12 month leases, are continually slightly behind the market rent for each unit assuming monthly rental growth and fixed lease terms.
The model will then trend the current Loss-to-Lease from T=0 to 2.5% by year 2.
The percentage applied in each period (Year 1, Year 2, etc) will be applied evenly across all months in years 1-3, and annually thereafter.
The resulting Loss-to-Lease will be equal to the Gross Potential Rent in any given period multiplied by the Loss-to-Lease percentage in that same period resulting in the estimated dollar value of the loss.

3. Understanding the Detailed Method for Calculating Loss-to-Lease

The Detailed Method for calculating Loss-to-Lease in the Archer underwriting model begins with an Rent Roll and it incorporates the following variables to determine an estimated Loss-to-Lease for each period of the analysis:
- Current In-Place Rents and Lease Expiration Dates from the rent roll
- Current Market Rents and anticipated Market Rent Growth rates
- Anticipated average Renewal Rates
- A Renewal Rent Increase vs Market differential, which calculates the expected lease rental rate increase for tenants that decide to remain in their unit and renew their lease versus tenants that vacate their unit and the new assumed lease is written at market rental rates.
The Detailed method will forecast lease turnovers in each month of the upcoming Year 1, 2 and 3, and will utilize the anticipated average Renewal Rates to forecast which of those lease turnovers will be renewals versus new leases written with new tenants
The Detailed Method will calculate monthly Market Rent for each floor plan utilizing the starting Market Rents and the Market Rent Growth rates to calculate the Gross Potential Rent in each period of the analysis
Using the Lease Turnover schedule, the anticipated Renewal Rates, and the defined Renewal Rent Increase versus Market percentage, the model will then forecast an anticipated achieved rent for each month of the analysis. Each new lease is assumed to be a 12 month lease, with new tenants receiving the market rent per unit at the time of their lease start while renewed tenants receive the lessor of the market rent at the time of their renewal or the existing rent multiplied by the allowable Renewal Rent Increase vs Market differential.
- To explain this difference better, if an existing tenant is paying $1000 per month and the market rent for their equivalent floor plan is $1200 at the time of their lease end date, then the Market Rent Increase for this unit is $200. If we assume this tenant does not renew their lease, then the new tenant in this unit will be charged $1200 and the Loss-to-Lease on this unit will be $0. However, if we assume this tenant renews their lease, and if the Renewal Rent Increase versus Market is 50%, then the new lease rental rate upon renewal will be 50% of the market increase, or $100, resulting in a new lease rate of $1100 and a Loss-to-Lease at renewal of -$100. This calculation is repeated for every unit of the property to calculate the total Loss to Lease

4. When to use the Detailed Method versus the Simplified Method

In most cases, the Simplified method is sufficient for screening new deals, estimating rough valuations and approximating a delta between in-place rents and current market rents further out in the future.
It is better to use the Detailed Method when:
- You expect to see significantly swings in market rent either rising quickly or declining quickly;
- Calculating more granular renovation plans where turnover planning becomes more critical in early periods of the analysis;
- Modeling lease-up scenarios and newer development properties where the timing early-period occupancy rates significantly impact the near-term value of the property;
- The property has higher renewal rates and/or less aggressive property management where renewals tend to receive below-market renewal rates, and this isn't expected to change in the near-term.

5. Switching to the Detailed Calculation

Navigate to the Setup tab.
Locate the Advanced Rent Scheduling Assumptions section.
Locate the Gross Potential Rent and Loss-to-Lease sections
Set both toggles to Detailed to ensure floor plan configurations and rent growth rates are used for calculating the Loss to Lease instead of a simple percentage.

6. Key Considerations when Validating the Loss-to-Lease calculations

Confirm that the Market Rents column aligns with your expectations. Large discrepancies between current in-place rents and market rents can result in large loss-to-lease values at the start of your analysis. Therefore, it is important to validate that the market rent assumptions at the time of acquisition align with actual expectations to minimize artificially high loss-to-lease adjustments
When using the Detailed Method for calculating Loss-to-Lease, remember that high rates of market rent growth, coupled with high renewal rates and lower Renewal Rent Increases versus Market can result in a growing loss-to-lease percentage and dollar value as market rents can outpace the rent growth achieved during lease renewals. Therefore, make sure you review and adjust the combination of Market Rent Growth, Renewal Rate and Renewal Rent Increase vs Market to manage your anticipated Loss-to-Lease calculation.

Summary

By following the above steps, users can ensure that their loss-to-lease calculations reflect actual market dynamics, normalize over time, and integrate seamlessly with renovation plans and market rent growth assumptions. The Archer model is designed to be flexible, allowing for both manual adjustments and automated normalization to provide the most accurate underwriting results.

Conclusion

Loss-to-lease adjustments are critical for accurate deal underwriting. The Archer model offers two industry standard methods for calculating Loss-to-Lease, creating a robust system for managing these calculations through detailed inputs, automatic normalization, and manual overrides. If further adjustments are needed, users should consider leveraging the universal assumptions feature or reaching out for support when running new deals.