Loss to lease is the difference between a unit’s actual lease rate and its market rental rate. While loss to lease is a basic calculation, it’s an important consideration when comparing investment opportunities. Likewise, real estate investors can use loss to lease to evaluate the performance of their current properties and determine where rate increases are appropriate.
What Is Loss to Lease?
Loss to lease is the difference between the market rental rate of a unit and the most recent rent charged for that unit. If the actual rental rate for a unit is lower than its market value, there is a loss to lease. If, on the other hand, the actual rental amount is higher than the market value, there is a gain to lease.
Loss to Lease Meaning
Real estate investors don’t experience loss to lease as an actual loss that the investor must repay. Instead, it represents a real estate investor’s actual or potential lost revenue on a per unit basis. For that reason, the metric can have implications for investors who are considering the purchase of a rental unit and those who already own the units in question.
Investors can use a loss to lease calculation when shopping for real estate to evaluate current and potential lease rates. Units with below-market rents can signal a strong local rental market that is growing faster than actual local rents have increased. It can also signal that a multifamily property suffers from poor management or a lack of amenities that prevent it from being leased at or above market value.
In either case, loss to lease may present an opportunity for new ownership to increase rents. Depending on the circumstances, though, it can be difficult to increase rents by a large amount over a short period of time. So, keep this in mind when using loss to lease as a way to compare opportunities.
Investors who already own rental units can calculate loss to lease to gain insight into how their units and amenities compare to others in the neighborhood. The metric can also point to poor property management if rents are not in line with the local market. Either way, loss to lease may mean the rental units have unrealized profit potential.
Loss to Lease vs. Concessions
In contrast to loss to lease, concessions are incentives property managers give tenants to entice them to rent their properties. For example, a landlord may offer a free month of rent, a reduction of the security deposit or move-in fee, or discounted amenities. Concessions are a common cause of loss to lease because they reduce the overall rent paid by a tenant, thereby pushing the lease rate below market value.
Loss to Lease Calculation: How to Calculate Loss to Lease
Follow these steps to calculate loss to lease:
- Subtract the actual rent amount from the market rental value of the unit.
- If there are multiple units in a complex, perform this calculation and then multiply the loss to lease by the number of rentable units.
- Where individual unit rental amounts vary, consider averaging them to determine the loss to lease for each unit.
The loss to lease formula is as follows:
Market Rental Value – Actual Rental Amount = Loss to Lease
Loss to Lease Example
Consider a duplex where each unit has a market rental value of $1,500 per month, and each of the two units is rented for $1,200 per month. In this case, the loss to lease equals $300 per unit, per month—or $600 per month for the entire property.
$1,500 per unit, per month – $1,200 per unit, per month = $300 per unit, per month
$300 per unit x 2 units = $600 total loss to lease
The calculation is similar for a larger apartment complex with 20 units. If each unit has a current market value of $1,000 and an average rental amount of $900, the loss to lease is $100 per unit—or $2,000 for the entire complex.
$1,000 per unit, per month – $900 per unit, per month = $100 per unit, per month
$100 per unit x 20 units = $2,000 total loss to lease
In both cases, there may be room to increase the rental amount. However, this may require some updates to the property’s condition or other upgrades to meet local market standards.
Frequently Asked Questions
Does loss to lease include vacancy?
Vacancy is not included in the calculation of loss to lease. Vacancy represents a period when the property is unoccupied and generating no revenue. Loss to lease reflects the difference between the lease rate a unit is valued at on the open market (market value) and the most recent actual rent for the same unit—regardless of whether the unit is currently leased.
What causes loss to lease?
Loss to lease may occur if a rental market has grown more quickly than rents can increase to keep up. In this case, a rent increase may be warranted at the end of the current lease term. Real estate investors also encounter loss to lease where a unit or multifamily complex has failed to keep pace with local amenities and other demands. This can result in lower than average rental amounts, and owners may need to make improvements before a rent hike is appropriate.
Does gross potential rent include loss to lease?
Gross potential rent does not include loss to lease. Instead, gross potential rent is the amount of rent a real estate investor can expect to make each month if all of their units are rented out at market value and all tenants make on-time payments.