Ever been seated on a plane and curiosity got the best of you? Curiosity to the point where you couldn’t resist asking your neighbor how much they paid for their airline ticket? Sure you have. The answer you received either pleased you (he/she paid twice as much as you did), or infuriated you (he/she paid one-half the price you did).
How is it possible that two passengers travelling to the same destination (from the same departure point) would be paying two entirely different ticket prices?
No, those ticket prices weren’t randomly plucked out of the sky. They were carefully calculated using a century-old mathematical system called algorithms. An algorithm, simply stated, is a procedure or formula used for solving a problem. In this case, the problem of arriving at a profit whether a plane is flying full or half full.
When it comes to solving problems that relate to bottom line (net profit) numbers, it stands to reason that perhaps something more sophisticated than an abacus would be necessary.
Enter Revenue Management Systems.
Keeping track of your flocks and your money
Though the Babylonians and Egyptians effectively used tally marks to keep track of their flocks, their sacks of grain and their money, clearly, this same method of keeping track of tenants, passengers and revenue would not be useful in today’s economy.
Which partly explains how airlines calculate those same flight seats differently.
Some history. After deregulation in 1978, airlines could fly where they wanted, when they wanted, and could price tickets how they wanted. Accordingly, they quickly figured out they needed to optimize the amount they charged by taking into consideration a sizeable number of factors.
In the 1980’s, a revenue management system (at the time called yield management) was pioneered by American Airlines former CEO Robert Crandall which focused primarily on maximizing revenue through analytics-based inventory control. Essentially, the system writes complicated code that figures out what a particular seat needs to be priced at in order to sell in order to calculate profits more accurately.
To tackle the issues of perishable inventory, customers booking in advance, lower cost competition and wide swings with regard to balancing supply and demand they asked themselves a string of pertinent questions. Are the flights operating during peak or holiday seasons? Would it be smarter to fill up seats for long haul itineraries; Dallas to London vs. Austin to Dallas for example? Will large cargo hauls be more profitable than filling seats (as more empty seats mean more weight capacity for cargo)? Does time of booking impact profit margins? Is the flight totally booked? … and so on.
Over the next couple of years, American Airlines early adoption of a yield management system proved fruitful, as revenue increased and its profits soared nearly 50%!!!
The yield management system used in the airline industry quickly caught on like wildfire as other industries took note and implemented similar systems bringing with them unbelievable tales of record breaking profits. By the mid-1990s, hotel chain Marriott International invested in a revenue management system which was wildly effective, adding between $150 million and $200 million annual revenue according to online reports.
In short, those industries that implemented demand management and forecasting as well as rent setting strategies were seeing unbelievable gains.
If it’s no secret that businesses across the globe, particularly airlines and hospitality industries, have realized rapid gains by investing in revenue management software systems, why are only 20 percent of those in the multi-tenant building industry utilizing such tactics?
Produce Output from Input
Like airline passengers, some apartment dwellers may be surprised to find that they are paying more for the same size apartment unit as someone who may have signed a lease just days or weeks before. This is due to some apartment owners becoming software savvy; utilizing the same software and algorithms airlines have employed over the last few years. Similar to airline operators, apartment operators can buy wherever they want, whenever they want, and charge however much they want. Accordingly, prices may change daily, creating wide variation in rents paid for the same size unit.
Airlines knew they could fill up every seat, on every flight, with lower-priced tickets. But this strategy is not necessarily a profit generating model. Whether it comes to “filling seats” or “filling apartment units” the same holds true – price your apartments or flights at rock bottom rates and it stands to reason you will increase renters and/or passengers.
But this does not automatically mean you will be increasing profits.
Although many in the apartment industry have known that having a 100% filled complex is not essentially the best profit spawning scenario, many owner/operators fail to utilize revenue management systems.
From Complexity to Simplicity
In recent years, a few players have arrived on the scene and simplified the process of taking complicated data and streamlining it to help maximize profits. In order to figure out supply and demand economics and pricing elasticity, one does not need to be a rocket scientist. One simply needs to implement smart systems that will do the math for you.
LRO Rainmaker is one such company. With a customer base of over one million units in North America, LRO Rainmaker claims that in every case, owner/operators who have used their technology, “positive results have been realized, from as early on as day one.” This is not hard to swallow given the aforementioned statistics on American Airlines and Marriott hotels gains.
LRO Rainmaker website issues this notice to their prospects/customers: “Positive results have been realized – many times far more significant than expected. LRO maximizes revenue from day one – balancing between rents, occupancy, and turn-costs while considering market conditions.”
While yield management is a preferred method of pricing in the airline and hotel industries, the apartment industry has some catching up to do. Still relying on manual methods to set rent prices, they fail to take advantage of these complex revenue producing methods.
Another player in the revenue management field is a company called Realpages Yieldstar. With a 98% customer satisfaction rate (according to their website) Realpages Yieldstar will “outperform your market 3 to 7 percent.”
“From property investors and owners to management companies, our customers can access lease-transaction data from over 4 million rental units across the country – thanks to the multifamily industry’s largest database. Whether it’s lease-up, long-term hold, renovation, and disposition, customers can benchmark their revenue performance to market for every phase of a property’s life cycle. Optimization has never been this easy.”
Patterned after the technology used to price airline tickets and hotel rooms, the software weighs competitors’ rental rates, market conditions, seasonal trends and hundreds of other variables to recommend the highest feasible rent for each apartment at a given time.
The technology is a win-win for both owners and residents as residents are often able to lock in lower monthly rents by agreeing to lease terms that help apartment owners avoid downtime or help them fill less desirable units.
Rent Revenue Takes Off
On average, operators using these systems collect an additional 1-3% more in rents than if the apartment manager set rates themselves. In addition, the rent rates can be 3-7% over what market rents are for the area. What does this amount mean in terms of profits and values in apartment complexes?
Here’s some eye-opening math: If an apartment complex has a net operating income (NOI) of $500,000 and increases NOI by 3% ($15,000) this would mean an increase in market value of $230,770, at a 6.5% capitalization rate.
Generally the software works for complexes that are 50 units and larger. Most software companies have a setup fee that can run from $2,000 to $2,500 and then a monthly charge per unit. The ideal situation for all operators, would be if everyone was using an optimization system to set rates, as the saying goes, “A rising tide lifts all boats”.
For now you have some operators that are beating out their competitors – in both raising rents and lowering rents – to keep vacancies under control when the market turns down or new capacity comes online. Revenue management software can generate options for renters by varying rental rates, start dates and numbers of months on the lease and still hit a landlord’s revenue target.
Interestingly enough, only 20% of apartment operators are using rent optimization tools. The days of self-performing market surveys, by calling and visiting competing properties, may be coming to end as it’s clear it is not the most efficient way to get accurate market values for rents.
If increasing bottom line profits is useful for your business, it would be prudent to say good-bye to outdated methods of performance and invest in a revenue management system.
After all, why would you not want to sell the right product to the right customer at the right time for the right price?