What Revenue Management is NOT

By Donald Davidoff

Note: The following are strictly the personal opinions of the author and do NOT represent any official opinion or position of Archstone or any other Archstone employees.

As revenue management is increasingly adopted by the industry, it’s interesting to see how various mythologies about what “revenue management is” have spread. Some are unintended, in that ideas form and get passed on from person to person without any real vetting and suddenly become “conventional wisdom.” Others have been carried out with intent, as vendors co-opt the term for marketing and sales purposes and multifamily housing operators co-opt the term to look like they’re doing something cutting edge. Both are actually avoiding the change necessary to implement a true revenue management system.

Here are three things revenue management is NOT:

Revenue Management is NOT just software and technology.

Instead, it’s a strategic program that happens to involve technology. Anyone viewing it as a technology project will be sorely disappointed. Revenue management is a way of thinking about the apartment business, and realizing that  a box is NOT a box is NOT a box. Rather, other important dimensions matter: when the box is rented, how long it is rented and whether it is renewed. Those aspects drive differences in value.

Revenue management fundamentally changes how you view your multifamily business. It will change not only how you price, but also how you budget, how you staff and what kind of reporting and business intelligence you need. And while it does affect your IT department and resources, that’s a necessary, albeit not sufficient, condition to succeed. Revenue management requires CEO or COO commitment – not  just involvement. A technology project, on the other hand, just needs money and a sponsor somewhere in the organization. Not sure of the difference between commitment and involvement? Just think about bacon and eggs: —while the chicken is involved, the pig is committed!

Revenue Management is NOT simply tracking and responding to your comps.

Knowledge of your comps’ pricing is important in setting rents, but it’s far from the most important piece of information for revenue management. Understanding your own value proposition, your own demand stream and your own supply behavior (e.g. what percentage of your leases will terminate early) are all more important, by a long shot. In fact, you can operate a good revenue management system with no comp data if you have to—we’ve done that at Archstone in places where it is very difficult to find reliable comps.

So while comp data can be useful — and a comp data tracking and response system is  better than nothing — it is NOT revenue management.

Revenue Management is NOT cheap.

It’s an alluring idea: maybe I can  get 70-80 percent of the benefit at a fraction of the cost. If you don’t really believe in RM, it sounds like an even better idea because, at least you’ll learn something along the way, right? Even if you ignore the fact that leaving 20-30 percent of your revenue lift on the table results in negative ROI, the simple fact is that the idea just isn’t true.

There is no such thing as a “poor man’s RM” because you can’t get most of the benefit with only simple tools. A good revenue management system involves sophisticated math that takes highly trained modelers (both RealPage and LRO have highly specialized staff for this very purpose) and programmers to develop the technology. That costs something. We all may want something for nothing, but it’s important to remember you get what you pay for. I know all multifamily companies need to be cost conscious, but I’m always surprised when an otherwise smart executive thinks  buying pricing software from a salesperson who emphasizes the low cost of their product is a good idea.

If you’re trying to maximize your own revenues, does it make sense to choose the option whose primary advantage is its low cost? A good system takes time, effort and money to develop. Just ask the two current software providers how many thousands of hours have gone into developing their systems. Execs in this industry, as in others, should be prepared to pay a fair price for them.

The author is Senior Vice President, Strategic Systems for Archstone.

Well, while not quite TMZ material, our very own Steve Lefkovits seems to have spurred quite a bit of discussion himself, at least among those who follow revenue management in the multifamily space.

It started on the Apartment Pricing Professionals page on LinkedIn when Steve asked a seemingly straight-forward question: “Are there revenue managers or pricing executives out there who factor in the cost of new leases when optimizing pricing?”

Steve explained that he had a recent discussion on revenue management and customer acquisition costs. He was wondering whether companies factor that into their systems when optimizing their rents.

“When we look at the expense of marketing to a new renter ($500 – 1000 or more) and the cost of turning a unit ($1500 – 2500) it seems like it’s worthwhile to factor in the relative value of new leases vs. renewal leases,” Steve explained to the group.

The post, as they say in Internet parlance, had traction.

Over the next week, Steve’s question spurred one of the most in-depth discussions of the inner workings and assumptions for using revenue management in the multifamily industry that we’ve seen.

It attracted some of the most respected names in the industry, including Archstone’s Donald Davidoff, AMLI’s Rich Hughes and SatisFacts’ Doug Miller. Finally, it spurred the genesis for not one but two panel sessions, one at the annual Apartment Internet Marketing Conference in Huntington Beach in May, and an in-depth discussion for the Apartment Revenue Management Conference this fall.

It’s no wonder. Steve’s underlying point harkens back to the value of renewals versus new leases in the apartment industry, a topic that perpetually garners attention among operators. If you’re interested in how revenue management works in multifamily, and some of the things operators need to consider when implementing the technology, make sure to check out this post. You’ll be glad you did.

Speaking of those conferences, have you booked your plans yet for AIM 2011? It’s just around the corner, set for May 2-4 at the Hyatt Regency Huntington Beach Resort and Spa. Last year, more than 400 of multifamily’s best and brightest attended this event, which is known for its insightful look at apartment world through the lens and perspectives of professionals from other industries.

And of course, the inaugural Apartment Revenue Management Conference is set for September 12-14.

Make sure to check out the LinkedIn discussion and then get your plans set to attend both.

The nuggets above came, respectively, from our interviews with Colonial’s Glenn Chmura, AMLI’s Rich Hughes, and the godfather of multifamily RevMan himself, Archstone’s Donald Davidoff.

Along the way, we’ve also heard about the dynamic and compelling corporate housing market from Oakwood’s Jeff Young – as well as how renting short-term units isn’t that much different from selling cruises, renting cars or even getting people to go to Disneyland. Lately, we heard about how UDR’s Mike Lacy transitioned from an acquisitions role at the REIT to help determine pricing for its 58,796 units.

Using this industry-wide knowledge base as a foundation, we wanted to open it up to you, noble MFR.com reader, to tell us what topics you’d like to hear more about when it comes to using RevMan in the apartment business. Is it RevMan’s potential to act as a valuation tool on the underwriting and M&A side? Is it mixing in risk-based rents and lease terms based on an applicants’ screening criteria? Or is it using RevMan to develop lifetime customers, much as UDR has started to do with its renewals engine?

Tell us what your thoughts are for the potential of RevMan in the multifamily industry. Is this technology here to stay, or will it have all the relevance of TheGlobe.com? What has surprised you – or even underwhelmed you – about using this technology to price apartments? What applications do you see for it down the road?

Of course, if you’re a revenue manager in the industry, we’d love to include you in the MFR.com interview, too, so let us know if you, or someone you know, would make for a good read. Send thoughts, comments and suggestions to joe@ameredit.com.

Finally, don’t forget to  mark your calendar for the inaugural Apartment Revenue Management Conference September 12-14, 2011 in Park City, Utah.  It’s an event you won’t want to miss.

As Group Vice President of Strategic Systems at Englewood, Colo.-based Archstone, Donald Davidoff is ultimately responsible for pricing the former REIT’s 65,049 units, spread among 191 communities in Washington, DC, New York, Boston, Northern California, Southern California, Atlanta, Florida, Texas, Phoenix and Colorado.

But he’s also recognized, rightly, as one of the godfathers of revenue management in the multifamily industry. Here, he shares his views on pricing, rising renewals and what metrics will mean the most in the future of the multifamily business.

Revenue Management Trends

MultifamilyRevenue.com: How do you view the current state of revenue management in multifamily today? What trends have you noticed lately?

Donald Davidoff, Group Vice President of Strategic Systems, Archstone: Revenue management has made a lot of progress over the past few years.  I just took part in a roundtable on revenue management at an NMHC conference and, by a show of hands, two-thirds of the people in the room said they use a system. Of course there are many people who weren’t there, so I’m sure the penetration isn’t quite that high. But that’s a long way from 2005 when you could count the number of companies on one hand.

The frustration I have is that the industry is still pretty unsophisticated in understanding how these tools really work. A few companies have brought in experienced RM people from outside the industry, but not many. Most people view “RM as RM” or get attracted by “pretty reports” instead of understanding the real business proposition behind the algorithms. I’ve got my own bias, of course, so I’ll just say factually that the various solutions out there take very different approaches to how they price. I wish more people spent time understanding that instead of just assuming “it’s all the same thing.”

MFR.com: How has revenue management changed the way your company does business?

Davidoff: Revenue management has been a catalyst for the fundamental strategic change of moving from a culture driven largely by a “gut feeling” to one based in data and analysis.  It’s facilitated a change in how we budget. It has reduced the workload for operations by a factor of 10, while increasing the accuracy of our revenue forecasts by a factor of 10 as well.  It’s changed our culture from one where the person with the highest title or loudest voice “wins” a discussion. Now, all stakeholders discuss and review the facts and truly collaborate to get to the best answer, with no one “losing.” It’s affected how we look at credit screening, how we analyze marketing and pretty much every piece of the demand side of our business.

Occupancy vs. Total Revenue

MFR.com: Traditionally, apartment operators have measured the health of a property by its occupancy. Given the impact of revenue management within the industry, and its emphasis on total revenue, how has evaluating a property’s metrics changed?

Davidoff: The industry is still addicted to occupancy, but that’s slowly changing.  At Archstone, over the years, we’ve been focusing on rent growth and have been willing to give up a few basis points of occupancy to get it. That creates long-term sustainable revenue growth. If we ever needed an occupancy boost, it’s easy to get. What’s important is that we’ve developed a culture that recognizes that steady rent growth is a better wealth creation strategy in the long term. And we see it in our numbers. We track 50  to 100 basis points lower on occupancy than our main competitors, yet we routinely beat them in overall revenue growth.

MFR.com: In more mature revenue management industries, such as gaming and hotels, total yield (or NOI) per square foot, has taken on much greater significance than occupancy itself. Will multifamily follow suit?

Davidoff: I don’t think so. The industry has seen that movie—it tried to make ancillary sales a “big” new revenue source in the late 1990s and early 2000s. The reality is that all the well-run companies get what they can from ancillary income and it amounts to a much smaller percentage of total revenue than a big hotel and even smaller compared to a gaming hotel. That’s not to say that total yield isn’t important—it’s just that when the vast majority of the yield comes from billed rent, the opportunity to significantly outperform on the non-rent revenue is limited.

MFR.com: Does revenue management have the potential to change the focus of keeping “the heads in the beds” to maximizing the cash profit of a property on a square-foot basis instead? Has it done so already?

Davidoff: Absolutely. It’s already done that for us and all the others who have embraced this strategy in the past few years. Occupancy still matters—it takes a lot of “plus 2 percents” to make up for a single “minus 100 percent.” But revenue management allows operators to balance the importance of occupancy with the importance of not leaving yield on the table. Nothing else can help an operator improve cash flow 3 to 5 percent the way revenue management has proven it does time and again.

Best Measures of Yield

MFR.com: The office/commercial sector tends to look at things in terms of their square footage. Why do you think we measure ourselves in terms of units owned or under management, instead of revenue per square foot? From a revenue management perspective, which is a more useful number?

Davidoff: My guess is that our legacy occupancy has always been by the unit, so that’s why we stick with that as the metric. Technically, square footage is probably a better metric for us, too. However, the variance in occupancy from small to large units isn’t enough for it to really matter, so unit-based metrics ought to be good enough. Frankly, I think we’ve got a lot bigger fish to fry in terms of revenue management in the multifamily industry before worrying about this.

MFR.com: What about NOI? How is this a helpful number? Are there any challenges when it comes to comparing NOI of two different properties within the same portfolio? How can the use of revenue management mitigate this challenge?

Davidoff: NOI is clearly an important operating metric, but it’s a bit dangerous to tie it directly to revenue management. RM has little to do with the expense side of things (you could argue it has some influence on turn costs, but that pales in comparison to payroll, property taxes, insurance, marketing, etc.). And it also doesn’t drive some elements of revenue (e.g. bad debt, most ancillary revenue, retail leases, etc.).

I believe executives should focus on billed rent when analyzing their RM systems against internal metrics. Since the public companies don’t report billed rent, you have to benchmark against revenue growth and take your lumps on the parts of that metric not controlled by RM.  Even then, it’s important to take a look at the reported occupancy and rent growth numbers, since revenue is a lagging indicator.

Growing  Adoption of Revenue Management

MFR.com: Let’s talk about adoption. Why do you think, historically, we’ve still seen relatively low penetration rates in multifamily, even though we’ve seen generally positive results?

Davidoff: Historically, that was the case. But we are starting to see a change. These days, most of the largest owner/managers have made a decision to use revenue management tools. Some small and mid-size companies have started considering it, too. Of course, that’s still the biggest area left to penetrate: smaller owner/operators and fee managers. One of the reasons for that trend on the fee management side is the fact that the RM benefit accrues to the owner, not the fee manager; meanwhile, fee managers can’t afford the expense unless they pass it on to the owner, and many are reluctant to have that conversation.  But we’re starting to see smart institutional owners require their fee managers to use a system. I think the smart fee managers, in turn, will start adopting revenue management systems as a point of competitive differentiation. When that happens, the adoption rate will kick into another gear.

Recessionary Performance

MFR.com: How has your solution performed in the current environment? What did you see on the way down, and what are you seeing now?

Davidoff: It has performed very well. We’re the only company that had an automated pricing system in place during the previous downturn, so we’ve now been through a full, long-term business cycle. A key discovery was how early LRO saw demand loosening. Econometricians will tell you that the recession started in Dec 2007, but most of us didn’t feel any pain until the late summer or fall of 2008. That’s because seasonality drove continued sequential results. But when we looked back at the LRO statistics, guess when we saw average demand start dropping? Right smack in Dec 2007. LRO suddenly started pricing less aggressively. If we were pricing manually, we would have thought things were perfectly fine, and likely would have gotten over our skis. The result would have been lower occupancy heading into the teeth of the recession, which would have hurt even more. LRO protected us, even though we didn’t fully realize at the time that it was doing so. Similarly, LRO recognized the dramatic shift in the demand-supply balance after bottoming out in April 2009. It drove us to be much more aggressive in our new rent pricing than we likely would have been coming out of such a terrible market.

Renewing Existing Renters Using Optimization

MFR.com: What are you seeing in terms of renewal rates using your revenue management tools today? Leases priced a year ago would have presumable been much lower. What’s the average renewal increase that your revenue management tools are recommending across your portfolio now?

Davidoff: We don’t disclose specific internal metrics, so I can’t go into hard numbers. I will say that I’ve learned over time that, when renewal rents are above new rents, we don’t have pricing power and vice versa.  Through the recession, renewal rents were at record spreads above new rents. That gap has disappeared. Renewals themselves are pretty tricky. On the one hand, you avoid turn costs when someone doesn’t move, which justifies a discount to market. On the other hand, residents avoid moving costs when they renew, which justifies a premium to market. So renewal pricing has a higher “art to science” ratio than new pricing — by far. The interesting thing is that every study we’ve seen in the industry clearly indicates that pricing has little to no correlation with renewals. The things that really drive renewals are tenure (people with less tenure are less likely to renew than those with more) and whether a resident has unresolved service requests.

My advice on renewals is that we should all have less teeth gnashing over the price, and focus more on what really matters. Fix the toilet quickly, and accept the fact that people in a transient stage in their life will eventually move, no matter what you do. Doing so will help you get on with your business.

MFR.com: At what point (or percentage increase) do you get push back from renewing residents? Will they renew at a 5 percent increase relatively willingly, but not at 8 percent, for example? Any insight you have here would be very helpful.

Davidoff: You always get pushback. I’ve never heard of a resident telling us that our renewal price is too low. The only time I’ve ever seen pricing really drive lower renewals is when, in a recovery, you price so much higher that people who took advantage of great deals and double-digit percentage drops now truly can’t afford the higher rents. You see that when increases are in the 12 to 14 percent or higher range. But you’ll be surprised by how many people still pay to not move. Accept the turnover from those who do, because you’ll get it back in the wealth creation from a better rent roll comprised of residents who can afford it.

MFR.com: If you do get push back, what are your options? What are the best practices you use to explain the market to residents, while remaining firm on the recommended price? How can you encourage them to renew, even at a higher price?

Davidoff: I think the best practices are openness, transparency and honesty. Share your own comp shops, and invite residents to shop themselves. Remind them of what they like about your community and the hassles and costs of moving. Our renewal pricing is consistent with market conditions, so it’s not likely they’ll find a similar product for less. If they need lower quality product to save money, then we have to accept that and make their move out as smooth and hassle-free as possible.

Now there is a special circumstance, which happens when the market shifts after we send the renewal letter.We have to send letters well in advance of when residents have to commit, which is very different than the new rent situation. So we can send a fair offer today that may not be fair 45 days from now if the market shifts down.

Career Arc

MFR.com: You’re widely viewed as the leading pioneer of RevMan in the apartment industry. How did you become a revenue management professional in multifamily?

Davidoff: My career went down what appeared to be a strange path at the time, but now feels like destiny. I studied engineering at MIT and then worked on missile systems in the Air Force. When I left that, I went to work in the retail travel industry—first managing my parents’ travel agency and then starting a company to provide consulting and marketing services to help other agencies run their businesses better. We sold that to Empress Travel in 1997, and I ran that franchise group until they sold to American Express in 1998.

Through a good friend who was an executive at Royal Caribbean Cruise Line, I networked into Talus Solutions, which was the premier pricing and revenue management software company. It then all made sense. The math and project management from my engineering days and the business process in the travel industry — where revenue management started – all came together. While there, I worked on package delivery pricing, hotel and hotel gaming pricing, a project for video rental pricing and a model for rental car systems.

Eventually, I was fortunate to land a spot as the lead consultant on the first study and simulation work with Archstone. That led to a system architecture study which eventually became the full-scale design and development of the Lease Rent OptionsTM (LRO) solution. I was proud to be named the project manager and lead consultant for that work. A few months after Manugistics bought Talus, I personally decided I wanted to work somewhere else. Rather serendipitously, Archstone was looking for a full-time pricing executive. The rest, as they say, is history.

MFR.com: Thank you.

Davidoff: Thanks for the opportunity.

The two multifamily revenue management mavens outlined how their respective solutions – the Rainmaker Group’s LRO and RealPage’s YieldStar Price Optimizer — behaved during the downturn, and what they saw in the first part of 2010 as markets began to recover.

Steiner Jovanovic said her clients were able to respond to falling demand with more moderate pricing adjustments and that YieldStar properties were able to sustain occupancy levels without the rent loss experienced by the general market. In general, she pegged her clients’ outperformance of the market at 3.2 percent nationally in terms of rent and occupancy.

While she didn’t detail the difference between YieldStar users and the market on the way down, she did give comparative numbers for the rising tide of 2010.

“If you compare our results in the first quarter of 2010 to the first quarter of 2009, [YieldStar] properties outperformed 3.7% in revenue, which was made up entirely of net effective rent,” Steiner Jovanovic said. “The markets are still catching up on occupancy, but because YieldStar properties were already in a more favorable occupancy position through the recession, they’re able to push price much more aggressively now.”

For Archstone’s Davidoff, perhaps the earliest adopter of revenue management technology in the multifamily industry, having his LRO pricing tool was the saving grace of an otherwise brutal two-year period.

“It’s fascinating to me,” Davidoff said. “I honestly don’t know how anyone could have made it through this past cycle without a revenue management tool.”

He said that LRO started reacting to the reduction in demand as far back as December 2007, even though seasonality was still giving many operators a false sense of strength, just as they approached the abyss in 2008. Then, the system started projecting strong demand at a time when much of the market was still in the doldrums – and scared into paralysis – when it came to pushing rents back up.

“We’ve had spectacular rent growth in the first quarter of this year, and our year-over-year numbers are up substantially,” Davidoff said. “It all started in the fourth quarter [of 2009], before operators could feel it, before there was that visceral understanding of what was going on in the market. But the statistics were bearing it out. The guest card counts were rising, the leasing velocities were more steady and solid, and supply wasn’t quite as brutal, and all of that played together.”

Speaking of raising rents, the two apartment execs also had an interesting perspective on the potential for “green” amenities to push rents in the coming cycle. Spurred by MFE’s moderator Chris Wood, who asked whether revenue management systems could generate “green” premiums in various markets, the two pricing pros were surprisingly optimistic.

“There are already premiums within specific portfolios being garnered by green buildings, I would say particularly within the Pacific Northwest,” Steiner Jovanovic said.  “With regards to YieldStar the results will be there…  any component that drives demand will be capitalized on by the system in the form of affecting rent growth.”

Davidoff, who said Archstone hasn’t explicitly discussed using LRO to get a “green” lift in rents at the company’s properties, pointed to the science of revenue management to say that if green buildings are valued more highly by prospects, they will, indeed, be priced accordingly.

“Where residents or prospects favor green buildings, and if we do our marketing job correctly in communicating those benefits, we will see demand rise, we will see our own internal supply drop and LRO will respond by raising rents,” Davidoff said. “The value of green, or any amenity or feature of a property, is ultimately going to be realized in the demand response.”

You can access the full exchange here.