Investor · Passiveadvantage.com · Member since 2019 · 166 posts · 91 votes
Hello All,
Can someone help me understand a particular term, Bad debt. In addition, what is means to see increased "Bad Debt" at this time, both in general and in quantitative terms. If this value (Bad Debt) does change during COVID, what changes are most operators seeing in this category.
Secondarily, in relation to two other categories that may change in new deals in relation to COVID I would be curious as what these assumptions or numbers were pre and post in relation:
1. Bad Debt: as discussed above how would you define this and how do you anticipate this changing pre and post-COVID.
2. Concessions: I am guessing these will go up to keep current renters in place but the question is how much from a quantitative standpoint are people figuring into the new assumptions/underwriting depending whether deal is existing or looking at a new acquisition. Dollar figure vs a percentage of expenses before and after.
3. Vacancy Rate: When looking at a new or existing deal, how are people changing their assumptions based on vacancy rate?
Investor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
6y
It is rent that is booked as rental income at the time that it is due, but subsequently unpaid. For most large operators, on the first of each month there is an accounting entry from gross potential rent to accounts receivable. When the resident pays, there is an entry from accounts receivable to cash. Once it is clear that the resident won't be paying, such as if they are evicted or skip, an accounting entry is made from accounts receivable to bad debt. It essentially reverses out the rental income that wasn't paid.
Initially it will probably go up, thanks to eviction moratoriums, etc. After that, say in a year from now, and depending on how the economy recovers, it will likely normalize. Bad debt assumptions range by property class and neighborhood. Class A might be 0.5% and class D might be 5% or more.
Concessions are likely to increase, but probably not because of retention. Concessions are used to attract new leases to stimulate occupancy. Renewals are more often incentivized by zero-dollar increases on their new lease (which is why we are expecting zero rent growth for at least a year and probably two years). Personally I've always built in concessions between 2% to 3% even though we haven't always given concessions to that level, just in anticipation for conditions such as this. So it won't change much for me, but will change for people who haven't been underwriting for this (or not, maybe they'll ignore reality and just continue to do what they've always done).
I haven't seen other syndicator's underwriting post-COVID, but for me it won't change too much. I tend to underwrite a couple of points above the in-place submarket vacancy rate average, or somewhere in between the in-place average and the long-term average. This should still work in most cases on a stabilized basis, but we've been bumping the rate up a couple points higher than normal for the first couple of years (which is pretty high because we typically already bump up the first two years by a couple of points anyway).
Oddly, as it relates to vacancy, we've actually seen an overall decrease post-COVID. My sense is that people just don't want to move right now for obvious reasons. We signed 60 new leases last month and have a goal to hit 100 leases this month (on our 3,000 +/- unit portfolio). Some properties are seeing record-high collections and almost all of ours have had month-over-month gains in April and on-track to repeat in May. Certainly unexpected--and I expect is a bit of a "honeymoon." The other shoe is certain to drop at some point and we'll see vacancy, concessions and bad debt play an increasing role. Our underwriting for new acquisitions is penciling that potential increase in from the start.
Investor · Passiveadvantage.com · Member since 2019 · 166 posts · 91 votes
6y
@Brian Burke thank you for your thoughtful and insightful reply as always.
So ti seems "Bad Debt" is basically rent that is not paid for that month, that was expected. I realize this varies by market, geography etc. but what would you say an average is for B-class properties (2-3%) and has this changed post-COVID?
Could "Bad Debt" also be considered "economic vacancy"?
Investor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
6y
1%-ish in the B-class. Too soon to tell if there is a post-COVID change. We are underwriting as if there will be an increase for the first year. But so far we haven’t seen a major difference. Then again, our properties are generally in areas where various stimulus exceeds most of our resident’s earned income and exceeds our average rents by a lot. Plus our areas are opening back up for business. Bad debt will likely spike in California and New York where the shutdown seems endless and the rents far exceed the stimulus.
Yes, bad debt is a component of economic vacancy. So is physical vacancy, loss to lease, concessions and non-revenue units.