The Long View: What’s the point of incentives in the resi market?

Research suggests goodies are less effective than price cuts

Concessions and sweeteners are everywhere in the rental and condo markets. At 357 West 17th Street, the lucky buyer gets a Bentley thrown in. The Nevins condo in Boerum Hill offers buyers gift cards. And seemingly every other luxury rental building sweetens the deal with a month or two in free rent.

As these goodies become more common, so do news reports about them. This publication, for example, has published pieces analyzing how concessions are symptoms of a weakening residential market and questioning whether they end up filling buildings with people who can’t afford them. But among dozens of articles, not one answers a very basic question: do concessions even work, and if not, what’s the point?

I understand that offering a free car makes a condo more appealing than not offering a free car. But the real question is whether offering a car worth, say, $100,000 is better at attracting buyers than just cutting the sales price by $100,000, or even by $75,000. There seems to be no consensus answer, which is surprising considering how long developers have been using concessions.

“That’s something that has always been around,” said Olshan Realty’s Donna Olshan. Even back in the 1980s developers “would give free trips, a car,” she added. “It’s like throwing everything against the wall and seeing what sticks.”

Attaching sweeteners to purchases was never strictly a real estate practice, of course. Retailers pioneered it. Think of McDonald’s’ wildly popular Happy Meal, which debuted in the late 1970s and comes with a small toy. As of 2011, McDonald’s was selling 1.2 billion Happy Meals annually, according to Time.

Plenty of research indicates these goodies work. In a 2012 paper in the Journal of Marketing, professors Haipeng Chen, Howard Marmorstein, Michael Tsiros and Akshay Rao ran experiments to figure out if people are more likely to buy a hand lotion if sellers offer 50 percent more content for the same price rather than simply a 35-percent price cut. They found that consumers tend to prefer a “bonus pack over the economically equivalent price discount.” But there’s a catch. As you move into pricier territory (such as real estate), consumers tend to calculate costs and benefits more carefully and gimmicks lose much of their appeal. The authors note that buyers even tend to prefer price cuts over bonus packs “for expensive or unfamiliar products.”

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Jonathan Miller, of appraisal firm Miller Samuel, has observed this exact phenomenon in the condo market. In his experience, price cuts are more appealing to condo buyers than creative concessions of similar value. Aleksandra Scepanovic, head of Brooklyn-centric brokerage Ideal Properties Group, said that concessions may be good at attracting initial attention, but as you move closer to the contract signing a “price cut starts making all the more sense.”

This makes you wonder why developers keep coming back to concessions. According to Miller, it’s about optics.

“One of the concerns if you do an all-out price cut is that it can be damaging because you acknowledge weakness,” he said. Price cuts make for negative headlines and get documented in public property records. Concessions don’t. These optics matter when it comes to landing a mortgage or finding a buyer for a rental building. “In the rental business it’s all about protecting the face rent,” he said.

Now you would think that mortgage lenders and multifamily investors are savvy enough to look past face rent and nominal prices and factor in all concessions, and that’s a fair point. In this sense, the question of whether concessions are effective is really part of a broader question: Is New York real estate an efficient market where buyers, lenders and investors aren’t influenced by sensationalist headlines, and where they crunch all the important numbers before making a decision based on cold, hard math? Or is it more like a McDonald’s, where customers get swayed by plastic toys and look at the big letters and numbers on the board, ignoring the fine print? The continued popularity of concessions makes me think that sponsors and landlords believe it’s often closer to the latter.

In the end, concessions depend on how sophisticated the market is. “If you were to offer me a car worth $50,000 I would probably pass at this very juncture,” Scepanovic said. “But if you made the same offer to the 18-year-old me, I’d probably be singing a different tune.”