Rental Deposits: Making Tenants Place A Bet On Themselves

When I talk to folks about owning and managing income property, many times they look at me like I am taking about the nuances of quantum physics.  I know just a little bit about quantum physics, and trust me, property management is a lot less difficult to understand.  In most cases, people simply don't know what they don't know about managing property.  Hopefully, sharing some of my stories with you will cast some light on the subject.

Fear is a great detriment to many people wanting to invest in real estate.  There is a fear of loss and a fear of the unknown.  It is true that there is no sure fire way to prevent undesirable outcomes in regards to unpaid rents or damaged property.  However, there are things that can be done to hedge against those risks and make them less likely.  Understanding the role of risk and then compensating for it is the key to success in owning income property.

Much of the success or misery experienced owning income property will be related a tenant's performance on a lease agreement.  The three considerations landlords care most about are:

1.  Will the tenant pay rents on time and in full?

2.  Will the tenant treat the property in such a way that it will be returned in the same condition in which it was delivered to them?

3.  Will the tenant be a respectful neighbor to others (especially if living in a multi-unit building)?

I came across an interesting situation that caused me to stop and think for a moment on how to  arrange the lease agreement for a prospective tenant.  I recently recieved an application for an apartment.  The application was delivered to me by a family member who explained that he was the executor of this applicant's finances and would be paying the rent.  The applicant was disabled and required assistance with paperwork and other personal record matters.  He also explained that the applicant had been notified by the previous landlord that their lease would not be renewed due to a problem with a misbehaving roommate who has since left the scene.  The income of the applicant was just barely below the required amount for an unconditional qualification.  When we pulled credit, there was a litany of medical collections.  Yet, the applicant didn't smoke, nor had pets.

This was the first time I have bumped into an executor situation with someone besides the tenant being in charge of paying rent.  I felt uneasy with the application.  I could understand the medical collections because that can happen to anyone who is uninsured.  The roommate issue was a concern but apparently that relationship had ended and that person wouldn't be around anymore.  But, what would happen if the executor decided he didn't want to pay rent or wanted to pick up this applicant and move them to another place without notice?  After thinking on the situation, it came to mind that there was no incentive for the executor to perform on the lease agreement because he was not tied to the lease.  

To resolve this problem, and to create incentives for performance, I asked the executor be a co-signor on the lease.  Otherwise, the only way I could justify taking the risk on this particular tenant was to require a significant security deposit well over the rent amount.  The executor agreed that paying a large security deposit was undesirable.  When I made the proposition about signing on the lease with the applicant, he hesitated and said he would call me back. 

To me, this was where the rubber hit the road.  Was he willing to place a bet on the performance of his family member and on his performance to pay rent by putting his good credit on the line while acting as a co-signor?  Whatever answer I received, I knew that it would make or break this application.  Ultimately, the executor called back and said he would be willing to co-sign.  That was the act of confidence we needed and we signed the lease agreement, received a modest security deposit, and got them keys.  

While investors are fearful of losing money due to tenants breaking the terms of a lease, so are tenants.  Thus, writing lease agreements that balance the risks for both parties through the use of deposits and co-signors is one of the pillars of successful property management.  Obviously, some tenants may not be able to afford the deposit amount that compensates for their risk factors.  In these cases, it requires the tenants to save a little more before moving.  Most don't.  But, if they do,  they find there are many more doors open to them.  There are ways to create win-win scenarios for both tenants and landlords.

If you have income property or want to own income property and are considering hiring professional management, CONTACT ME, and lets discuss your property management needs.