The nation’s homeownership rate has declined to its lowest level since 2003, and foreclosures nearly doubled in September 2007 as compared with September 2006.
The dip in homeownership rates is at least partially the result of tighter lending standards. While many defaulted subprime borrowers are being forced back into the rental market in such markets as Arizona, Texas, Florida, and California’s Inland Empire, even would-be condo and co-op owners with good credit scores that are seeking jumbo loans in areas such as New York City are not immune from the fallout of the subprime debacle as lenders adopt more conservative lending criteria.
These more stringent residential loan standards have precipitated a surge in rental applications, and the multifamily industry stands to gain handsomely as a result. Marginally qualified individuals who had hoped to buy will no longer qualify and instead will continue to rent, while current apartment residents are extending their leases, waiting for sales trends to firm up and interest rates to stabilize.
According to the National Multi Housing Council’s July 2007 Quarterly Survey of Apartment Market Conditions, more than half of respondents (55 percent) noted a decrease in the flow of apartment residents leaving to become homeowners. In fact, the National Apartment Association’s 2007 Survey of Operating Income & Expenses in Rental Apartment Properties revealed for a second consecutive year healthy improvements in net operating income (NOI) and a drop in overall economic losses. Industry NOI rose to 56.9 percent of gross potential rent in 2006 from 53.9 percent in 2005 and 52.2 percent in 2004.
But those numbers do not tell the whole story. The nation’s apartment industry is estimated to have lost as much as $18 billion in 2006 due, in part, to vacancies, concessions, and collections. With a surge in rental applications coming from those beleaguered by foreclosures and compromised credit histories expected for the foreseeable future, property owners may feel some pressure to lower their credit standards to achieve greater occupancy levels.
This trend is only compounded by the fact that a glut of properties slated for condo conversions are expected to come back online as rental properties, especially in overheated or overdeveloped markets like Las Vegas, Phoenix, and South Florida. As a result, despite the uptick in rental housing activity, owners will find themselves still competing for qualified residents, many of whom have come to expect rental concessions based on the widespread practices of the 1990s.
This confluence of evolving market conditions has put added pressure on property owners and apartment management firms to take proactive steps to protect themselves against bad risk and market their properties more aggressively as they capitalize on the downturn in for-sale housing. This means reestablishing and adhering to sound risk management principles while putting in place better safeguards against the kinds of staggering losses that the industry sustained last year.
Security deposit alternatives are already part of a sound risk management and aggressive marketing approach at some 3,500 communities nationwide. Most often found in the form of a surety bond, security deposit alternatives protect apartment owners and management firms against losses that a unit sustains as a result of damages or if a renter skips out on his rent. At the same time, the surety bond option offers a distinct marketing advantage because it offers the renter dramatically lower move-in costs.
The cost of a surety bond is much lower than a traditional cash security deposit, which the landlord then holds in escrow for the duration of the lease term. For example, one program that offers surety bonds offers a minimum coverage of $500, with coverage in $250 increments thereafter. So, for example, for $1,000 worth of coverage against losses, the resident only pays $175 for the surety bond premium as an alternative to the traditional security deposit typically costing more than five times that amount.
How does the security deposit alternative work? At lease signing, the renter chooses between the surety bond and the traditional security deposit. If the renter selects the bond, he makes payment directly to the surety, which in turn assures the landlord/property manager that the renter will fulfill the lease obligations at the end of the lease term. The onetime, non-refundable bond premium remains in effect for as long as the renter resides at the leased apartment. And because the program is available nationally, residents can transfer their coverage to different communities within an owner’s portfolio.
At move-out, if the resident meets his rental obligations and vacates the apartment in good condition, he moves out without any further obligation. If, however, any lease-covered damages, rent loss, or other lease violations occur, owners file a claim with the surety provider for prompt reimbursement of the debt amount up to the coverage limit.
The benefits of the surety bond program to owners can be substantial. It discourages renters from failing to pay their rent or leaving their units in poor condition when they move out. This is because the renter remains fully liable for his lease obligations under the terms of the surety bond. In addition, the resident’s lower up-front costs required to move into a new apartment make it easier for a leasing agent to close the sale. But arguably, the most dramatic benefit to owners can be found in their enhanced level of protection and the subsequent and significant impact on a property’s bottom line, particularly in markets where requiring full cash deposits puts a property at a competitive disadvantage. This is because the surety bond provides a level of coverage to the apartment community against losses or lease violations that may exceed that of a market-based, traditional security deposit, allowing apartment owners and managers to reduce the amount of unrecovered debt and improve their NOI.
Furthermore, this significantly improved financial protection costs property owners nothing because the surety bond premiums are paid by residents. The only indirect cost to owners is the time required to evaluate and integrate the program into their leasing process.
Security deposit alternatives are not the only means by which owners and managers can safeguard their balance sheets in the current rental housing market. Another good step to that end is to identify potential trouble areas using a qualified screening provider. Screening providers can not only provide details about an applicant’s credit card payment history, but also information on how the resident has performed with regard to previous housing obligations, based on information such as landlord and tenant court records, eviction filings, and collection accounts. Screening can be tailored to an owner’s varied risk tolerance levels, highlighting or ignoring certain account types such as medical collections or delinquent mortgages or foreclosures.
Other measures that an owner can take to better protect against losses include offering “probationary” leases that, in the short term, allow management to monitor a resident’s rent payment track record. Higher security deposit levels also can serve as a deterrent to losses but, at the same time, may negatively impact the marketing appeal of a property over one that offers a move-in special, for example. Owners can reward conditionally approved or first-time renters for making timely monthly rent payments by reducing these higher security deposit amounts over time.
In addition, by integrating automated lease forms with a screening provider as well as a security deposit alternative provider, owners and managers can prevent inconsistencies during the leasing process and ensure compliance with fair housing and other federal laws. This level of integration allows leasing forms to become populated with data derived from the applicant screening process. In addition, leasing agents will be better able to comply with owners’ own corporate leasing rules regarding conditional applicants and to ensure conformity at all communities.
Apartment owners and managers can seize the moment to achieve higher occupancy rates in the wake of the mortgage industry fallout—without sacrificing good balance sheet management.
By implementing a concerted risk management program that includes a security deposit alternative and screening program, owners can safely tap the potential of a significantly larger renter pool.
Dan Rudd is chief financial officer of SureDeposit. With more than 1 million units in nearly 3,500 communities under agreement, SureDeposit is the nation’s leading provider of alternatives to traditional security deposits. Founded in 2000, SureDeposit is headquartered in Livingston, N.J., and has regional offices in Arizona, California, Florida, Georgia, Indiana, Nevada, Rhode Island, and Texas. For more information, call (800) 531- SURE (7873).