Subprime Sympathy

Last September, an alarming trend began to emerge  among rental applicants at Drucker & Falk, a third-party  manager of 30,000 apartment units across the Sun Belt. One applicant  in every 20 was coming into the leasing office bearing a credit record   with a mortgage foreclosure. What was even more disconcerting was  the likelihood that those numbers would increase—especially as national headlines  touted the worst housing downturn in a generation.

 Kellie Falk-Tillett, principal at Drucker & Falk, could see the writing on the wall as  more consumers defaulted on loans for their homes. But she also knew that these applicants  had likely rented before, and in that reality she saw an opportunity. In rental  markets where competition was starting to pick up due to the “shadow market”—  homeowners trying to rent out their house or condo before getting foreclosed on—  these prospects were a ready-made segment to tap back into for her clients.

“These were our renters to begin  with ,  and a lot of them just weren’t ready to  own a home,” Falk-Tillett says. “We lost  a lot of renters in the industry because  of the no-income, no-money-down, nointerest  loans that let them go and buy  homes they couldn’t afford. They were always  our renters. Now we’re just getting  them back.”

 Falk-Tillett is definitely onto something.  RealtyTrac, an Irvine, Calif.-based  real estate research firm, recorded  2.2 million foreclosure filings nationally  in 2007, a 75 percent increase from 2006.  The firm said more than 1 percent of all  U.S. households were in some stage of  foreclosure during 2007, nearly doubling  the number that faced the possibility of  losing their home in 2006.

 Indeed, across the multifamily industry,  owners and managers say the foreclosure  trend is real; they’re increasingly  seeing prospects coming back to them  who have lost their homes, or who will  shortly. Many voice sympathy for the situation  these once-and-future renters face  today. But they also see a market opportunity—  and, in many cases, an obligation—  around supplying for-rent housing to  individuals who have lost the homes that  they gained through subprime mortgages  and the unchecked excesses of the real  estate bubble.

 That national trend comes at the  exact moment when resident screening  technology has evolved to a point where  multifamily operators can easily isolate  and look past foreclosures. But some  apartment vets also question the wisdom  of using the technology to do so, especially  in an industry where limiting exposure  to the risk of uncollected rents is only  second to keeping occupancy rates at  profitable levels.

 OPTING OUT

 At Drucker & Falk, company executives  realized that in order to recover those  renters, they had to modify their internal  systems. Basically, the prospects had to  gain approval through ResidentCheck,  the resident screening system the firm  uses to vet income, financial, and criminal  background data among its applicant  pool. Traditionally, those systems have  viewed foreclosures in an applicant’s  credit history as grounds for automatic  denial.  with a rising number of individuals  facing foreclosures in today’s market,  Falk-Tillett asked Dallas-based ResidentCheck  if it could isolate foreclosure  data among lease applicants and still  consider them for approval if the rest of  their credit was intact.

 “We changed our screening criteria  so that those people would still have  opportunities to lease an apartment,”  Falk-Tillett says. “Now, even if they have  a foreclosure, we can look at the rest of  their credit, too. If they’re still paying their  other bills, we don’t hold the foreclosure  against them.”

 Neither does Camden Property Trust,  the Houston-based REIT that counts more  than 62,000 units in its national portfolio.  In fact, the firm is now proactively identifying  prospects who are getting squeezed  by the mortgage crunch. “We are actively  marketing to individuals who are in preforeclosure,”  says Kristy Simonette, vice  president of business services at Camden,  who notes that the firm subscribes  to an information service that provides  foreclosure data on mortgage holders in  various markets.

 Working  with LeasingDesk, the resident  screening unit of Carrollton, Texasbased  multifamily software firm RealPage,  Simonette adjusted Camden’s screening  criteria to allow for applicants  with foreclosures  in their histories, so long as other  financial benchmarks were still intact. “If  they are still credit-worthy, aside from  having a foreclosure, we want them back  as our residents,” Simonette says.

 And at Jupiter Communities, a  Chicago-based owner and manager of  approximately 11,000 units in 11 states,  Shridhar Shah, vice president of finance,  says the company started working  with its  resident screening provider, Richardson,  Texas-based Resident Data, to exclude  foreclosures from its screening criteria  when the number of applicants  with foreclosures  began to balloon last December.  In just two months, the firm went from  what Shah describes as “a handful” of  prospects to 163 would-be residents who  had past foreclosures or were facing the  imminent loss of their homes.

 RISKY BUSINESS?

 But there are those who don’t see the  trend as an opportunity. In fact, their outlook  is much more cautionary. “The prospect  that multifamily owners are about to  shoot themselves in the foot is very real,”  says Nevel DeHart, executive vice president  at First Advantage SafeRent, a rent  screening agency that is advising clients  to stick to traditional criteria in the face  of the subprime meltdown. “You’ve used  resident screening in the past on foreclosure  issues; use it now for the same reason.  These things have not changed.”

 Indeed, not all multifamily operators  view applicants  with foreclosures as  desirable today. “We absolutely do not  want to create any type of an exclusionary screening model that would say, ‘OK,  if you have a foreclosure, we don’t care,  we’ll just score you on everything else,”  says Scott Youngman, credit and collections  manager at Home Properties, the  Rochester, N.Y.-based REIT that owns  almost 37,000 units in the Eastern United  States and is a First Advantage SafeRent  client. “The level of risk a property management  company deems acceptable  is their own business decision, but we  believe if you allow those individuals in,  ultimately you are going to increase your  bad debt.”

 The division  with in the industry of  whether applicants  with foreclosures are  desirable can largely be drawn along the  lines of which type of screening technology  a company uses. On the one hand,  systems such as ResidentCheck, ResidentData,  and LeasingDesk are built on a  “rules-based” architecture, where multifamily  operators can decide which criteria  should be included on a given screen  at a given time. Proponents say that allows  for flexibility, while critics contend  that it allows managers to change the  rules as they go. Conversely, a second  option is to use a statistical model that  looks at which factors are statistically  relevant for predicting future behavior.  That’s the underlying structure of First Advantage SafeRent’s system. Advocates for  statistical modeling say statistics don’t lie,  while naysayers contend it unfairly lumps  individuals, such as those who were sold  a bum mortgage, into one “bad” group.

 DeHart says that fair or not, the fact is  that foreclosures are rarely stand-alone  financial events. “If you look at people  who lose their homes, they’ve extended  themselves in almost every other area of  credit as well, because the last thing they  want to do is give up the castle,” DeHart  says. “The risk of renting to someone who’s  been foreclosed on is that you don’t know  who else is pounding on their door. Statistically,  they’ve got train-wreck credit.”

 NO CARTE BLANCHE

 Indeed, even proponents of rules-based  screening systems concede that the flexibility  the systems offer needs to be used  judiciously. “There comes a point when  you have to ask yourself if you’re being  like Ben Bernanke and letting everybody  off the hook,” says Pam Storm, vice  president and general manager of  Resident Data. “Yet, at the same  time, in this market, it’s extremely  important to be adaptable.  We try to provide our clients that  ability, while giving them data that  helps them make the decisions they need  to make.”

 In other words, just as foreclosures  rarely happen as unique events, forgiving  them in your applicants’ financial history  shouldn’t open the door to lowering  all your screening standards to sidewalk  level. For instance, Storm points out that  even if clients choose to opt out of foreclosure  screening, they can still run their  applicants through her firm’s proprietary  database of habitual rent skippers or limit  their financial exposure in other ways.  “What we’re seeing now is more people  changing their overrides to say, if they do  have a foreclosure, then maybe we should  increase the security deposit,” Storm says.  At Camden, Simonette says the company  is doing just that.

 Whatever side of the issue multifamily  companies come down on, though,  one trend is clear: The issue of applicants   with foreclosures in their histories is only  going to become more widespread, not  less. They’re so prevalent, in fact, that  some see the situation as a call to arms  for multifamily owners. “There’s so many  people being foreclosed on right now that  their only alternative for housing is to  rent,” says Jupiter’s Shah. “The industry  has to take that into consideration.”

Joe Bousquin is a Sacramento, Calif.-based freelance journalist.