Security deposits have long been an albatross around the apartment industry, burdening both residents and operators. “Frankly, the security deposit is a thing of the past,” explains Mark Stringer, vice president at Avenue5.

For operators, security deposits are a major administrative hassle, and often provide inadequate defense against rent loss and damages—a challenge which has been exacerbated by economic uncertainty during the COVID-19 pandemic.

For renters, deposits present a significant financial burden. A CareerBuilder study found that 78% of U.S. workers are living paycheck to paycheck, meaning nearly eight out of 10 renters don’t have the savings to pay for an upfront deposit, the average cost of which is $500 to $750. That study was also conducted before the pandemic, which has plunged many into deeper financial distress.

“The apartment industry is in transition. Operators have grown more frustrated with security deposit restrictions while residents are demanding more affordability,” says Kelli Jo Norris, president of Goodman Real Estate.

Solving for Renter Affordability

Surety bonds cropped up decades ago to address a key security deposit problem: renter affordability. To purchase a surety bond, a renter typically pays a nonrefundable percentage of the total security deposit upfront—or monthly payments—rather paying the full deposit.

Today’s economic landscape, characterized by shutdowns and job loss, has accelerated the already fast-growing issue of affordability for renters nationwide. Data indicates that full-time minimum-wage workers cannot afford a one-bedroom rental in 95% of U.S. counties, while the majority of Americans can’t afford an unexpected $1,000 expense. “With COVID-19’s impact on the rental housing industry, it’s more important than ever that operators offer an affordable move-in experience for residents while also protecting themselves from potential rent loss,” said Ian Bel, managing partner at Olive Tree Holdings.Surety bonds may address renter affordability, but do they also provide the protection operators need in an age of growing economic uncertainty?

Operators Increasingly Concerned About Protection

Apartment operators today must balance between renter affordability and their own need for financial protection, and the tightrope is becoming increasingly unstable.

Shutdowns have impacted traffic and occupancy rates, prompting some operators to offer concessions or $0 deposit fees to drive leases. While this may create an initial boost, it leaves little protection if the resident doesn’t pay rent or causes substantial unit damage. With no way to cover these losses, NOI and economic occupancy take a big hit. This risk has only magnified in the face of high unemployment rates and an unclear economic future.

Can surety bonds offer both affordability and reliable loss protection? Some operators are closely examining the financial structure of surety bonds, and growing increasingly wary.

“Financially, deposits—along with alternatives like surety bonds—don’t make a lot of sense,” says Stringer. “They don’t correlate to the amount of damage that could be done to a unit or the potential amount of debt. They’re just not relative to the risk.”

A typical surety bond program contributes on average $50 in premium to the loss ratio equation. This amount is insufficient compared with the average amounts paid out in claims. Based on National Apartment Association survey data, $103 per unit on average remains in collections post move-out, serving as a good indicator of claims payouts at scale. If the reinsurance carrier backing the surety bond is losing money, it may choose not to renew a policy. Nonrenewal disables the surety bond provider from issuing new bonds, creating significant operating risk for multifamily operators deploying these bond programs across their portfolios.

As Bel explains, this is why Olive Tree opted to roll out a “more sustainable lease insurance product instead of surety bonds—many of which were turned off in this environment.”

Lease insurance offers a completely different financial model. It eliminates security deposits for residents and provides operators over $5,000 in rent loss and damage coverage on every lease with a standard plan, far exceeding typical security deposits and surety bonds. It is built on a sustainable loss ratio model, and is the first insurance product designed to solve the security deposit problem long term for operators, eliminating operational risk rather than adding yet another deposit alternative to manage.

“Surety bonds and other alternatives don’t hold a candle to lease insurance,” says John Detore, director of asset management at White Oak Partners. The company launched lease insurance portfoliowide and saw a 96% conversion on the Zero Deposit program—providing nine times more protection on every lease than a security deposit. Surety bonds are sold to renters by leasing staff, and do not typically see this level of adoption—meaning fewer units are covered.

As Detore explains, lease insurance “makes move-in affordable for our residents, and dramatically increases our protection against rent loss. In any economic environment, it is important we reduce upfront costs for residents while still mitigating financial risk for our communities.”

A Future-Proof Technology Solution

Finally, as more on-site teams shift their operations online and streamline their leasing process in an increasingly competitive environment, the administrative burdens of deposits and surety bonds are becoming more apparent.

“Security deposits require a lot of administrative burdens that are becoming less appealing to operators,” says Cindy Clare, COO at Bell Partners. “Considering they can also create upfront affordability issues and disputes at move-out, the benefits just don't outweigh the challenges."

Because surety bonds are a deposit alternative, they do not replace deposits or fully eliminate these burdens or liabilities. Some bonds also leverage off-system application processes and manual claims forms, creating more work for on-site teams and impacting adoption and conversion rates.

Lease insurance is an entirely new insurance technology, fully integrated with multifamily system data and leasing processes. It is automated within the native workflow at both the point of application and the move-out claims process. “The multifamily industry is changing,” explains Marcie Williams, president at RKW Residential. “Replacing security deposits with lease insurance enables us to meet the affordability needs of our residents, simplify the leasing process, and protect our assets in an uncertain economy."