By Eric D. Jarvis, Esq. | Founder of ReassureRent
It’s every landlord’s nightmare: A tenant who can’t, or won’t, pay the rent. You’ve invested in your property. You are obligate to continue to pay taxes, insurance, a mortgage, and maintenance, and you depend on that income. You provided a home for your tenant and you have a right to expect that tenant to keep their end of the deal. Now you’re involved in a time consuming and emotionally draining eviction process. In the best situations, you will pay some legal fees and lose some rent. In the very worst situations, you could spend thousands in legal fees and lose half a year of rent before you get your property back.
It’s clear that the risk of a tenant who fails to pay rent is a risk that needs to be managed. In business, risks are generally managed in ways that fall into one of four categories: 1. Risk Avoidance, 2. Risk Mitigation, 3. Risk Retention, and 4. Risk Transfer. Some of these risk management strategies will not be very useful for landlords, while others can bring tremendous advantages in managing the risk of the non-paying tenant. In part one of this article, we will address the first two risk management strategies, Risk Avoidance and Risk Mitigation. Next month, in part two of this article, we will look at Risk Retention and Risk Transfer, and come to a conclusion about which strategies are best when a tenant can’t, or won’t, pay the rent.
- Risk Avoidance – Avoid it
Some risks are simply too large to take. Risk avoidance is the risk management strategy that is the most effective at managing the risk – simply avoid engaging the activity that gives rise to the risk. As anyone who remembers the movie Jaws, the most effective way to avoid being bitten by a shark is to simply stay out of the water!
This strategy, however, also means that you will miss out on opportunities. The opportunity to spend a day at the beach with family, or, in the case of property owners, to make income by renting your property. While the residential landlord can avoid a non-paying tenant by staying out of the rental business altogether, it will be at the cost of the very reason the landlord is in the business in the first place – to receive an income from rents. Risk avoidance is thus obviously not a good strategy for anyone who is committed to the rental business and who depends on rental income!
- Risk Mitigation – Reduce it
Mitigation is the action of reducing the severity, seriousness, or painfulness of something. In risk management terms, it is also reducing the likelihood that something bad will happen at all.
Conscientious landlords run background and credit checks on their prospective tenants. They screen income levels, check on prior evictions, and evaluate the character of their prospective tenants as well as they reasonably can. These steps are all factors to help reduce the likelihood that the future tenant will default on the payment rent. Renters with higher income levels, strong credit history, and a history of making rent payments on time are thought of as less likely to default on their lease.
Other strategies can reduce the financial impact of a rent default if it does happen. One is the collection and holding of a security deposit. The deposit may be used to pay for all or some of the unpaid rent. Other, less traditional, strategies that can also help a landlord through the impact of a default and eviction. A standby short-term line of credit, in the form of a bank loan or credit cards, can help a landlord cover the mortgage and other payments while the eviction takes place and until another tenant can be placed. Pre-paid legal expenses can make the cost of legal services associated with an eviction less painful.
Risk Mitigation is an effective and prudent strategy to manage the risk of the tenant who can’t, or won’t, pay the rent. Screening can help reduce the likelihood of a default happening, and security deposits and stand-by financing can help reduce the impact when it does happen.
On the downside, these risk mitigation strategies require some expense and cumbersome processes and controls. Credit reports not only cost the fees to obtain them, they also cannot predict a tenant’s future financial hardship, such has job loss, divorce, illness, or a general economic downturn. Security deposits are similarly burdensome in that they are governed under a set of laws and regulations requiring strict compliance and accountability in the processes of collecting, holding, and processing those deposit funds, and managing their refunds.
Risk Avoidance and Risk Mitigation are two strategies that landlords can use to manage the risk of a tenant who fails to pay the rent. Risk Avoidance is extremely effective, but is throwing out the baby with the bathwater – you miss out on the opportunity to make any rental income at all. Risk Mitigation by tenant screening reduces the likelihood of a lease default, but doesn’t protect you when the tenant defaults because of job loss, accident, or other unforeseen economic circumstance.
Next month, we will look at Risk Retention, and Risk Transfer as risk management strategies for landlords. We will come to a conclusion about Risk Transfer that may be a surprise to many!
Eric D. Jarvis is the founder of ReassureRent, the exclusive provider of tenant default insurance. Eric is also an attorney, who, prior to his 20 years as an insurance and risk management professional, practiced landlord/tenant law in Southern California. ReassureRent can be reached at (833) 5TENANT (833-583-6268), and at http://www.reassurerent.com/aptnews.