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Have you ever heard about the great bargains available on cruise vacations booked at the last minute? Well, the concepts of inventory management and lost revenue also apply to the rental housing industry. Units that sit vacant for too long are usually overpriced, and each day that passes with your rental property vacant is more lost rent you can never collect. Either re-evaluate your asking rent or concessions or see what you can do to make your rental unit superior to the competition to secure those long-term tenants.
Not into wheeling and dealing? Perhaps you prefer telling your prospec- tive renters that unlike all the other landlords offering gimmicks and spe- cial deals, you’re all about cutting the hype and offering them the best net monthly rental rate. In my experience, many tenants find a lower, straightfor- ward rental rate quote more attractive, especially if they plan on staying for a long time.
Regardless of which marketing strategy you take, avoid the temptation to set your rent based on the number of occupants your rental unit can hold. Some landlords have a policy that the base rental rate is for a certain number of ten- ants; they then charge more for each additional tenant in the unit. This prac- tice is sometimes called per head rent. However, the Department of Housing and Urban Development considers such policies violations of the Fair Housing Act. The only exception is if you can show a legitimate business necessity, or verifiable increased cost to maintain your rental property, such as higher water or sewage bills. If you think you can prove a business necessity, check with your landlord-tenant legal expert before setting rents. Otherwise, take my advice and avoid these turbulent waters.
Ultimately, your marketing strategy is often influenced by what’s most com- monly done in your local rental market, but don’t be afraid to incorporate your personal style.
Coming Up with a Fair Security Deposit
As an owner of rental property, you need to make sure the security deposit you collect adequately protects you from tenant damage or default. The secu- rity deposit serves as the protection you need before turning your real estate asset (the rental unit) over to a tenant. It needs to be large enough to moti- vate the tenant to return the rental property in good condition, plus serve as an accessible resource to cover the tenant’s unpaid rent or reimburse the costs to repair any damage. If your security deposit’s set too high, many qualified tenants may not be able to afford the move-in costs for your rental property, resulting in fewer applicants.
State laws typically limit the amount of the security deposit you can collect and regulate its return, along with any lawful deductions. If you collect the first month’s rent upon move-in, this money is not considered part of the security deposit. Some states specifically allow certain small rental owners to be exempt from these rules. See the CD for more information on state laws about security deposits.
The next several sections help you determine the right amount for your security deposit.
Figuring what you can legally charge
Many states limit the amount you can collect as a deposit to the equivalent of one or two months’ rent. The limit varies in each state depending on certain factors, such as whether the rental is furnished, whether the tenant is on a lease or a month-to-month rental agreement, whether the tenant has pets or waterbeds, or whether the tenant is a senior citizen.
In most rental markets, the security deposits are well below the maximum allowed by law. While staying within the legal limits, I recommend you collect as large of a security deposit as the market can bear.
Security deposits are more than just money you hold for protection against unpaid rent or damage caused by your tenant. Although the actual cash amount may be relatively small compared to the overall value of your rental property, the security deposit is a psychological tool that’s often your best insurance policy for getting your rental unit back in decent condition.
When trying to determine how much to charge for your security deposit, make sure you avoid the following potential costly mistakes:
Don’t lower the security deposit or waive a security deposit payment.
If the funds required to move in are too high, collect a reasonable
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portion of the deposit prior to move-in and allow the tenant, in writing, to pay the balance of the security deposit in installments. This type of written agreement usually indicates that any funds paid by the tenant are first applied to the security deposit and then applied to the rent. Don’t allow the tenant to miss or delay payment of any subsequent security deposit installments. Take legal action immediately if the tenant misses making any security deposit payments or fails to pay the rent in full.
For single-family homes, I strongly advise getting as large of a security deposit as possible. Aside from the inherent increased value of the rental home itself, you likely have tremendous value in the grounds, landscaping, and pool or spa (if applicable) — meaning much more of your valued property can be damaged by tenants. Rental homeowners also tend to inspect or visit their property less frequently, and it takes only a few weeks of inadequate watering or shoddy landscaping main- tenance to find you’ve suffered significant damage. See Chapter 17 for advice on ways to convince tenants that landscaping or pool/spa main- tenance are best left to professional contractors.
Don’t completely eliminate security deposits. Property owners in soft or low-demand rental markets often offer free rent or “no security deposit” move-in specials. Prospective renters attracted by such offers typically aren’t the types to become long-term stable tenants who treat your property with respect and care about peaceful, harmonious living with their neighbors.
Although staying competitive is important, I recommend avoiding free rent or “no deposit” specials whenever possible. Offer to pay the pro- spective tenant’s security deposit instead. You still receive the first month’s rent when your tenant moves in, and he can potentially receive a security deposit refund if the property is in good condition at move- out. Essentially a form of free rent (because you’re crediting the tenant, not receiving money), this move reduces the total funds your incoming tenant must pay. Unlike a risky move-in special, you’re offering the con- cession at the end of the lease, not the beginning. As a result, you’re less likely to attract tenants who move from landlord to landlord in search of up-front freebies. You also have a better shot at creating a strong psy- chological and practical motivation for the tenant to fulfill the terms of his lease. Why? Because that security deposit cash comes in handy for covering the costs of moving to a new residence . . . after several good years at your property, of course.
Keeping security deposits separate from your other funds
Security deposits are liabilities from an accounting point of view because these funds legally belong to the tenant. You hold them in trust as protection in case the tenant damages the property or defaults in paying rent.
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Because the funds don’t belong to you, several states require security depos- its to be held in a separate bank trust account instead of being mixed in with other funds from your rental properties or personal resources. Some states even insist you provide your tenant with a written notice indicating the loca- tion of this bank trust account at the beginning of the tenancy.
Keeping the security deposits separate from the rest of your funds means they’re readily available whenever a tenant moves out and is potentially enti- tled to the return of some or all of her money. Doing so, even if not required in your area, can be a great way to avoid cash flow problems. Say a tenant fulfills all contractual obligations before move-out and deserves a security deposit refund. If you commingled her deposit with your personal funds, you may find your current cash availability can’t cover a large security deposit refund within the short time frame required by law in most areas. This situation can lead to legal action by the tenant and additional penalties and interest. The lesson? Always make sure you have available funds to cover the potential refund of security deposits.
Avoiding nonrefundable deposits
A nonrefundable security deposit, which is allowed in some states, is a portion of the deposit that you, the property owner, retain no matter what’s allowed by state law. A nonrefundable security deposit may sound like a good idea, but it may also send a message to the tenant that he has to pay for the costs of preparing the rental property for the next tenant. My 30 years of experience with tenants leads me to question the benefits of nonrefundable security deposits in most instances because the incentive is gone for tenants to keep and maintain the property in the best condition.
In fact, I recommend avoiding nonrefundable fees in general in favor of seek- ing a higher, fully refundable security deposit so you have funds to cover damage repairs and cleaning, if necessary. It’s a good day as a rental owner or property manager if your tenant vacates and leaves the rental property in good condition, so I prefer to have the entire security deposit be refundable.
Approximately a dozen states have specific laws permitting rental property owners to have nonrefundable security deposits or fees. These fees cover the costs of services such as cleaning, repainting, or redecorating. Some states have very specific limitations on these nonrefundable deposits or fees and don’t allow charging for any excessive costs incurred. On the other hand, several states don’t have laws specifically prohibiting nonrefundable depos- its and leave such decisions to the mutual agreement of the property owner and the tenant.
Regardless of where you live, not using nonrefundable deposits allows you to avoid potentially time-consuming disputes with your tenants, such as what
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happens if the $150 nonrefundable cleaning deposit is insufficient to cover the $250 costs for cleaning a filthy rental property.
Paying interest on security deposits
Several states have laws requiring rental property owners to pay interest on a tenant’s security deposit. You can find some basic information about security deposit interest on the CD, but check with your local affiliate of the National Apartment Association for the exact requirements in your area because the laws differ dramatically from state to state.
The method of calculating interest varies greatly, with some states providing a formula tied to the Federal Reserve Board rates or flat percentage amounts.
Most states require interest payments to be made annually and at termination of the tenancy.
No laws prevent you from voluntarily paying interest on deposits, and some owners offer to pay interest as a competitive advantage or an inducement to collect a larger security deposit. If you’re able to get a much larger deposit, I recommend paying interest on it. The additional peace of mind is worth the relatively small amount you’ll pay in interest.