How To Minimize Risk When Looking For Tenants
By JD Esajian on May 15, 2015
How can you win as a landlord, even when you can’t find tenants with great credit?
A lot of focus has been put on tenant screening and tenant quality recently. Perhaps too much. The truth is that you aren’t going to find golden tenants for every property. At least not in terms of credit score. So how can buy and hold real estate investors still come out on top when there isn’t a prospective renter with a 700 credit score in sight?
We’ve Got Credit Challenges
Despite some of the data being thrown around, your credit score probably isn’t that much lower than average. Consider that in March 2015 RealtyTrac reported as many as 1 in every 200 to 400 housing units in some parts of America in foreclosure. This is 10 years after the foreclosure crisis really started. No one wants to publish just how many have been through foreclosure. But it is a very substantial percentage of US households. Even among those that managed to hold onto their homes or sold and got out, many missed other payments. In fact, many of those that have the best credit today are simply those that went through foreclosure and bankruptcy first.
There are still over $100 billion bad loans and properties in foreclosure. Maybe even more than double that. That is more individuals and families to be poured out into the rental market. It is going to take some a very long time to build their credit again.
Hardcore Landlords
US landlords have become tougher than ever. In some ways they have a reason to be cautious. But some may arguably be taking their rigorous screening process too far. Even too far for their own good. In some cases it is out of paranoia. In others lack of experience. And for others it is the only way they feel they can manage at scale.
This doesn’t mean that there aren’t markets where that don’t have an abundance of eager tenants with awesome credit and financials. And that landlords can be as picky as they like in these markets. But many are asking for a lot of money up front, are demanding pristine credit and background checks, require non-refundable upfront deposits, and still charge premium rents. Some get it all. Others are wallowing in high vacancy rates. Even in markets where there is massive demand for rentals.
Hot Tip: Note that not all tenants that look great on paper, or talk a good game will perform as well over the long run.
7 Ways to Reduce Risk and Boost Returns
If you aren’t renting units fast enough you might have to loosen up a little. That can be scary for landlords. But you can minimize risk, avoid loss, and maximize returns, even if you can’t find a single tenant with a 650+ credit score. Remember time is money too. And vacant properties are taking your money rather than putting it in your pocket.
- Look beyond the Score
At the very beginning of the crisis the very biggest institutions went under. They even went under first. So it’s hard to judge the individual who took a hit. Soon mortgage lenders will be accepting 500 something credit scores again. Some are already pushing the boundaries of subprime style lending again. And there is a lot of pressure to lower standards even further. Mortgage lenders have more at risk than buy and hold real estate investors. It is harder for them to claw back properties than for landlords to evict tenants. So why shouldn’t landlords be willing to look beyond score? That doesn’t mean to be reckless. Look at credit history. Look at trends, and current activity.
- Income Capacity
Does the prospective renter have a good capacity to pay their rent? How much are they earning? How much debt do they have? How much disposable income each month? How much are they stretching themselves? Maybe their credit is shot, but they are trying to live well within their means.
- Cash Upfront
If credit and income are weak landlords can ask for more money upfront. This doesn’t have to be deposit. It could be advance rent.
- Rental History
What’s the most powerful predictor of future performance of rental payments? Past performance. If applicants have poor credit scores, and little upfront money, but have a concrete track record of paying their housing payments on time regardless of that, why not give them a shot?
- How they’ll Treat Your Property
Maintaining property condition and value is as important as cash flow. A tenant that pays on time, but trashes your property isn’t more profitable than the one who is late, but keeps it pristine.
- Offset with Higher Rents
Mortgage lenders offset lower credit scores and higher risk loans with higher interest rates. So why shouldn’t real estate investors simply charge higher rental rates to balance risk and reward?
- Short Term Leases
If the fear is of being locked into a long term lease, why not offer short term rentals. How about month to month, or even weekly?