In the midst of an unsteady job market, the prospect of lease defaults and chronic late payments pose even bigger than usual worries for owners and property managers. By some accounts, the quality of the nation’s applicant pool remains subpar.
According to First Advantage SafeRent Inc.’s most recent quarterly survey, released in February, the applicant pool was a few notches riskier in the fourth quarter than it was in the fourth quarter of 2008. Specifically, First Advantage gave the national applicant pool a score of 96—below the 100 mark that represents risk equilibrium. Economic pressures compound the challenges of qualifying prospective renters, a group that historically has more credit problems than homeowners—today’s residential mortgage crisis notwithstanding.
That leaves property managers in a quandary. The imperative to generate revenue offers an enticement to lower screening standards. Yet the value of reviewing applicants’ credit records, work history and other background elements has not diminished, contends Jon Segner, president of Plymouth, Minn.-based Dominium Management Services LLC, which manages 17,000 units. “Because the economy is going through this rough stretch, it doesn’t mean you should really change your criteria,” Segner maintains. On the contrary, “credit screening is even more important than it used to be, with a greater number of folks on the bubble.”
But while owners are hardly throwing caution to the wind, many are embracing thoughtful, targeted adjustments. At the heart of the issue is a willingness to view screening as more than a way to keep applicants out. “People tend to look at screening as a knockout system rather than as an inclusionary system,” contends Mike Lapsley, president of RentGrow, a multifamily resident screening consultant based in Waltham, Mass. “It’s in nobody’s interest to look for ways to reject people.”
An uncertain outlook for industry fundamentals gives operators and their consultants a ready incentive to try some new tacks. In some respects, projections for applicant traffic and other indicators are the most encouraging since the start of the recession. RentGrow estimates that resident applications will pick up by between 8 percent and 16 percent in 2010. Vacancy increases are still widespread but are expected to slow, even in the toughest markets. In Las Vegas, the vacancy rate could decline by about 70 basis points—less than a quarter of the 320 basis-point jump recorded only a year ago. Nevertheless, the lag time between an improving economy and an improving multifamily market means that fundamentals will remain under pressure this year.
Asking rents will slip an average of 1.7 percent nationwide this year, and net effective rents will decrease 3 percent, estimates Marcus & Millichap Real Estate Investment Services Inc. in its annual multifamily forecast. Concessions will hit 9 percent of asking rents in 2010—fully 400 basis points higher than the 2005-2008 average. Whether the market’s performance this year matches its potential hinges on whether the job market starts improving in earnest, say industry veterans.
Confronted by a number of mixed signals, operators who are willing to qualify more applicants must then decide which criteria can safely be tweaked, and by how much. “I could lower my criteria on 100 people, and 99 could be fine,” explains Eric Hartz, CEO of RentBureau. But it might take only one default to wipe out the revenue gained by accepting dozens of responsible residents.
One way to manage risk is to set a goal of expanding the number of qualified applicants by a predetermined degree. Modifications will vary by the operator’s experience and geography and may even focus on a single criterion. For Dominium, that issue is residential foreclosure. A standard credit check might automatically disqualify any applicants carrying recent foreclosures on their records. But given the meltdown of the single-family market, such a rigid policy might unnecessarily screen out thousands of applicants who have the potential to become reliable residents. In response, Dominium’s property managers have the discretion to take a closer look at applicants who have lost their homes to foreclosure.
Red flags vs. red herrings
Another way to accept more applicants while controlling risk is to distinguish between red flags and red herrings. The size and nature of the problem is crucial. In any economy, skipping out on a $6,000 car loan in the past year would almost certainly be a deal-breaker; failure to pay a $75 cell phone bill, probably much less so. “The fact that you might have a medical bill or a video charge [on your credit record] is not going to affect how you pay your rent,” argues RentGrow’s Lapsley.
Besides honing in on specific indicators, some operators are also reducing the number of years of an applicant’s credit history they evaluate. Rather than four years of acceptable credit history, for example, three years might be enough. Though it is difficult to gauge how well this risk management effort is working, early anecdotal evidence suggests that it can yield benefits. One RentGrow client trimmed the security deposit after determining that it was creating a barrier to applicant traffic. “It’s been six months, but they’re very pleased with the result,” reports Dan Kosciak, RentGrow’s senior vice president for sales and client services.
Two demographic groups, in particular, embody the classic arguments for alternative approaches to screening. As Marcus & Millichap points out, younger workers have been especially hard hit by the recession; unemployment among those aged 20 to 34 exceeded the national rate by 200 basis points at the beginning of the year. That compounds the perpetual challenge for young applicants who lack an extensive credit history. Nevertheless, consultants argue that considering additional factors can qualify many twenty-somethings who will become responsible renters. For example, someone who rented an apartment during college and reliably paid the rent for a couple of years could be a good risk, suggests Jay Harris, vice president of business services for First Advantage SafeRent.
Immigrants, too, constitute an applicant pool that often justifies a flexible approach to screening. A record of reliability on a used-car or payday loan, for example, can reveal creditworthiness that a conventional credit review might miss, Harris explains.
Some suggest that resident screening works most effectively in concert with other strategies. “For a screening policy to work effectively, the operator needs to have an effective [security] deposit policy,” Harris says, noting that an appropriately scaled deposit gives the resident a strong incentive to make payments on time.
And both Harris and Hartz suggest that monitoring the performance of an entire property against comparable properties in the market is a logical extension of the screening process. A pattern of problems related to timely rent payment or security may offer early warnings that call for follow-up action. “The idea,” Hartz explains, “is to not stop screening [residents] the day you rent to them.”
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