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I’ve recently made the decision to stop taking security deposits.
I know, I know, I’m crazy, right?
Clearly, I am a little bit, but I have some solid business reasons behind it.
We all know that tenants can do some pretty terrible things to a property. Destroying appliances, smashing walls and pipes and more. Obviously, the most important reason to take a security deposit is to protect the landlord from the tenants.
Though the security deposit rarely covers the cost of damages that a tenant may cause, it helps offset the loss and covers basic things like unreasonable cleaning and some small repairs.
There’s also a relationship between how much a Landlord demands up front and the housing market, risks, and state laws. In two states I’m very familiar with, Texas and Massachusetts, there are some stark differences.
Texas is a very landlord friendly state with quick evictions.
It also has a crazy hot housing market with major shortages in housing. Rents have risen a lot in recent years the Dallas market has been rising 4-7% per year for several years in a row now.
But, apartment buildings generally require first months rent, some application fees, and a small deposit around $300. You can move into a $1,000 apartment for around $1,500.
Massachusetts has a solid housing market and rents have been rising. It’s hard to compare but I’d say it’s not quite as hot as Texas. Regardless if the market is hot or terrible (like in 09 when I started investing there), it’s standard to request first, last, and a security deposit equal to one month’s rent.
The same $1,000 apartment would require over $3,000 in upfront cash to move in. Crazy, right?
I believe Landlords in Massachusetts would charge a lot more if they could and the reason is simple – the laws are so tenant friendly that landlords have to protect themselves by charging a crazy amount up front. The market will naturally balance out and incorporate all those costs into what is charged to the tenants.
Unfortunately, the state had to put a cap upfront front charges.
So, Landlords have to become more strict on their applications and screen out people who might have been qualified tenants in other states. In Texas, it’s not hard to find an apartment that allows for your income to be 2x or 2.5x the cost of the apartment. Often a higher security deposit is charged if you can meet the requirement.
In MA, I never accept anyone with an income under 3x the rent. NEVER. No matter how great they may appear or how great they seem as people. Those are the rules I have because I need to protect my business and ensure every tenant can pay.
Also, landlords may take several applications and choose the best among them to get the highest quality person in there.
Then laws get more strict about discrimination and applications – Seattle just passed a “first come first serve” process for applications. If laws like this become more prevalent in tenant-friendly states, landlords will respond by increasing the application difficulty or implementing pre-application processes to get around the law.
Then as landlords respond, the state will pass more laws to “protect” the tenants from the evil landlords. And so the game goes on between the state and the landlords, with the tenants being the ones who have to deal with higher fees, more strict applications, and landlords who become complete A**holes and have zero tolerance for anything.
In places like Texas where markets can operate freely, landlords compete with each other which pushes those upfront costs way down for new tenants. Why would you move into a nice apartment and pay $3k up front when another apartment is only charging $1,500 up front? Landlords can be more lenient and reasonable because the laws are not so strict.
This varies widely from state to state. “Reasonable wear and tear” is not deductible but anything beyond that generally is deductible.
So, a tenant that lives in an apartment for 5 years and wears out a carpet probably can’t be charged for the carpet. But, a tenant that lives there for 6 months and leaves pet stains all over the place probably can be charged.
Someone who leaves a few small nail holes in the wall from pictures and such probably can’t be charged to patch and paint those areas while someone who uses 3/8″ lags to hang a 100lb tv on the wall probably can be charged.
It seems that most states require landlords to keep deposits in an escrow account. The reason is simple. Rent (including last month’s rent) belongs to the landlord. Deposits belong to the tenant – unless/until they are charged for damages.
Should the landlord fail to pay some bills, creditors can go after the tenant’s money. Put it in escrow to keep their money safe and be a good agent of it.
Then, itemize, document, and repair before deducting. You should not deduct for a damaged window, for example, then rent it to the next tenant with that damage unrepaired and pocket the cash.
It may not be a law everywhere, but just morally you shouldn’t charge someone for something you have no intention of actually repairing.
Some states, such as Massachusetts, require receipts and contracts from licensed professionals showing the work is complete. Other places allow deductions based on a standard list agreed upon before move-in.
There is a lot of risk for landlords if they take security deposits. If the money is handled wrong (even if you make your best faith effort to do it right) you can be subject to damages in consumer protection laws.
Security deposits also create a false belief from tenants that they can only lose a certain amount of money. If the landlord is going to take the $1,000 anyhow, why not cause an extra few thousand in damages?
Obviously, this is completely untrue, but the impression is there.
Additionally, security deposit laws dictate what can and cannot be charged for and EXACTLY how the charges should be made.
Any mistake can make it so you can’t collect for damages.
I’ve survived almost 10 years in MA taking security deposits, but I think I found an easier way.
By only taking first and last month’s rent, I can increase my stringent screening process even further. Require higher incomes and credit scores, and just be more strict overall.
I will have a wider selection of tenants because the cash required to move in is lower.
“If you have no deposit, how can you get paid for the damages they cause?”
Just because there is no security deposit does not mean the tenant is not responsible for damages. You’d have to go through the normal legal channels to get paid – send a bill, demand payment, file a complaint in court.
Follow the normal move-out procedures. This includes a walk through with the tenant if possible and document the apartment both before they move in and after they move out.
If the preponderance of the evidence points to their damage, then you’ll have a strong case in court. Plus, people are a lot quicker to settle the damages when they see a summons from small claims court.
Eric is an investor that achieved financial independence at the age of 30. He started in 2009 with the purchase of his first triplex and now owns over 470 units. He spends his time with his family, growing his businesses, diversifying his income, and teaching others how to achieve financial independence through real estate. Eric has been seen on Forbes, Trulia, WiseBread, TheStreet, and other financial publications.
I started out as a full-time student, over $60,000 in debt, and didn't even have a full-time job (two part-time jobs).
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