Thirty-billion dollars. That’s how much money is currently sitting, collecting dust, doing absolutely nothing for property managers across America. Where is this money hanging out? If you guessed security deposits, you win.
Security deposits represent an enormous amount of money, constantly changing hands in the SFR community. Traditional security deposits exist for good reasons but aren’t ideal for everyone. If you’re at all familiar with our Triple Win approach and resident benefits, it probably won’t surprise you to learn that, yes, there is a different way.
What are the risks of a security deposit?
Security deposits are clunky and inefficient. It’s an enormous expenditure beyond a month’s rent for residents that often represents a serious barrier to rental. Even though it’s refundable, residents rarely think of it that way because they aren’t refunded until they move out, which could be years down the road. Even though professional property managers return about 70% of collective deposit balances, residents often expect never to see that money again.
“The majority of people leaving believe ‘you’re not going to give me my money back,’” says Birdy Properties Founder and CEO Brian Birdy.
As rents continue to rise across America, so do security deposit requirements. After these sums are collected, they don't do much, mainly just sitting until they’re either returned to the resident or used to cover damages at move out. Security deposits are also a major source of 1-star reviews and are generally a pain to administer and manage. Savvy PMs have started looking for ways to turn this legacy process into a triple win. Here's the breakdown on four new ways of approaching it:
Types of security deposit alternatives
Security deposit alternatives that are beginning to go mainstream aim to lower the barrier to rental for residents. This lower barrier, in turn, increases ROI for the owner and boosts the PMC’s bottom line. It’s one of the best examples out there right now of a triple win.
First though, what are they? Alternatives to security deposits are not one size fits all. They can vary based on business size, strategy, and state and local laws, and there are several different ways to apply them. The general concept is roughly the same, though. Offer your residents a small recurring fee that buys them the privilege of not having to pay a security deposit. You can achieve this goal in four different ways.
- Pure insurance
- Surety bonds
- ACH authorization
- In-house program
Insurance, surety bonds, and the ACH authorization are all available through third-party vendors, which are increasing in popularity.
This is exactly what it sounds like. Instead of a deposit covering potential damages, the resident takes out an insurance policy to cover any damages. The resident pays a small premium, and on move-out, the policy covers any damage to the property up to a certain amount.
Pure insurance is great for the resident, who pays a premium and then bears no financial responsibility for damages after move-out.
Inherent in that approach, however, is a flaw that makes the pure insurance play tough to buy into as the industry's future. It doesn't incentivize the resident to take care of the property, as they won't owe any additional money for any damage they cause. This flaw leads to higher premiums, leaving insurance as a less effective way to keep costs down.
The surety bond business model is not new. Still, it's become more popular as vendors have modernized the enrollment experience thanks to over $150M of VC investment into the category.
Surety bonds are agreements between two parties managed by a third party, known as the surety. In the case of property management, the contract is between you as the property manager and the resident. It states that the resident agrees not to damage the property and agrees to cover damages should they be responsible. In case of a contract breach at the end of the lease, the surety pays out the sum required to the property manager, then bills the resident the cost of the damages.
Surety bonds attempt to incentivize the resident to take care of the property, which is more than a pure insurance program will do, but there's not a definitive set of evidence yet that this is highly effective. It's still a challenge to educate some residents that this isn't an installment plan or insurance product. In many cases, that falls on the property management team.
Another concern with the surety bond model is the post-move-out collection results. The majority of damages due from the resident never get collected, which leaves the model with potential recourse ahead:
- Vendors figure out how to collect a higher percentage
- Vendors increase monthly pricing
- Vendors expand into other, more profitable products
- Less reliable claims payouts
- Layoffs or other financial controls
- More investment requested for more runway
The jury is still out on whether surety bonds have the unit economics to win the category.
The ACH (Automatic Clearing House) authorization is a popular alternative. It mirrors the method hotels have used for years to compensate for incidentals and applies it to long-term rentals. Residents permit a financial institution to directly draft money up to a certain amount to cover damages.
The ACH authorization does check the box of incentivizing proper treatment of the home, and the vast majority of money due from claims is collected. So far, this method seems to be getting the best results in post-move-out collections.
A fair critique is not 100% of residents qualify for this, and the ones that don't must pay a traditional deposit, so it isn’t a complete solution in some people’s minds.
Todd Ortscheid, CEO of Revolution Rental Management, built his alternative program in-house. Ortscheid spoke on this topic in an episode of Triple Win LIVE in February.
“We offer the resident two different options. You can either pay the security deposit amount based on your [application] score, or the alternative is you can pay a monthly security deposit waiver fee,” says Ortscheid. “What the waiver fee is doing is buying you the privilege of not having to pay a security deposit upfront.”
Ortscheid clarifies that his implementation of this program is neither insurance nor a refundable installment towards a security deposit. However, there is debate among other PMs and their attorneys about what compliance risks there could be here. Some property managers also struggle to get comfortable with the financial liability.
When deciding to outsource or DIY, we recommend considering three things:
- How much of a difference can scale make now? Over time?
- How large is the skill or expertise gap here? Over time?
- Is this the best investment of my time? Will it be later?
Benefits to the resident
All of these programs can be relatively simple to administer and offer choice to the resident.
According to Ortscheid: “About 70% of the people we rent to now select the security deposit waiver option.”
“When I first started doing this,” Ortscheid says, “my assumption was the only people who will take this are the people with the worst scores. What we actually found was our very first person who signed up for it was someone with an 800+ credit score. He was the CEO of a publicly traded company and had millions in the bank. So I asked why he took the waiver option, and he said, ‘I would rather pay monthly than give you a big chunk of my money.'”
While it may seem counterintuitive that a resident would want to pay a non-refundable fee over a refundable one, it’s important to remember how residents feel about deposits. Alternatives are designed to lower the barrier to rental for residents, but many people who can clear that barrier still find the alternative programs preferable.
Benefits to the investor
Perhaps the investor sees the most significant win from security deposit alternatives. And, given the PM’s fiduciary responsibility to the investor, an investor win is usually a win for you.
The biggest thing here is the attractiveness of the program to the resident. A security deposit alternative is something you can and should advertise in your listings. It adds a differentiating factor to your listing that moves the needle for many prospective residents, which helps keep your days-on-market low. Revolution Rental Management has been sitting at an average of about ten days on the market over the last year. And as we all know, minimal vacancy equals increased ROI for investors.
Additionally, some property managers claim the lack of a deposit drives fewer damage claims at move-out. This reduction in claims helps to protect the investor’s assets more than a deposit does.
Again, this may seem counterintuitive, but Birdy Properties reports this scenario playing out since they moved away from security deposits two and a half years ago.
“There is this philosophy out there from residents. Most people believe ‘you’re not going to give me my money back. And since I’m not getting my money back, I’m not going to clean up too well because if I do all that work, you’ll still keep my money anyway. Well, now, you were nice enough to let me move in and not have to give you all this money. Everything has gone well, and now it’s time for me to leave and I can recognize that if I don’t leave the property in good shape, I’m going to have to pay for it.’”
“We’ve watched the numbers,” continued Birdy. “We have seen a reduction in overall move-out claims. What it’s costing to turn a property over has gone dramatically down, and we have almost eliminated the turnover cost to the owner. That is the most vulnerable time for us as property managers because that’s when the investor decides if they want to keep this asset any longer.”
The speed with which Birdy Properties can roll in another resident with minimal costs keeps the property investors happy, which prevents the PM from losing inventory while maintaining great service and relationship with the client. This great relationship comes from a service residents love, so it all works together to benefit every party. Best practices are developing that will drive triple-win experiences.
Security deposit alternative companies and their services
We’ve seen several new companies popping up in this space over the last few years. They span different approaches, and each has its pros and cons. Most contract directly with the property investor, and the property manager oversees its execution.
Unfortunately, several of these services are strictly available in large apartment communities, though some work for single-family rentals. Examples include Rhino, Assurant, LeaseLock, and Jetty.
The cost of a security deposit alternative
Security deposit alternatives don’t necessarily save money for the resident, but they offer a choice that many residents prefer – not giving up a big chunk of cash right at the start.
In general, the cost structure for security deposit alternative companies is either a low monthly fee or an annual fee. For most PMs, you can include the cost in a Resident Benefits Package, or it’s billed directly to them by a vendor.
The cost can depend on the property's value, the rent and deposit amount, the resident’s credit, etc.
How 1,000+ professional management companies create Triple Win experiences
Security deposit alternatives are an innovative solution that solves problems for residents, investors, and property managers.
- For residents: A quality alternative lowers the barrier for residents and give them more choice and agency in the rental process.
- For investors: A quality alternative can boost your listings’ marketability and reduce vacancy costs.
- For property managers: A quality alternative with more relevance for residents and investors – creates new value with an opportunity to monetize and eliminate administrative pains of traditional deposits.