How to handle security deposits

In the world of property management, nothing is more important yet controversial as security deposits. Owners try to “make money” off tenants by keeping their security deposit. Tenants sue owners often to get their security deposit back. Here are a few ‘basics’ to help keep both parties out of hot water.

Setting the amount: A lot of owners will set a very low security deposit. Their theory is that by setting the deposit low they can attract a lot of prospective tenants and rent their unit quickly. And they are absolutely correct.

The problem is they attract the wrong kind of tenant. They find people who are not able to save money — who live day-to-day. This becomes a problem when the tenant has a large expense (such as an auto repair or medical bill). Often the rent plays second fiddle to the other expense and rent is either late or not paid.  Once this cycle starts, it rarely ends without an eviction.

Hardly ever do owners set the security deposit too high.  But at Full Service Property Management, we set a security deposit equal to about one month’s rent.  We have found this is not too high of a deposit for most good tenants, but is high enough to attract those tenants who are resourceful and plan ahead.  Have you seen those apartment specials advertising “Move in for just $50”?  You can be sure that in most instances the ‘move out’ will cost the landlord a LOT more than that!!

Managing the deposit:  There are lots of rules to keep landlords from spending the tenants’ money.  (And until the tenant moves out, it should be considered the tenants‘ money, and not the landlord’s!!)  In WA state, owners must have the security deposit in a separate account (so they don’t co-mingle the tenants’ money with their own and end up spending it).  For one rental this may not be that big of a deal.  But as the number of rentals increases, so does the importance of this accounting practice.

Owners cannot hold a security deposit (in WA) without a detailed move-in checklist showing the condition of the property.  Many landlords think they are holding a security deposit, but without a move-in checklist all they have is prepayment towards rent — hardly any security at all!

Returning the deposit – the move out: Many owners abuse the security deposit by keeping it without justification, and give the rest of us landlords bad names.  It is important to be fair.  That works both ways.  A tenant also needs to understand sometimes that what they consider ‘clean’ isn’t necessarily commonly agreed upon.  For example, just because it is convenient to leave behind a large piece of furniture doesn’t necessarily mean anyone wants it!

In WA state, just like with the move-in, a move-out checklist is also required.  This is when the rubber meets the road.  Comparing the two checklists will determine and discrepancies.  But owners cannot simply get new carpet at the tenants’ expense.  It is not that simple.  The cost of that carpet needs to be depreciated over the life of carpet.  If the carpet is 5 years old and it has a 10-year lifetime, then the landlord can only deduct half the cost of installation of new carpet.  Different tasks have different lifetimes, and there is no standardized table of material lifetimes.  It is all a gray area that should not be abused by either party!

Also in WA state, a landlord has to give an accounting of what he/she is holding back on their security deposit.  This accounting has to be mailed or given to the tenant within 14 days.  At Full Service Property Management we call it ‘the 12-day letter’ to make sure we do not run afoul of the law.  This is a sticky area that needs to be adhered to religiously.  A landlord may not know all of the costs in 2 weeks.  So we will put estimates and placeholder amounts in our calculations.  We almost always do a $250 utility holdback.  We cannot tell you the number of times we have refunded a tenant’s security deposit only to have an unpaid utility bill come in afterwards!

In summary: Be smart and be fair.  If you are a tenant then leave the place as you found it or be prepared to take responsibility for damage.  If you are a landlrod, don’t play with other people’s money.  In both cases, handle the other party with respect.  Treat them as you would want to be treated.  Best of luck.

 

Disclaimer:  We are not lawyers, and this information is not offered as legal advice.  Laws change and different states may have different rules in place.  You are advised to seek the counsel of a licensed legal representative regarding any of the matters discussed here.

Peter Nelson is President of Full Service Property Management in Seattle, WA.  He and his wife have their own rental portfolio and have been successfully managing their portfolio and those of their clients for over 30 years.  More information is available on their website at www.fullservicepm.com.

Seattle Rental Market Report

Dupre’ and Scott just released their 1-19 unit Rents & Vacancies report.  This report is always highly anticipated as Patty Dupre’ and Mike Scott do the best job analyzing and forecasting the rental market in Seattle and sub-markets.  They also publish a similar report for medium and large apartment communities.  This report focuses on single-family, multi-plex, and small apartment buildings.

Findings show rents are up between 4.3 – 6.9% over last year (versus apartment rents which rose 8.8%).  The vacancy rate across all unit types is a very low 2.6%.  75% of respondents to the survey reported they plan to raise rents over the course of the next year on average 3%.

Interestingly, less than 40% of renters in multi-plexes and 5-19 unit apartments pay for their own water & sewer.  The report goes on to break down vacancy rate, average rent, and number of units surveyed by each sub-market.  For example, the average rent for a 3-bedroom house in Renton among 174 units was $1,595.

Why we don’t call ‘Rooter’ companies

We all have those ‘moments’ — those moments when the kitchen drain or the toilet don’t drain or flush.  Usually such moments are meant with angst and worry.  We want the plumbing fixed, and we want it fixed NOW.  So we go running to the phone book or internet looking for a plumber.  We’ve all been there.  It’s likely we’ll all be there again.plumber

When it happens to a property we manage, though, our service manager has been given specific instructions to stay away from companies with the word ‘rooter’ in them.  I am not going to name names, but we have all seen them.  Why?  We have a few reasons.  None of them are scientific or proven — all of them are based on experience or superstition.

We have found that companies with the name of ‘rooter’ in them tend to charge more than other companies.  They usually have large advertising budgets which need to be funded through higher labor and bid rates.  We would much rather call ‘ABC Plumbing’, or better yet “Joe’s Plumbing’.

Call us soft, or call us a small business.  But we like the idea of entrepreneurship — of some small-time plumber struggling to make it in business.  I guess we like underdogs.  We also figure the small-time plumber doesn’t have the advertising budget or the bureaucratic overhead of a large company.

It doesn’t take rocket science to figure out how to snake a drain!  Joe probably has the thing figured out just as well as the rooter dude.  And Joe just might add some personal service on top of it!.  One thing we know for sure from experience: Joe’s bill will be less than the other guys’ bill.

We continue to work hard to save our owner’s money whenever and wherever we can.  It is too easy and too convenient to not care and pretend you have a blank check.  We don’t like that at all.  So the next plumbing clog, we’re tipping our hat to the little guy!

The long-term advantages of investing in real estate

Investment property, or rental real estate, is considered by most investment brokers to be a cornerstone to a diversified investment strategy.  But it typically is not a “get rich quick” type of investment.  Sure, there are the stories out there of “flippers” buying foreclosures at the auction and turning them around and selling them a few months later for tens or even hundreds of thousands of dollars.tenant-screening-process1

But those stories are in the minority, and most Americans’ real estate investment adds up to the equity they have in their home or previous home.  Since the 2008 real estate crash, that equity has shrunk.  Nevertheless, the soundness of real estate investing remains the same.  A quick peruse of Forbes Top 100 reveals that these thoughts are shared by most of the world’s richest people.

Here is a simple example that illustrates the point.  It’s called “other people’s money”.

Assume you purchase a home for $200,000.  Say you put down 20%, or $40,000, and get a loan for the other $160,000.  A year goes by and real estate in your area has appreciated 10%.  At the end of one year your chunk of ground on Baltic Ave. or Boardwalk is now worth $220,000.  Right?

Suppose for the sake of this example that after one year you decide to sell.  Further suppose, for simplicity sake, that there are no real estate commissions or closing costs.  So you sell the property for $220,000 and pay off your $160,000 loan.  That leaves you with $60,000 gross profit on a $40,000 investment.

That, my friends, is called a 50% return on investment (ROI)!  Even Wall Street can’t come close to matching those numbers.  Not legally anyway!  🙂  For those of you doing the math at home, you can arrive at the ROI by multiplying the leverage factor ($40K out of $200K is a 5:1 leverage) by the market appreciation (10% in our example).

The savvy investor will immediately counter with: 1) no one holds real estate for just one year; 2) there is no guarantee of a 10% rise in real estate, and; 3) everybody knows that closing costs can be a significant part of any real estate transaction.  And he would be perfectly correct on all three accounts.  But let’s delve into each of these arguments a little further because they warrant further consideration.

1. Liquidity.  You should not go into real estate with the idea of holding for one year and then selling.  We’re not talking stocks here.  Real estate is an illiquid investment and anyone who tells you otherwise is either lying or a foreclosure flipper.  Real estate as an investment strategy is a long-term, “buy-and-hold” deal.   We used one year in our example to prove a point.  The reality is, just like most other investment, the gains compound over the years.  The gains in subsequent years add on top of the gain this first year.

2. Guarantee.  We can’t argue this one.  There is no guarantee to this investment, or to life.   A lot of people who bought in 2007 and 2008 at the height of the recent market found that lesson our the hard way.  Markets go up and down.  But if you are in it for the long haul then you have history on your side.  Just as the Dow Jones Industrial has had recessions and depressions, over the long haul it has continued to go up.  So if you stick with the buy-and-hold strategy then you’ll recover from a short-term loss.

3. Closing Costs.  The effect of closing costs on a transaction decrease over time.  In our example above after just one year a 6% real estate commission would reduce that $40,000 by $13,200.  (Still not a bad profit!).  But in 5 years if that property rises to, say, $250,000 then the $90,000 profit ($250K – $160K) is only reduced by $15,000.   A bigger number to be sure, but a smaller percentage of the gross profit.  And would anyone be crying over a $75,000 profit in 5 years?!!

This example is a very simplified example.  The reality gets more complicated.  For instance, we did not take into account the tax benefits that might accrue from depreciating real property.  Nor did we account for the return on principal that occurs every month as a little bit of the principal of the mortgage is paid down.  These secondary effects only add to the equation.

Peter Nelson is President of Full Service Property Management in Seattle, WA — a full service property management and real estate brokerage firm providing a fresh, rewarding approach to real property management.  Their website has a wealth of information.