The risk of financial loss in operating a property management company is high especially in today’s economic environment. Between rising interest rates, slowing rent growth, and surging inflation, asset value margins are exposed, and property owners are feeling the pinch.
Security deposits have historically been the go-to financial instrument to protect against such loss, yet they fundamentally cannot provide adequate protection. So, how can property owners prevent significant economic loss and avoid leaving too much revenue on the table?
“We challenge conventional thinking when it comes to mitigating multifamily risk, redefine the problem at hand, and offer a fresh perspective on how property owners and operators can achieve significant NOI and asset value lift through better loss protection,” says Paul Schaefer, founder of LeaseSurance, a new B2B InsurTech product underwritten by Bryte.
The occupancy obsession
If you ask any property manager or investor in the multifamily industry what the most important performance indicator is, they will in all likeliness say, occupancy levels. Most, if not all, would agree with this, but the follow-up question carries just as much weight, and that is, at what cost are occupancy levels achieved?
Property managers have a few ‘tools’ at their disposal to drive leads and ultimately, place new tenants. These ‘tools’ include reducing deposit requirements, offering promotional incentives, lowering rental prices and in some cases, even reducing tenant screening criteria. All these options, used to drive occupancies, present risk which comes at a great expense to the property.
Deposits: Reducing deposits increases the landlord’s exposure to future rent loss and damage which leads to more bad debt and reduced net operating income. On the other hand, if one had to increase deposits to reduce bad debt, less tenants would be approved, thereby reducing occupancies.
Promotional incentives: Offering incentives such as one month rent free, lowers the barrier to entry for prospective tenants, but it creates an unwanted and significant expense line, which lowers net operating income. Incentives also increase tenant churn and the cost of a new lease (advertising, commission, administration etc.) is extremely expensive, further affecting the bottom line.
Tenant screening: Weak tenant screening criteria can attract more tenants to the property to lift occupancy levels in the short term but eventually pressurized tenants will default and leave properties exposed to rent loss and damage, increasing bad debt and lowering net operating income.
Ultimately, cash deposits, as a financial instrument, are weak at mitigating tenant default risk and at the same time, attracting new tenants to drive occupancy levels – they act as mutually inclusive – what you win with the one, you lose with the other.
Lease insurance is the only way to drive occupancies, reduce discounts, lessen the administration burden while at the same time, providing more protection to reduce bad debt and increase properties’ bottom line.
The true cost of deposits for tenants
According to LeaseSurance’s data of numerous properties in the multifamily sector between 2018 to 2022, only 25% of total deposits were refunded to tenants. The balance, 75% of total deposits, were not refunded and were allocated against outstanding amounts. This means that tenants must pay a large, upfront amount for future rent loss and damage, which creates a financial burden to tenants and forms a barrier to leasing for property managers.
LeaseSurance analysed 12 000 tenants that vacated their rentals during this period, with various Final Account Statement (FAS) balances from zero to hundreds of thousands of Rands, including deposit refunds and deposits allocated towards outstanding debt.
What the data further indicates is that despite property managers requiring cash deposits to protect against future losses, cash deposits do not provide sufficient protection since bad debt levels remain above the 2% industry acceptable level – an opportunity that property managers give up on.
“LeaseSurance has seen that properties with lower deposit requirements (i.e., 0% deposit or 50% deposit), have much higher bad debt than properties with the ‘normal’ deposit equivalent of one month’s rent,” says Schaefer.
“If you add the cost of the promotional incentives, which stands at almost 2% of rental revenue, based on data from LeaseSurance, the true cost of occupancy is further magnified. So, although lower discounts and deposits might be solving the occupancy ‘problem’ on the one hand, they have created higher operational costs and lower economic occupancy on the other.”
Many tenants live from paycheck-to-paycheck and cannot afford a cash deposit. They must use other means to come up with the cash required and, in many instances, these tenants borrow the required cash (deposit), which comes at a very high cost – adding more risk to the landlord’s ability to collect rent in the future.
All in all, cash deposits make tenants poorer – many of them already plagued with high debt levels. It is more affordable to pay a small monthly waiver fee, than having to come up with an expensive deposit which they, in all likeliness, will not get back and most probably will have to finance with debt.
The only solution to this is lease insurance. The insurance premium, which is added to the tenant’s rental amount in the form of a waiver fee, provides the landlord with the key to attract new tenants and reduce discounts, while having more protection against future rent loss and damage, driving bad debt down and improving the property’s net operating income – and importantly, the asset value.
Why lease insurance is different to deposit alternative products
“LeaseSurance is not the first company in South Africa to provide a solution to the cash deposit problem. However, there are distinct differences in how the LeaseSurance’s product is composed, and why it is arguably, the most comprehensive solution to date in the South African market,” notes Schaefer.
Business model: LeaseSurance is a B2B lease insurance solution where the insured is the (multifamily) landlord and the insurer is Bryte, providing the landlord with reputable protection and cuts out unnecessary parties (such as the tenant or another company providing a guarantee with an unknown balance sheet).
Pricing and insurance cover: LeaseSurance performs risk analysis on actual property data from the landlords to provide the most optimal lease insurance cover and premiums which leads to a sustainable business model.
Technology: LeaseSurance uses state-of-the-art technology to automate processes to reduce administration for the property manager. LeaseSurance currently integrates with MDA (from MRI), the leading property management software in the country, and are planning to include other integrations in the future.
See the table below for a complete list which compares LeaseSurance against other deposit replacement alternative companies:
The LeaseSurance (Pty) Ltd is a Juristic Representative of Bryte Insurance Company Ltd., Licensed Insurer and Authorized FSP No. 17703