We worked with Chad Carson on this article, particularly in choosing the topic of how to screen for the best tenants. Chad is an excellent resource on running a real estate business – so much so that he and his family can travel the world from their real estate holding success!
Chad thought valuable content for his audience would be this step-by-step guide, including real-life examples of what works and doesn’t work. Thanks Chad, and be sure to check out his blog.
Great Tenants make Great Rentals
If you’ve been a landlord for a while, you probably agree that great tenants are the foundation of a great investment property. And, if you haven’t been a landlord before, this is probably one of your biggest concerns – how do you make sure you select reliable renters and not get burned? For both of these reasons, learning how to screen tenants to find and select only the best renters is a must-have skill.
Screen for the Best Tenants: Applicant Acceptance Standards
A bedrock to selecting great tenants is knowing and documenting your applicant acceptance standards. And, it’s a valuable skill that you can master.
Simply put, applicant acceptance standards are the criteria you use to evaluate applicants. When you apply the criteria, the output is 1 of 3 options:
- Accept an applicant
- Decline an applicant
- Accept an applicant with conditions (such as an extra security deposit)
Think of acceptance standards like Standard Operating Principles (SOP’s), and imagine trying to run a business without SOP’s.
We’ll address the benefits you’ll reap from great acceptance standards and how to create your standards. Then we’ll review a few case studies to demonstrate the impact of using acceptance standards — and what happens when you don’t.
Benefits of Using Applicant Acceptance Standards
In addition to selecting reliable residents, other meaningful, desirous benefits will follow from using applicant acceptance standards:
- Removing emotion
- Facilitating compliance
- Establishing baselines
1. Removing emotion
When using acceptance standards, declining applicants that don’t qualify becomes easy. There is no emotional fatigue about should I or shouldn’t I, or trying to help someone out, or liking an applicant and wanting to rent to him/her when you know that person is high-risk.
Simply put, there are minimum qualifications for ‘lending someone this asset’ – and if it’s not a fit, it’s not a fit. Communicating this to applicants also becomes easy, because you will have given applicants your acceptance criteria before they apply.
So this one practice removes emotion that can lead to bad decisions, and it is also removes emotion from communicating with applicants — two huge benefits from one practice.
2. Facilitating compliance
Documenting your standards and communicating them with applicants helps ensure consistency while evaluating your applicants.
There are two major federal regulations to stay compliant with at all times – Fair Housing and Fair Credit – and this one practice helps facilitate compliance with both. To go wayward, you would have to deliberately violate your own rules and SOP’s, which alone will give you pause.
With written standards, you are well on your way to treating everyone the same way and avoiding discrimination. Remember that even when you “bend” or “sway” with good intentions to “help someone out”, it’s discrimination and poor business practice.
Consistency is key, so the two benefits discussed will help you make better decisions, avoid pitfalls, and be a professional. But there’s more.
3. Establishing a baseline that can be adjusted over time
Lastly, as macro-economic factors change over time, using acceptance standards will help you establish a baseline to adjust over time.
As you see employment conditions change, school systems improve, and so on — you will be in a good position to easily tighten or loosen certain criteria over time. You will be able to draw correlations between these changing conditions and your acceptance criteria.
In a sense, it becomes much more natural to review and correlate your financial results to your operational standards.
How to Create Great Applicant Acceptance Standards
Now that we understand how critical this talent is, let’s review how to be great at this skill.
Let’s go a bit deeper in some of these areas.
Income and Employment Verification:
This can be challenging since few employers are willing to provide references. There are 3 pieces of evidence you can try to obtain from the applicant:
- Pay Stubs: Preferably for the last two months, minimum. Be cautious, it’s easy to buy a fake pay stub off the internet. You must still call the employer, look at LinkedIn, and find collaborative evidence that the pay stub is legitimate
- Tax Returns: Especially if your applicant is self-employed. Last 2 years minimum.
- Bank statements: Trace the inbound paychecks – again preferable for two months minimum
Debt to Income Ratio:
This is one of the key financial measures you should use, especially for low-income properties where a credit score isn’t really helpful. Use gross figures for both income and expenses, and refer to the example below:
- Rent = $1,200
- Monthly bills from credit report total = $525 (also add in child support, alimony if relevant)
- Income = $42,200 (either average out last 2 years’ income or use current income, include alimony etc). Monthly = $3,373
- Monthly Debt = $1,725 ($1,200 rent + $525 from credit report)
- Debt:Income = 51.1% ($1,725 / $3,373) x 100
Prior Landlord References:
Rental history verifications are an excellent resource when done properly. Again for low-income properties where credit and financial measures can be a stretch, a differentiating factor can be these references.
Use your professional skepticism — current landlords may say glowing remarks about their renters simply to offload them. Your best sources are prior landlords who have nothing to gain or lose by telling the truth.
You have two objectives here:
- Validate information on the rental application for trustworthiness
- Ascertain rental behavior
Validating Info on the Application:
Ask detailed questions specifically to verify the information your candidate stated on the rental application. Decline all applicants who have any mistruths on the application. Good examples include:
- What dates did he/she live there?
- How much was rent?
- Was he/she a smoker?
- Were they ever late on a rent payment
Ascertaining rental behavior:
Ask other open-ended questions like:
- Was the security deposit returned in full?
- Would you rent to him/her again? Why/why not?
- Were there pets?
- Any neighbor issues you had to address, like being loud etc
Now, having said all that, this only helps if you are speaking to the actual landlord and not your applicant’s best friend. To verify you are speaking with the landlord:
- Try to match the person’s name to the public records as the homeowner
- Google the person’s name and call that number versus the # listed on the application (if they are different, beware)
- Before you identify yourself to the landlord as to who you are and why you are calling, ask “is your rental still available?” If the response is “What rental?,” you might be speaking to a friend.
Case Study Vignettes:
Let’s try to bring all of this information together with some case study examples. These will show you how the applicant acceptance standards work in action.
1. Crisis averted at a low-traffic, low-income property
Brooke inherited a rental in a different state that had rented for years to one individual. When the renter gave notice, she was terrified. She said “I was so worried, I needed the rental money, but I’m older, I was scared of being taken advantage of, and knew the home was in a bad area.”
First, Brooke traveled to the rental and had an open house one weekend. Traffic was low at 4 candidates. She didn’t have acceptance criteria, ran credit reports on the candidates, and saw they all had essentially poor credit and similar backgrounds. She selected the one with the best credit. He moved in, paid rent twice, and moved out without notice.
Brooke was now stuck and really stressed.
Desperate, she called a screening company that suggested she document acceptance criteria, with particular focus on employment, income, and debt. Still with low traffic, this next time she selected a candidate still with poor credit, but also with:
- Verified income at 2.6x rent from 2 verified employers
- A high but improving debt to income ratio at 54% with no new tradelines in the last 6 months
- Prior landlords who verified facts on the application and said the candidate left the rentals in fair condition
Brooke says “I had such low traffic, I was worried about having acceptance criteria at all. My criteria were actually very low. It was actually the criteria discussion that helped. When I relayed the criteria to one applicant, he was honest about his situation, and he followed up. What he relayed was backed up by the references so although the criteria was low, there were no surprises.”
2. Experienced Landlord With 8 Properties in Decline
Tony had been a landlord for many years and had 8 properties in the Southeast. The properties had generally done well for him, but with each turn over the years, he was finding the renters were getting worse and he was now evicting a renter.
Tony updated acceptance standards for each of his 8 properties:
- For the 3 low-income properties, he emphasized steady employment criteria (6-12 months+ with one employer depending on the property), debt-to-income under 50% for all 3 properties, no evictions or bankruptcies in the last 2-3 years (depending on the property)
- For the most stable property, he focused on credit score (700+) and debt to income of 35%
- For the student property, he incorporated 3x debt to income requirements, allowed co-signers, required 2 months’ security deposit, no smoking or pets
- When the student property turned, the property was left in much better condition
- One of his low-income properties had been turning routinely. He has reduced turnover there entirely with a couple that pays routinely and intends to stay for years.
- Tony has restored confidence. “When the properties turn again, I have a system. It’s no wonder my properties were going downhill. That won’t happen again.”
Information in this article covers a broad array of landlords and properties, but of course each property, situation, and locale is unique. If you want to learn more and go deeper, resources abound:
- For more localized information, check with your local real estate investor association (REIA). Usually they have a google discussion group in which you can ask networks how they handle this in your specific area
- Google “rental acceptance criteria” and you’ll find a lot of examples from realtors, property management companies and so forth
- Check out some of our How To Guides or additional resources in our landlord toolkit
Reliable renters make great rental properties, and selecting reliable residents can be a systematic skill that you develop. Use these tips to create and deploy great applicant acceptance standards for each property and drive solid financial performance.
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