HOW TO ANALYZE THE RENTAL APPLICATION
Written by Peter Strauss of Iconic Investments
Rent control laws are becoming stricter, and evictions are harder to win. That’s why multifamily landlords must protect themselves by prudently selecting tenants. Before we start, I want to stress that all landlords most obey fair housing laws. This article is in no way meant to suggest that landlords discriminate when choosing tenants, but they must do their homework.
I will break down three of the most important parts of the apartment rental application: Credit Score, Income and Employment. A potential tenant's rental application is not black and white. You must spend some time analyzing each one.
Credit Score
In the past, a tenant’s credit score was the most important metric when deciding on a new applicant. Iconic spoke with three local management companies, and all three agreed that affordability (what the tenant can afford) outweighs creditability (the tenant’s likelihood to pay based on a credit score). The credit metric is still important, but don’t simply look at the credit score number without digging deep into the applicant’s credit history
Credit Score Number: Yes, it’s possible to have an 800-credit score with a few credit cards, and a short credit history. Is this person more qualified than someone with a 700-credit score with multiple credit cards and a lengthy credit history? Probably not! Look at the length of the credit history and number of credit accounts.
Negative Items on their Credit Report: Are collection accounts bad? Not necessarily. It depends on what they are for and when they occurred. Ten percent of the United States was unemployed in 2009. That could explain why the applicant’s payments were not timely during 2008-2010 or why they have collection accounts. Are the collection accounts from doctors or hospitals? Was the tenant hospitalized during this time and not able to work? There could be explanations for these events. If in doubt, ask the applicant. The most important thing to note is whether the applicant was timely with payments before and after the event. A red flag for many experienced property managers are delinquent utility bills. If the tenant doesn’t pay his/her utility bills on time, property managers feel there is a higher likelihood that the tenant will be late or default on rent.
Income
Over the last five years, we have seen rents grow in Los Angeles at a greater pace than income. As a result, landlords have become more lenient on income-to-rent ratios. In the past, the acceptable ratio was 33%. But landlords are now allowing tenants to spend up to 50% of their income on rent. When analyzing a potential tenant think to yourself: Can this tenant afford to pay his/her rent.
Income Verification: Make it a requirement that the applicant provide you with at least the last two paycheck stubs to verify income. If the tenant is self-employed ask for the previous year’s income taxes along with personal bank statements.
How much can the Applicant Afford? Using the paycheck stubs and the credit report, you can do determine how much the applicant can afford. Assuming the applicant nets $4,000 per month (after taxes), can he or she pay $2,000 per month in rent, which would be a 50% income to rent ratio? Well, maybe. The credit report will tell you the amount of credit card debt and student loans (minimum monthly payments) and car payments. You can assume:
Net Income – Debt/Obligations – Desired Rent = Free Cash Flow
Determine if the amount of Free Cash Flow is enough for the applicant to survive on. This formula will help you determine how much the applicant can afford, and it is the same theory a lender uses when giving a loan on a single-family residence.
Employment
The rental application provides information about the applicant’s employment history. Use it to your advantage. How long has the applicant been at his/her job? Three years or three months? Typically, longer lengths of employment are a sign of stability and lead to more highly qualified tenants. But say an applicant recently graduated from college, moved to Los Angeles, and found a job. Now they are looking for an apartment. The applicant has no rental history and a short length of employment, but he or she meets the income requirements. Don’t automatically dismiss this applicant. There are workarounds. In this case, a friend or a family member can cosign and guarantee the lease.
Be meticulous, landlords. Spend time analyzing each rental application. There are a number of different ways to determine a tenant's ability to pay, and good-paying tenants will not all fit the same profile. Remember, don’t only focus on creditability. Look at affordability. How much rent can the tenant afford?
Peter Strauss is co-founder of Iconic Investments, a commercial real estate brokerage firm focusing on multi-family (apartment) buildings within the Los Angeles MSA. Iconic represents apartment building owners with the sale of their investment properties.
Iconic Investments
16530 Ventura Blvd
Suite #409
Encino, CA 91436
T: 747-444-3300
W: www.iconicinv.com