Existing tenants in rental property that is being considered for purchase can be either assets or liabilities.

The most obvious benefit is having no rent-up time for any units that are currently leased. A related secondary benefit is that obtaining financing may be easier because the lender knows what the true rental income is for the property rather than having to depend on the borrower’s projections, possibly overly optimistic, or do extensive market research of its own.

However, inheriting existing tenants can also mean more risks unless the buyer takes adequate steps to know exactly what he/she is getting. In this short article we’ll briefly discuss a few of the issues.

Some potential risks are minimized by (1) actions prior to making an offer, (2) writing a good purchase offer contract, (3) adequately analyzing accounting records and lease documentation during the due diligence period, (4) verifying the condition of unit interiors as early as possible, and (5) corresponding with the tenants immediately following close of escrow.  We will discuss these items only as they relate to the existing tenants.

Pre-Offer Tasks

If possible, require certain written information prior to even writing a purchase contract. In addition to knowing the current rents and the lengths of existing leases, this should include knowing the terms of any options for extensions or renewals because when rents can be increased, tenancies terminate, and introduction of the buyer’s own lease agreement can be important to current value and future operations. It is particularly important to know such information for
commercial properties before deciding on the price to offer, because multi-year options are almost always part of commercial lease agreements, while only occasionally seen in residential agreements.

Writing a Good Purchase Contract

In general, the most important issues related to a good purchase contract is that it contain requests for copies of all relevant documentation and adequate contingency clauses related to all issues that are material factors in a buyer’s decision of whether to own the property for the price that will be offered.

Regarding existing tenants, the most important documentation includes lease agreements; Rules & Regulations or other policy statements issued by the seller to tenants; rent payment histories; and application forms, screening reports, and move-in checklists. If the property currently has a resident manager, the employment contract and associated lease agreement as well as instructions and policy statements related to management should be requested. It should also require copies of leases and related documents and verify that leases agree with information previously provided and contain adequate legal clauses and no illegal ones.

It is recommended that there be contingency related to inspection of units early in the due diligence period, not only to determine general interior physical conditions, but to also ascertain that there are not damages that could not be reimbursed from existing security deposits – hence the need for move-in checklists.

The offer should require that the seller confirm that there are no lawsuits, regulatory agency actions, or other claims pending against the property related to previous or current tenants not previously disclosed in writing and require a warranty that the seller has complied with federal and state lead laws and other potential contaminants. It should require that the seller provide copies of required disclosure documents for existing tenants under federal, state, and local laws and any
inspection reports related to possible contaminants. The contract should require that the seller provide copies of documentation related to complaints by other tenants, neighbors, and government agencies about any tenant.

Avoid potential after-closing problems by utilizing Estoppel Certificates and making execution by all tenants a contingency. Although often not utilized unless required by the lender, as they usually are for larger properties, Estoppel Certificates should be used for every purchase of a tenant occupied property. An Estoppel Certificate is a document signed by a tenant that, among other things (1) affirms the lease documents (attached to Certificate) and the deposit/rent amounts; (2) confirms that there are no agreements outside of the attached documents; and (3) confirms the amount of security deposit, the current rent, and the date to which rent has been paid. The document is sometimes called a Certificate
of No Defense. In addition to verifying information provided by the seller, the Estoppel Certificate “stops” the tenant from making claims regarding the included issues after close of escrow.

If closing is delayed, it might be necessary to get updated amendments to the certificates to cover rents collected since the previous versions were executed or because of certain other special changes in circumstances, including amended or new leases.

Although the buyer would theoretically have legal recourse against the seller if he/she had been provided false information or not been provided “material” information, doing anything about it might take years. It might even be impossible, for example if the seller moved to Switzerland immediately after closing escrow.

Escrow Issues

Since the buyer will be responsible for returning all or part of security deposits when the existing tenants leave, the purchase offer contract (and any subsequent escrow instructions) should explicitly state that the buyer is to be credited with security deposits at closing. The seller should also be required to provide a signed letter at close of escrow informing the tenants that the property has been sold to the named buyer.

After Closing

A buyer should correspond with the tenants immediately following close of escrow. A copy of the letter from seller mentioned above should be attached to a letter from the buyer. The buyer’s letter should confirm being the buyer, instruct the tenants where to pay their next rent and how to contact the new landlord, inform them that he/she and/or his/her vendor will be making a detailed inspection in the near future (with reasonable notice) to check for maintenance problems, and request them to report any problems of which they are aware. If the previous owner utilized Rules & Regulations and the buyer wishes to change them as would be allowed under the lease agreements and general lease agreement legal principles, the new Rules & Regulations could also be included. The new landlord can also affirm that he/she is a “Fair Housing” landlord.

Question

The applicant I had selected for my vacant rental house just told me, prior to our final walk-though inspection in two days, that he has had unexpected problems coming up with the full amount of security deposit and first month’s rent that we had agreed on in the already executed lease agreement. What are my options?

Answer

Occasionally, the selected applicant informs a landlord at the time when security deposit and rent are to be paid that he/she is short some of the funds due. In such a case, a landlord has basically two choices, assuming that the lease agreement included adequate clauses and the selected applicant has not been given legal possession.

If the lease agreement has words that make its commencement contingent upon receipt of all funds due, you can tell him/her that you will have to select another applicant unless he/she can come up with the funds before the agreed deadline. Many times the potential tenant will miraculously find the required funds after all. If that doesn’t work and you prefer, for some reason (e.g., he/she was the only qualified applicant), to allow possession upon payment of less than the total funds due, there are certain ways to minimize the risks.

First, be sure that you require execution of an addendum to the lease that clearly states the agreed schedule of payment of the deficiency and that failure to perform is a material default of the lease resulting in its termination.

Second, be sure that the addendum clearly states that the unpaid portion is rent rather than part of the security deposit. The reason why this is important is that it is usually easier and faster to obtain an eviction for non-payment of rent than for most other defaults.

Possession should never be given until all funds have been received (either cash or bank check). If the selected applicants have been given legal possession (e.g., by giving them a key or allowing them to store personal property on the rental property) the landlord might have to proceed with eviction if the parties cannot come to agreement regarding resolution of the problem.

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Question

I am concerned about how many keys a tenant who is currently being evicted may have made and passed out to others during his tenancy. Would I have liability related to this issue?

Answer

It is highly recommended that locks be re-keyed between each tenant. When a tenant departs, the landlord has no way to know how many keys are in existence or who might have one. Accordingly, the best policy is to re-key every lock each time there is a change in tenants. The cost of re-keying is almost negligible if a landlord invests in moderately priced re-keying kits. There are also now lock designs which allow owners to easily rekey a lock without such a kit. Owners of
multiple properties can avoid the labor involved in that approach by keeping a few extra locks on hand and rotating locks among properties. Even the single-unit landlord can re-key his locks for $5.00 per lock plus about $1.50 per new key or less if he takes them into a home improvement store himself. A landlord’s expenditure of $25 or less to re-key a unit is an important investment in the safety of his new tenants and a major reduction in exposure to costly lawsuits. If locks are not re-keyed and future tenants are victims of any crimes, the landlord will likely be subject to litigation and it is quite possible that a Jury or Judge would assign some liability to the landlord in view of how easy and inexpensive it is to re-key.

Since deadbolts located near windows are often accessible to someone who is willing to break the window, some experts advise that inside-keyed deadbolts be used. However, as a missing key can result in inability to get out in an emergency, one should always provide for a place to hang the key that is easily accessible to the tenant while beyond reach of a potential intruder. Furthermore, the matter should be covered by adequate lease clauses wherein tenants understand the
issue and accept responsibility for maintaining the key’s availability to all occupants. However, landlords must conform to the laws and regulations of all levels of government, including building and fire codes regarding the issue.

Basically, landlords should provide as much security related to door and window security as is reasonably practical. At a minimum, they should secure the premises with latches or locks on all windows, good deadbolts on all exterior doors, sliding door handle latches or, better yet, sliding door security bars, and door viewers. Chain locks are, in general, worthless. All external doors in each rental unit should be solid rather than hollow core doors that can be easily
broken through within seconds. As with most things, landlords need to be aware of any special requirements related to these issues in their state and local areas. For example, California has very specific requirements for door and window locks, both as to what needs locks and specification of what locks are acceptable. Other states may also have specific requirements related to the issue of tenant security.

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Question

I own a property that I suspect might have contamination problems. Are there any issues related to willing this property to my son?

Answer

Landlords who own property that may have risks of environmental contamination should use care when passing the property to a beneficiary of his/her will or trust. Not only does the recipient of the property have potential liability, but also the executor or administrator under a will or intestate probate or the trustee of a trust could face liability under certain circumstances. Failure to adequately consider contamination can result in costly future problems for your executor/administrator or successor trustee or to a beneficiary.

Owners of contaminated real property are exposed to possible liability lawsuits from those of the public who have been adversely affected by the contamination. This can include adjacent property owners or from users of water underlying or flowing through the property. Additionally, there can be pollution liability under federal and/or state statutes and owners of contaminated properties can be held liable for the costs of cleaning up the contamination. Cleanup of contamination sites can be extremely costly, usually not just thousands of dollars. Costs often vary from tens to hundreds of thousands, sometimes even millions of dollars. Contamination on a property can also expose an owner to lawsuits from adjacent property owners or from users of water underlying or flowing through the property.

The most common form of pollution liability is the federal Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA), 42 U.S.C. §§9601-9675. Individuals, estates, and trusts and even managers of estates may also be liable under state environmental statutes and the growing body of state common law environmental liability for nuisance and trespass. However, CERCLA liability is currently probably most prevalent. Although the Act doesn’t
single out estates and trusts, neither does it afford them special treatment.

Under CERCLA, “responsible parties” can be held liable for the costs of cleaning up contaminated land. Responsible parties include past owners and current owners of the property. It matters not whether anyone in the chain of ownership knew of the contamination or contributed to it.  Lenders receive protection as long as adequate due diligence is performed prior to financing a property. The only one who is personally fully protected from liability is the one who died.

There are possible defenses related to inherited contaminated property, adequate discussion of which is beyond the scope of this response. For the executors or administrators who manage the estate and the trustees who manage trust estate assets, personal liability usually depends on the degree of their control over the use of the contaminated property. However, with the numerous court statements about the breadth of CERCLA liability, and the recognition by courts of the powers that these offices wield over property operations, liability is becoming more common.

Therefore, if you own property that you know or have any reason to suspect might be contaminated, do not leave that property to anyone under your will or living trust without adequate consideration of the issue. You should consult an attorney who is experienced in dealing with problems of contaminated property including the issue related to estates. Real estate which is known or suspected to being contaminated should not even be transferred into a trust.

You should also consider discussing the issue with those who might have to deal with the property following your demise. This would include likely executors or administrators of your estate and successor trustees of your living trust.

Finally, you might consider determining whether or not there actually is a serious risk of contamination liability. If contamination of a property is suspected rather than being a certainty, you might want to consider obtaining a Phase 1 Environmental Site Assessment (ESA) on the subject property. A Phase 1 ESA on the subject land includes examination of potential soil contamination, groundwater quality, surface water quality, and sometimes other items.

When the site includes improvements, the assessment may include: identification of possible asbestos containing building materials; inventory of hazardous substances stored or used on site; assessment of mold and mildew; and
evaluation of other indoor air quality parameters.

If the results of the Assessment show no problems, the risk of future problems is greatly reduced. If the results indicate a potential problem, a Phase 2 Assessment might also be required. A Phase 2 ESA is a more “intrusive” investigation wherein samples of soil, groundwater, or building materials are collected and tested for quantitative values of various contaminants.

Beyond a Phase 2 ESA there is potential Phase 3 ESA wherein remediation of a site is investigated.

Checking References

As a best business practice, checking applicant references should be considered one of the essential tenant screenings. Interviewing previous landlords and personal references are screenings that can be performed fairly easily and with minimal expense by a landlord.  The information obtained through reference checking complements the information obtained from identity verification, employment verification, credit reports, public reports, and other background screenings. Contacting the current landlord may reveal an impending eviction or serious lease violations that could spell trouble for you.

Before conducting an interview it is helpful to prepare a worksheet listing questions to be asked. Being prepared with a script is professional, courteous, and efficient. It also helps to ensure all questions are asked and asked in the same manner with each reference. Answers to the questions can be recorded on the worksheet and serve as written documentation to be placed in the applicant’s file.

Rental History

A landlord wants stable, responsible tenants, ready and willing to pay rent as agreed, maintain property to acceptable standards, and conduct themselves as good neighbors. Do the applicant’s rental references characterize the applicant as meeting these qualities? It is generally held that past behaviors give indications of expected future behaviors. Rental behaviors are key to risk assessment. A current or former landlord can provide the type of information needed to assess
the risk. A brief interview with an applicant may indicate a good match between the housing needs of the applicant and the rental property of the landlord.  Details of a year-long rental relationship with a prior landlord may tell a
different story.

Keep in mind that the landlord-tenant relationship is a contractual, business relationship. A lease agreement is legally enforceable with rights and obligations clearly defined for each party.  Calling a prior landlord to determine whether the applicant fulfilled his lease obligations is a business safeguard, not an invasion of applicant privacy. During the application process, the applicant acknowledged and authorized permission to conduct verifications and screenings for consideration as a tenant. If the tenant has been a problem tenant there will likely be red flags that show up in other screenings. Due diligence will help uncover false or misleading information.

Some landlords are reluctant to contact former landlords thinking perhaps the landlord might give a glowing recommendation just to move a problem tenant out. The willingness and extent of a former landlord’s cooperation may be dependent upon the approach the inquiring landlord takes during the interview. Most landlords will extend the courtesy of honest answers to the questions being asked and appreciate the same consideration if they were to make a similar call in the future. It is a matter of good business.

Consider the length of the applicant’s rental history. If the applicant has been a renter for several years, try contacting the landlord previous to his current landlord. The renter has already moved on but his records and/or his reputation may be recalled and prove helpful. There is always the possibility that the applicant’s current situation is at the opposite extreme of the recent rental past. Changing markets, employment shifts, health considerations, or family matters can
drastically affect the ability of a tenant to meet his lease obligations. Make sure there is no rush to judgment without sufficient information and analysis of the current situation. Be equally sure that there is no unintentional
violation of fair housing laws by extending preference, privileges, or waivers of rental policies to certain individuals in certain circumstances. A policy of non-discrimination must apply to each and every applicant so that tenant
screenings are conducted in the same manner, in the same way for all applicants.

Some landlords may be reluctant to provide information even with the assurance that there is the applicant’s signed release of information. It may be personal reluctance or stated policy. At the least, a landlord or property manager should be able to confirm dates of tenancy, rental amounts, and security deposit amount. An important question that should be asked: “Would this tenant be welcomed back?” The answer or the manner in which the answer is given may say it all.

Applicants wanting to withhold rental history may try to use friends as landlord references or use false or misleading street addresses. Make sure that you are speaking with a valid and appropriate party to verify past rental history. Verifying the name of the owner and property address can usually be done using searchable online County records. Public directories can also be used to verify address information and phone numbers. Legitimate landlords will have knowledge of rental information that a “fake” landlord will not have.

Some applicants hope that a landlord will be too busy to check rental references and the applicant can slide by, avoiding a negative reference or notice of coming eviction. Since the references are an important source of information, make it a policy to always check.

There may be a request from an applicant that the current landlord not be contacted. Possibly the applicant has not yet given notice or doesn’t want the landlord to know he is looking. The applicant may think that the current landlord will give unfavorable information, which may or may not be justified. While the request is understandable, the landlord should adhere to his stated policies. If one exception is made, other exceptions might follow. However, the timing of the
decision to contact the current landlord could depend upon whether the applicant meets other qualification criteria. If the applicant fails to meet minimum criteria there is no need to continue the process. If the applicant meets criteria, the current landlord should be contacted. Any information obtained from the landlord interview would be analyzed with information obtained from other screening reports for final evaluation.
If your rental policies allow pets, ask the landlord about his pet policies. Did the tenant comply with pet policies? Were any complaints received regarding the pet? If the tenant had a dog, can the landlord confirm the breed of dog?

A customized rental references worksheet might ask questions such as:

• Who were the signers on the lease?
• Were there additional occupants? How many?
• What were the basic lease terms?
• What was the amount of monthly rent?
• What was the security deposit amount?
• Did the tenant lease other facilities such as parking, storage, or garage?
• What were move-in move-out dates?
• What reason did the tenant give for leaving?
• Was notice given per the lease agreement?
• Was a walk-thru checklist used for move-in and move-out?
• Were there other deposits or fees collected?
• Was there satisfactory history regarding maintenance that was responsibility of the tenant?
• Was the full security deposit refunded?
• Were any legal notices served?
• Was it necessary to issue any warnings? Was situation cured satisfactorily?
• What was the rent payment history –number of times late, most days overdue, was resolution satisfactory?
• If pets allowed, was landlord satisfied with pet behavior, with no significant pet problems?
• If smoking allowed, were there any related damages or other problems?
• Would the landlord re-rent to the tenant?
• What types of screening does this landlord use?

Personal References

Personal references generally include friends, relatives, co-workers, or other individuals the applicant regards as being able to give favorable character recommendations. Most applicants would not list a reference who might give a negative opinion. This should be taken into account when contacting personal references.

However, while some landlords may consider personal references to be self-serving for the applicant, personal references should not be overlooked as a good source of information.  Particularly in a tight rental market, or for first time renters, students, and former homeowners returning to the rental market, the information provided by personal references can make a difference when customary sources are not available or insufficient.

Some questions to ask personal references may be:

• How does the reference know the applicant?
• How long has the reference known the applicant?
• How frequently does the reference keep in contact with the applicant?
• Is the reference a former roommate or co-tenant?
• Has the reference served as a reference before? If yes, for what purpose?
• Is there a business relationship with the applicant?
• Does the reference think that the applicant would be a good tenant? Why? (Can the reference provide examples of behaviors that demonstrate the applicant’s good qualities?)

Due diligence in all phases of property management is key to reducing risk and avoiding unnecessary stress and expense in tenant selection. Without sufficient information obtained from a variety of sources, an informed business decision cannot be made. Reference checking is an essential part of risk management for landlords.

The Choice is Yours

Most landlords agree that credit reports provide a wealth of valuable information about an applicant. Although other sources can be used to verify some of the information supplied by the applicant in his personal interview, on his application, or identification documents, a credit report is the most complete compilation of data about the applicant’s use of credit, payment history, and overall financial management. This document is the one document a landlord needs to paint in the details to make an informed decision. The applicant’s historical credit usage can be a predictor of future money management. The landlord must analyze the risk exposure that the applicant’s data history presents.

Each landlord operates a unique business with differing characteristics and resources. Markets vary and regional economies impact the size of applicant pools to fill vacancies. The decisions on how to run his business are made according to sound business criteria but often take into account the landlord’s individual comfort level and resource capabilities. What works for one landlord may not work for another landlord. The landlord is free to choose products and services that help him, his business, operate efficiently and effectively.

Tenant screening products have expanded to provide landlords – of every size, market, and comfort levels – the information they need to quickly and easily manage their properties. From the traditional scored credit report to credit recommendations based upon specific rental criteria to the latest interactive web-based landlord-tenant information partnership, the landlord has a real choice in the type and delivery of a credit screening product that meets
his needs.

Traditional Credit Reports

Long considered the gold standard of tenant screening, a full, scored credit report is familiar to landlords and tenants alike. Many a tenant has been selected using a credit score as the criteria for his tenancy. However, the full credit report contains much more than just a score. It is in detail the credit life history of the individual as reported by his credit grantors.  The history may be long or short depending upon the individual’s use of credit over time.

With a full credit report, a landlord can corroborate personal information as supplied on the rental application – Social Security number, full name and aliases, date of birth, current residential address and previous addresses if reported, employer name, address and job position if reported, spousal information; review of the individual’s payment history including credit trades, revolving, and installment accounts, account numbers and balances, accounts placed for
collection or written off; and public records for bankruptcies, tax liens, and civil judgments. A separate inquiries section lists recent requestors of the report which could indicate the applicant is shopping rentals or is being reviewed by
another grantor.

This credit report is ideally used by the landlord who wants to see detail, and carefully analyze that detail to gauge his risks. This type of landlord prefers to go beyond a credit score but at the same time does not underestimate the risk that a score can represent. Management of larger properties, multi-unit properties or multi-location properties is often best served by this kind of full-service screening.

The Fair Credit Reporting Act (FCRA) requires end users of consumer reports to have a legitimate and lawful business reason (permissible purpose) to receive a report or information contained in such a report. Tenant screening companies require submission of applicable business documents to comply with this requirement.

In addition the credit bureaus have instituted more stringent requirements for data security protection to reduce instances of identity theft and fraudulent use of credit data. To comply with this credentialing requirement, landlords as the end users of credit data must pass a physical on-site inspection of the location where consumer reports are accessed and stored. Establishment of permissible purpose and successful approval of on-site inspection is required before credit bureaus will approve access to credit reports.

Rent Recommendation

Another type of credit screening product available to landlords is a “rent-decisioning” model that analyzes the applicant’s credit history and presents a summary of the credit-report based information. The credit risk summarization is a decision tool that is sometimes better known as a “rent right,” “pass-fail,” or “scorecard” rental recommendation.

This tenant credit screening product is a software-based proprietary risk analysis model programmed with the landlord’s specific credit criteria. The landlord customizes his scoring criteria for each property and specifies the action to be taken for certain types and dates of credit events. The model can use a simple rules base (similar to if…then) or a statistical based program to evaluate the applicant’s credit risk. Most decisioning models provide a credit recommendation to accept, to accept with conditions, or to decline based upon the applicant’s information and the scoring criteria supplied. A scorecard model provides a letter grade based upon the applicant’s credit score.

The rules and criteria set for the decisioning model should fully reflect the landlord’s credit policies and give emphasis to those issues that are of concern to his unique operations. In the rent recommendation model, a landlord does not have direct access to the applicant’s credit report. The model does the screening and prepares the recommendation report.

Some landlords prefer to use this type of credit screening for the very reason that it is a so called “third party review.” The landlord does not have to be as concerned about securing or eventual disposal of the applicants’ sensitive personal information and can feel more confident that screening is performed consistently and objectively, that is, without discrimination.

Consumer Initiated Option

An innovative new credit product provides screening options to the private landlord that hadn’t been possible before. The process of requesting credit reports is streamlined, requiring no membership fees or complicated enrollment.
There are two significant features of this product – no credentialing is required and the applicant plays an active role in the process. In fact, the applicant must give his permission to release a copy of his credit report to the landlord.

The process is done online using secure technologies to safeguard sensitive personal information. The landlord creates a property account and sends the applicant an e-mail requesting the applicant’s permission to release a credit report to the landlord’s secure account. The e-mail directs the applicant to the secure Web site where the applicant must first successfully answer personally identifying questions before proceeding.

The applicant creates his secure account and accepts or declines the landlord’s request. If the request is accepted, the landlord receives the applicant’s credit report in his online secure account. If the applicant declines the landlord’s request, the application is rejected and no report will be sent.

The landlord receives the benefits of no document submission and no on-site inspection. The applicant feels more secure about data privacy and receives the added benefit that because the request was consumer initiated, the request does
not affect the applicant’s credit score.

Choose One

With more options available now than ever before, there really isn’t any reason for a landlord not to take necessary precautions to protect his business and help reduce his risks.

Which credit screening product should you choose? You should choose the product that makes sense for your business operations and your comfort level.

Tenant Screening Products for Every Business Model

Whether you’re the hands-on type of landlord or prefer to contract out property management, you owe it to your business to routinely review what new services and products are available to investors and managers of rental property. Periodic review of your operational procedures is always a good idea. Working smarter is more effective than working harder. If there’s a new product or a different product that better fits your business needs you might just want to give it a try.

Tenant screening products now being offered deserve your review. Over the years tenant screening has come to include more than just credit reports. Tenant screening now encompasses verifications for identity, address, personal data, employment, source of income, rental history, and personal references; database searches for criminal convictions, evictions, judgments, bankruptcy, sexual offenders, and OFAC terrorist list; background investigative checks; and credit tools such as credit reports and leasing recommendations.

With multiple screening products landlords can tailor the type of screenings most effective for their unique properties and local markets. By using tenant screening products landlords help protect their rental investment. Thorough analysis and evaluation of comprehensive screenings can help lessen the threat of a bad tenant. A key point to remember is to always screen and to use the screening reports that fit your business model.

Identity verification at time of application is a critical first tenant screening of the individual applying to be your next tenant. Obtaining screening reports on an identity thief can be much worse than doing no screening at all. If there is any doubt as to proof of identity, there is no need to advance further time and efforts to qualify the applicant.

Many landlords choose to conduct credit screening as soon as possible in the application process. Better to know sooner rather than later if the applicant is a viable candidate. As has been stated many times a credit report is regarded as the most valuable tool to assess the applicant’s creditworthiness, that is, his ability to pay and to pay on time.

Traditionally a full credit report was the only tool to evaluate an applicant’s credit history. Now you have choices for credit screening – the traditional detailed credit report sent directly to the landlord; a rent recommendation to approve, decline, or accept with conditions based on the landlord’s set rental criteria; or a new innovative credit screening which uses e-mail to complete the request process.

Selecting the right screening tool is an important part of your screening process. To make an informed decision, you must be knowledgeable about your legal responsibilities under The Fair Credit Reporting Act (FCRA), credit reporting agencies (CRAs), and the requirements of your tenant screening services provider. Don’t wait until the last minute to set up a provider account or complete any required certification process. An applicant in search of a new home is eager to get settled. Unnecessary delay in processing may have an unfavorable impact on the applicant’s decision to choose your rental. The good tenant you’re looking for expects good customer service.
In general, credit screening is conducted through membership with a third party service provider. The provider is legally required to have certain documentation on file before granting landlord access to consumer credit information. This would include acknowledgment and acceptance of the user service agreement, permissible purpose, proof of business ownership, and various other business documents. Landlord certification or credentialing may also be required before access to certain credit screening reports can be granted.
Various providers have different names for the credit screening tools they offer. The following designations do not necessarily reference any specific provider or product offering. Landlords interested in credit products are advised to conduct their own research and analysis of providers and products.

Traditional Credit Report

A traditional credit report is the gold standard of credit screening. With a full credit report, you can corroborate information shown on the rental application; review the individual’s payment history including credit accounts, account
balances, and collection accounts; and view reports compiled from public records on bankruptcies, liens, and judgments. You can also see who has recently requested a copy of the applicant’s credit report.
The basic credit report has four sections: identifying information, credit history, public records, and inquiries.

Identifying information identifies the individual by name, alias (also known as), shows current and previous addresses, Social Security number, date of birth, telephone number, and current and previous employers.

Credit history shows the individual accounts (also referred to as trade lines) with historical and current records of payment activities. Each account references:

• The name of the creditor, the account number, and date when the account was opened.
• The kind of credit (installment or revolving).
• Whether the account is in the individual’s name alone or with another person.
• The total amount of the loan, high credit limit, or highest balance on the card.
• How much is still currently owed.
• Fixed monthly payments or minimum monthly amount.
• Status of the account (open, inactive, closed, paid, etc.).
• Payment history (How well the account has been paid).
• Account review inquiries.

If a charged off notation is seen, the creditor has given up, usually after having attempted collection, and then written off the amount.

Public records include tax liens, court judgments (including child support judgments) and bankruptcies. Ideally, the public records section should be blank.

Inquiries show a listing of everyone who has requested a copy of the individual’s credit report. Inquiries are divided into two sections. “Hard” inquiries are ones initiated by completing a credit application; “soft” inquiries are from companies that want to send out promotional information to a pre-qualified group or current creditors who are monitoring the account.

Your screening provider may provide the option to add a credit score to the credit report. A credit score is a numerical value that represents overall credit-worthiness. It is a mathematical formula based on the information in the credit files compared to information in tens of millions of others’ credit files. Credit scoring systems assign points to each factor that indicates ability and willingness to pay creditors in a timely manner. Factors that are considered in the scoring calculation are: payment history, outstanding balances, credit history, new credit, and type of credit. Under the Equal Credit Opportunity Act (ECOA), credit scoring systems cannot use certain characteristics such as race,
sex, marital status, national origin, or religion.

The total number of points, a credit score, provides a means to evaluate credit-worthiness quickly and in a relatively objective manner. In general, the higher the score, the better (meaning less credit risk).

A credit score serves as a general indicator of financial responsibility rather than an absolute measurement of credit risk. It is a prediction of the individual’s ability to pay and to pay on time. It is not a guarantee that the individual will be a
good or bad tenant.

Landlords requiring a traditional credit report must have a one time site inspection of their rental business office (the location where rental records are stored) before being granted access to applicant credit information. The site inspection helps ensure that the applicant’s personal identifying information is kept safe and secure to help protect against identity theft.

Rent Recommendation

A rent recommendation is a report based on a software-based scoring model programmed with your specific credit criteria. The model uses a simple rules base or a statistical based program to evaluate your applicant’s credit risk. The
decisioning model provides a credit recommendation for either acceptance, acceptance with conditions, or decline based upon the applicant’s information and the scoring criteria you supply.

The rules and criteria you set up for your decisioning model should fully reflect your credit policies and give emphasis to those issues that are of concern to your unique operations. In using a rent recommendation model, you do not have
direct access to the applicant’s credit report. The model does the screening for you and you receive an analysis of the applicant’s credit report as per the selected standards.

Online Screening – Email

The latest credit screening option is conducted entirely online through cooperation between the applicant and landlord. Designed to protect the applicant’s privacy and certain personal identifying information and to give the applicant some control over the process, the landlord creates an account through his screening provider, selects the type of credit report, selects payment method, and enters the applicant’s email address. The online system sends an email request to the applicant for approval to send credit information to the landlord. The applicant responds to the email and after answering personally identifying questions, and confirming payment arrangements, submits the credit report request to the credit bureau. The landlord receives a report at his email address.

Conclusion

The landlord’s mantra should be screen, screen, screen. Filling a vacancy without knowing something about the person who will be your partner (willing or not) for the length of the rental contract is creating a liability. A filled vacancy only begins the landlord-tenant relationship. There is no guarantee of how successful and profitable that relationship will be. Screen every applicant, whether family, friend, or that seemingly really nice applicant. If you do not screen, it is a high risk roll of the dice. Are you that lucky?

Co-Signers & Guarantors

Based upon a greater perceived risk, you may offer conditional acceptance to an applicant by requiring the applicant to provide a co-signer or guarantor. The terms co-signer and guarantor are often used interchangeably and they can mean the same thing. However, there can be a significant difference between a co-signer and a guarantor if the co-signer becomes a co-tenant due to the manner in which the agreement is constructed.  We will further discuss this potential problem below and for simplicity will hereafter use the term co-signer from now on, as that is probably the term most often used by residential landlords.

Approval of the applicant as your new tenant is contingent upon the co-signer being financially qualified and fully screened. If the potential co-signer cannot successfully qualify, his guarantee is worthless, and your offer can be withdrawn since the contingency was not met.

The conditional offer, depending on the source of the information used to condition the acceptance, may or may not require notification to the applicant of his rights under the federal Fair Credit Reporting Act (FCRA).
The notification, an “adverse action” letter, is a mandatory disclosure of an action taken that is unfavorable to the interests of the rental applicant; that is, creates a burden in order for the applicant to be approved.  The subjects of adverse action and FCRA requirements have been discussed in previous tenant screening articles.

Common adverse actions by landlords include:

• Requiring a co-signer on the lease;
• Requiring a deposit that would not be required for another applicant;
• Requiring a deposit larger than might be required for another applicant;
• Raising the rent to a higher amount than for another applicant; and
• Denying the application.

If your conditional offer was based in whole or in part on any information contained in a consumer report, you must send the applicant an adverse action letter. You must send an adverse action letter even if other factors influenced your decision.

If you offered conditional acceptance based upon information personally supplied by the applicant, such as the rental application, a personal request from the applicant to provide a co-signer, or during conversions held with the applicant, you do not need to send an adverse action letter.

The applicant should be made aware that the potential co-signer will need to complete a rental application, pay any applicable processing fees, and submit to your regular tenant screening procedures. In short, you will evaluate the co-signer as thoroughly as you did the applicant. Character, capacity, and credit are the areas of interest as you conduct screening.

In particular, you want to determine that the co-signer can take on additional financial obligations. This is important since the co-signer will be responsible for not only his own housing costs but also the tenant’s rent in case of default, and, perhaps, damages by the tenant. Does the co-signer have enough liquid resources to cover the tenant’s rent or other financial obligations for some period of time? If the tenant skips out, will the co-signer be able to pay as agreed – both the rent until a replacement tenant is found and any damages?

You will need to deduct the co-signer’s housing costs from his gross income before comparing that income amount to your income standards.  For example, if the co-signer has a gross monthly income of $4,000 and mortgage costs of $1,000, then his adjusted gross monthly income is $3,000. Accordingly, if you use a 3:1 income to rent ratio, the tenant’s rent cannot exceed $1,000 if the co-signer is to qualify under your terms.

As mentioned earlier, absent adequate language in the lease, a co-signer can be considered the same as a signer regarding the lease agreement. Accordingly, the co-signer can become a co-tenant who, even though not living in or doing business in the leased premises, has all the same rights as a co-tenant who resides in the subject unit.

A guarantor is someone who assumes certain financial liabilities for a lease, but does not actually sign the lease agreement and, accordingly, has no rights to the premises. Accordingly, the landlord usually wants the co-signer to legally be considered a guarantor. There are basically two different types of guarantees, broad and narrow. The broad form of guaranty makes the co-signer/guarantor liable for all financial matters including rents and damages. The narrow form limits the liability to the rent.

Whatever the title of the agreement, it is important that the language makes it clear that the co-signer or guarantor is only guaranteeing all financial aspects of the tenant’s lease and is not occupying the premises pursuant to the lease and that the co-signer or guarantor does not become a tenant.

If the co-signer agreement is not contained within the lease agreement or signed concurrently with the lease agreement, the lease agreement should contain a clause that the lease is contingent on receipt of the signed co-signer agreement. The co-signer should receive a copy of the signed landlord-tenant lease agreement as well as of any separate co-signer document.

If a co-signer does not sign the lease agreement in person (e.g., the out-of-state parent of a college student) it is very important that, in addition to providing copies of the same identity verification documents that should be required of the applicant, the co-signer’s signature be notarized in order to minimize the possibility of forgery.

Guaranty agreements can be written to cover only an initial lease term or to include future extensions and renewals. The agreement should include any assignee of the lease during the term of the original guaranty. If a lease is modified during the guaranty period, all parties, the co-signer/guarantor and the tenant, should be required to sign a new document related to the modified lease.

In community property states landlords should require that both husband and wife execute a co-signer or guaranty agreement in order to be certain of binding the community. For the same reasons, both husband and wife tenants should be required to sign lease agreements. It is best to have both signatures whether or not this is an issue in a particular state because it eliminates potential disputes regarding liability for a lease and any issues regarding the fine print in the statures. The same recommendation applies whether the co-signer or guarantor is guaranteeing a commercial lease for a limited liability entity or parents are guaranteeing a residential lease for a student child.
Having a formal, written co-signer agreement emphasizes the legal obligations of both co-signer and tenant and what the consequences will be if the tenant defaults. Language in the co-signer agreement should make it clear that:

• The  co-signer is jointly and severally responsible with the tenant for any and  all financial obligations of the tenant under the lease agreement  including but not limited to rent, deposits, fees, or other charges as a result of damage to the unit.
• The co-signer acknowledges that the landlord has no obligation to give notice to the co-signer if tenant defaults.
• The co-signer agrees to appoint the tenant as the co-signer’s agent for service of process in the event of any lawsuit that might arise from the agreement, releasing the landlord from any obligation to separately serve
  the co-signer directly.
• The co-signer acknowledges the landlord may demand that the co-signer perform per the co-signer agreement in the event of tenant default without first using any of tenant’s security or other deposits.
• The co-signer shall remain liable for the performance of an assignee or sublessee of the tenant unless expressly relieved by written termination of this condition by the landlord.
• The prevailing party of any legal action brought by either party to enforce any part of the agreement will recover reasonable attorney fees, court costs, and other expenses associated with collection of a judgment.

While it can provide a means to fill vacancies, particularly in tight markets or college towns, many landlords feel because of the additional time, effort, and costs to screen co-signers and coordinate the lease/co-signer agreement process, the practice of accepting co-signers is of little real value. As a practical matter then, a landlord can legally set his rental policies to refuse to consider co-signers with one exception.

If a disabled applicant with insufficient income but who is otherwise qualified under the landlord’s standards, asks the landlord to accept a co-signer to guarantee rent if need be, the landlord must make an exception to his rental policy and conduct screening on the proposed co-signer. If the co-signer qualifies under the criteria previously discussed, the landlord must accommodate the applicant’s request and accept the co-signer.

Pre-Leasing

Some landlords like to minimize downtime of units by “pre-leasing.” Although at first thought this might seem like a good idea because it can theoretically reduce the period for which no rent is being paid, it sometimes creates enough trouble to more than make up for the times when it was advantageous.

By the term “pre-leasing” we mean renting a property that is still occupied by an existing tenant, more specifically signing a lease with the prospective new tenant before the existing tenant gives up possession.

While the landlord has the right in most states to show the unit while current tenants are still in occupancy, it is not always a good idea to do so.

The procedure has the potential for creating conflicts between the landlord and the departing tenant. Because the departing tenant is already stressed out about the pending move, probably already packing and organizing for it, there is a greater potential for such conflicts. Conflicts can relate to disputes regarding invasion of privacy and proper notices of entry, even claims of theft.

While privacy is somewhat subjective, in most states notice of entry can be a practical problem if the departing tenant wishes to hold the landlord to the letter of the law.  Many states require the landlord to provide the tenant 48 hours notice prior to each non-emergency entry. Entry must be during reasonable hours. Not only is 48 hours, even 24 hours, a long time when potential applicants are looking for housing, but the tenant may not consider it reasonable to show the unit during the dinner hours or at certain other specific times on certain days.

While in theory the landlord could push the issue of entry at any reasonable time after the minimum notice period, in practice this should not be done. The landlord should not enter a rental unit against the tenant’s wishes except for reasons of safety or preservation of property. The landlord’s only recourse against failure of the tenant to cooperate is to file a lawsuit. Use of force or even excessive pressure could result in a lawsuit against the landlord, even
criminal charges.

Security of the departing tenant’s unit is of particular concern if the property is being shown when the tenant is not present. The tenant is more likely to make theft claims against unknown persons viewing the unit than against the landlord or manager who is doing the showing. The landlord should
remember that he/she is providing entry to persons on whom no screening has yet been done. There have been cases where the showing has served as a chance for a burglar to case the unit prior to breaking in.

If the current tenants are uncooperative or outright hostile, it is best to wait until the unit is vacant.

The matter of privacy and advance notice is best dealt with by discussing the issues in advance of marketing the still-occupied unit. Often, agreeing on a specific time of the day when showings might occur is helpful.

The issue can be minimized by following certain procedures, including the following:

• Discuss the property showing issue with the outgoing tenant, including whether he wishes to allow it in evenings or on weekends;
• Give the tenant as much notice as possible before entering;
• Try to limit the number of showings each week; and
• Offer to reduce the rent slightly if the outgoing tenant considers showing to be an imposition.

Another issue is related to both privacy and security. A sign in the yard or advertising in any other format that provides the address of the unit can cause problems for the departing tenant. The least problem is when it results in interested persons knocking on the departing tenant’s door or the door of another tenant in another unit of the same property. The worst problem is if it results in a home invasion because someone broke in expecting the unit to be vacant. If a sign is put up, be sure to include the words “Shown by Appointment Only, Call (phone number), Do Not Disturb Occupants.”

The prospective applicants for the coming vacancy may be turned off by the housekeeping of the departing tenant and/or the current condition of the unit. At the very least, the unit may not appear to be worth the rent being asked. Even worse, it may be considered not even habitable to discriminating potential applicants. Obviously, the degree to which this is an issue will depend primarily on the housekeeping habits of the departing tenant, but will also depend on the condition of the unit compared to the condition it will be at move-in of a new tenant.

It is difficult for a prospective new tenant to properly evaluate a unit that is overly filled with furniture and other belongings, including a lot of already packed boxes, some of which hide defects that would be objectionable to the prospect. As examples, there can be carpet stains or tears and/or dirty or damaged walls, under and behind furniture, respectively. When such defects are found after the unit is vacant, the landlord must correct them or hope that the tenants will be happy living with them after being surprised at move-in, with the latter almost certainly being wishful thinking.

When the prospect sees the condition of the unit before it has been rehabilitated, he/she may consider the quoted rent to be too high for what can be seen and may be concerned about depending on the landlord’s promises regarding work to be done. Offering to put promises in writing can help, but many people can only see what exists and cannot visualize promised work or their expectations may be more than what is done. The matter becomes even more problematical if the landlord discovers once he has possession of the empty unit that significantly more work than expected will be required.

Potentially most troublesome, is what can result from the landlord committing to a replacement tenant before the departing tenant has actually vacated the unit. When the unit for which applications are being taken is still occupied, one must be concerned that the departing tenant may not vacate in a timely manner. A landlord who has signed a lease with a replacement tenant and then finds that the existing tenant fails to vacate as scheduled can end up between a rock and a hard place.  At best, there is an unhappy beginning for the new landlord-tenant relationship, and, at worst, there may be a lawsuit, even further delaying re-leasing of the unit.
For landlords who wish to pre-lease in spite of the disadvantages, there are ways to minimize the potentially greatest risk of being unable to give possession to the new tenant on the date promised. The risk of problems can also be reduced by having lease clauses that clearly define adequate move-out procedures and by providing notice to the departing tenant as previously discussed.

The best protection for the landlord is to put some of the risk on the incoming tenant by lease clauses or separate document in which the incoming tenant understands that possession is contingent on the old tenant vacating by a specific date, meaning that possession will be given within the time required for preparing the unit after the vacating. This may, of course, eliminate some potential candidates from the pool of applicants and even seriously deflate the pool in a bad market.

The bottom line is that landlords should consider the overall picture when deciding whether to pre-lease. The vacancy period between the tenants is usually most dependent on the time that will be required to clean, paint, and perform other work required between the tenants. Under normal market conditions, pre-leasing does not provide much advantage over not showing the property until possession has been returned to the landlord. A
landlord must decide whether that small advantage is worth the risk of extra trouble associated with interfacing with the departing tenant, the other issues
related to an occupied unit, and the potential for serious problems.

Consumer Reports and Adverse Action Notices

Tenant screening is a process of investigation, analysis, and selection/rejection of rental applicants. Not everyone can be your next tenant and not everyone should be your next tenant. Your decision to accept or reject an application will be based upon information you obtain from various sources and by qualification under sound business criteria.  The circumstances of a rejection determine what you must do by law to notify an applicant that his application has been rejected. Handling the situation in an appropriate manner and doing so legally is the subject of this article.

Landlords using consumer reports for evaluation of rental applicants must follow the provisions of the Fair Credit Reporting Act (FCRA). A consumer report contains information about a person’s credit characteristics, character, general reputation, and lifestyle. A report also may include information about someone’s rental history, such as information from previous landlords or from public records like housing court or eviction files. Consumer reports include

• Credit reports from a credit bureau, such as  TransUnion, Experian, and Equifax or an affiliate company,
• Reports from a tenant screening service that describe the applicant’s rental history based on reports from previous landlords or  housing court records,
• Reports from a tenant screening service that describe the applicant’s rental history and also include a credit report the service got from a credit bureau,
• Reports from a tenant screening service that is limited to a credit report the service got from a credit bureau; and
• Reports from a reference checking service that contains previous landlords or other parties listed on the rental application on behalf of the rental property owner.

The FCRA is designed to protect the privacy of consumer report information and to guarantee that the information supplied by consumer reporting agencies (CRAs) is as accurate as possible. To be covered by the FCRA a report must be prepared by a credit reporting agency (CRA). The most common type of CRA is the credit bureau.

Landlords often ask applicants to give employment and previous landlord references on their rental applications. Whether verifying such references is covered by the FCRA depends on who does the verification. A reference verified by the landlord’s employee is not covered by the Act; a reference verified by an agency hired by the landlord to do the verification is covered.

The FCRA requires landlords who deny a lease based on information in the applicant’s consumer report to provide the applicant with an “adverse action notice.”

An adverse action is any action by a landlord that is unfavorable to the interests of a rental applicant. It includes not only a landlord’s denial of a rental application but also a landlord’s action that imposes a burden not required of all tenants. Common adverse actions by landlords include

• Denying an application
• Requiring a co-signer on the lease
• Requiring a deposit that would not be required for  another applicant
• Requiring a larger deposit than might be required for  another applicant raising the rent to a higher amount than for another applicant

The landlord must provide the notice if the adverse action in any way is based on a consumer report that played a factor in the landlord’s action, even though its action is based primarily on an applicant’s income or prior reputation as a tenant. In fact, even if the information in the report plays only a small part in the overall decision, the applicant must be notified. This means that the landlord must usually send a notice if you hire a tenant screening company or even if just
looking at a credit report. Disclosure of this information is important because some consumer reports contain errors.

As examples, landlords must send an adverse action letter to applicants who are denied a lease if the following describes the decision related to denial even if other factors also played a part.

• A tenant screening company is hired which gives the landlord a report that includes negative information leading to rejection of this applicant,
• A consumer screening agency is used that supplies only a credit report and the applicant is rejected on the basis of information in the report,
• A local landlord or owner association has an arrangement with a tenant screening company that provides a member with a report on an applicant that results in the landlord deciding that the applicant is unacceptable,
• The landlord pays someone on a contractual basis (as an independent contractor rather than an employee) to do tenant screening and the contractor’s report leads the landlord to conclude that he shouldn’t accept the applicant,
• The landlord contracts with a property management company to investigate applicant and the landlord rejects an applicant based on what the management company says,

An adverse action report is generally not required if the basis for the rejection is one of the following:

• Information obtained from applicants themselves on the application form or in conversations with them or
• Oral or written information provided by an applicant’s reference.

Furthermore, landlords usually needn’t send a formal adverse action letter if the following describes the situation.

• The applicant is not accepted because the landlord, when asked by the applicant, won’t vary a rental term such as the rent or deposit amount or the pet policy,
• Information supplied on the rental application indicates that the applicant cannot meet the landlord’s criteria – e.g., no income,
• The landlord learns from a conversation with the applicant that he has to move in by a certain date because he’s being evicted and the eviction is considered to indicate a poor risk,
• The landlord or his employee calls the applicant’s past or current landlord, employer, or personal reference and which provides information that leads to rejection, or
• A self-employed applicant provides tax returns that show an income below the landlord’s qualifying criteria (e.g., “3 times the rent”),
• Upon analyzing an employed applicant’s pay stubs the landlord discovers that the applicant was untruthful regarding place of employment or income when filling out the application form.

Section 615(a) of the FCRA requires landlords, when they take an “adverse action” against a rental applicant based in any way on a “consumer report” from a “consumer reporting agency.” to provide an adverse action notice to that consumer. In particular the law requires landlords to provide tenant applicants with a notice that informs them about the adverse action, identifies the consumer reporting agency that provided the report that contributed to the landlord’s action, and
specifies consumers’ rights under the FCRA.

When an adverse action is taken that is based solely or partly on information in a consumer report the FCRA requires the landlord to provide a notice of the adverse action to the consumer. The notice must include:

• The name, address and telephone of the CRA that supplied the consumer report including a toll-free telephone number for CRAs that maintain files nationwide,
• A statement that the CRA that supplied the report did not make the decision to take the adverse action and cannot give the specific reasons for it, and
• A notice of the individual’s right to dispute the accuracy or completeness of any information the CRA furnished, and the consumer’s right to a free report from the CRA upon request within 60 days.

Although the law can be interpreted to allow oral adverse action reports, it is best to mail an adverse action letter to rejected applicant. Although emailing is probably better than a phone call, it really does not provide the paper trail that might be needed if the applicant claims he never received a letter. It is best to send the letter Certified Mail return receipt requested, providing proof that the letter was received by the applicant on a specific date. At a minimum send it with a
Certificate of Mailing proof of mailing, as this will at least prove when it was mailed.

Landlords who fail to provide required disclosure notices potentially face legal consequences. The FCRA allows individuals to sue landlords for damages in federal court. A person who successfully sues is entitled to recover court costs and reasonable legal fees.  The law also allows individuals to seek punitive damages for deliberate violations of the FCRA. In addition the Federal Trade Commission (FTC), other federal agencies and the states may sue landlords for non-compliance and get civil penalties. However, a landlord who inadvertently fails to provide a required notice in an isolated case has legal protections, so long as he can demonstrate “that at the time of the violation he maintained reasonable
procedures to assure compliance” with the FCRA.

The above discussion relates only to federal law. As for many property management issues, landlords must also understand and abide by any more restrictive consumer credit laws that might exist in their particular states.