Risk Management — Part 3

In previous issues we discussed the approaches of avoiding risks and of controlling (minimizing) risks that can’t be completely avoided.  In this issue we will briefly discuss another method of managing exposure to loss – that of transferring risks to other parties.

The most common method of transferring risk is to buy insurance (which transfers some or all of the risk to the insurance company). There also are non-insurance ways to transfer risks.

Insurance

When you insure your home, car, boat, or rental properties you are transferring certain of the risks of loss related to each item to the insurance company. You pay a relatively small amount in premium rather than run the risk of not protecting yourself against the possibility of a much larger financial loss. The insurance company averages its risk of paying occasional large claims over a large number
of premium paying policy holders who have no losses.

Having adequate rental property insurance is an absolute must. One needs different insurance for a rental property compared to an owner occupied home. Both liability and casualty coverages are
significantly different. Liability insurance is even more important for a rental, as you could be held financially liable for damages, injury, or death of your tenants or their guests and service vendors or for anyone else on your property including trespassers even though you have much less control over these people for your rental than for your personal residence.

Recognize the Risks

As for general risk management, the first step toward good insurance protection is to recognize the risks you face. Some landlords will need coverages not required by most other landlords.

Organize Your Insurance Program

As with good risk management in general, good insurance management is achieved through planning and organization. To ensure that you are adequately covered you must seek competent professional advice, recognize the various ways you can suffer loss, and buy adequate insurance economically.

Essential Coverages

While there are a large number of types of insurance coverages available, many ofwhich are very desirable, four kinds of insurance are most essential.

They are: liability, casualty, automobile, and, for some, workers’ compensation.

Liability

Liability insurance covers payment for claims up to policy limits. Liability insurance (particularly for property damage and bodily injury) usually includes legal defense at no additional charge when the policyholder is a party to a lawsuit that involves a claim covered by the policy. In addition to bodily injuries, many liability policies will cover personal injuries (libel, slander, etc.) unless specifically excluded.

Liability coverage can be much more important than all hazard coverages put together.  Exposure to financial loss due to physical hazards is actually limited, although the limit can be quite high, by the value of the damaged or destroyed property. However, loss from liability is only limited by what a judge or jury wish to award.

The bottom line is that you should obtain the highest possible liability limit even if it means accepting high deductibles on casualty coverages.

It is often more cost-effective and otherwise better to increase liability protection through the use of excess liability (umbrella) coverage. An umbrella insurance policy takes over after the limit of another policy has been exceeded. An important feature of an umbrella policy is that it also provides extra coverage for other policies that are covered by the umbrella policy.

Casualty Insurance

Casualty insurance almost always means fire insurance, but usually includes such as windstorm, hail, smoke, explosion, vandalism, and malicious mischief which add very little cost relative to basic fire insurance. If you need comprehensive coverage your best buy may be one of the special policies that offer the broadest available protection for the money.

Flood and/or earthquake insurance may also be desired by the owner or required by a lender.

Automobile Insurance

In addition to adequate insurance for your personal and business motor vehicles, you should carry non-owned automobile insurance. This coverage protects from liability when an employee or a contractor uses a vehicle on your behalf.

If employees will ever use their own vehicles on your behalf, you should also require that they have you named as an additional insured on their policy.

Workers’ Compensation

Landlords who have employees or who hire independent contractors not having liability or workers’ compensation insurance should be particularly concerned that their insurance covers these persons.

Other Insurance

There are a variety of coverages for special risks. For example, there is a coverage that compensates for loss of value due to down-zoning or other legal considerations that prohibit replacement improvements of the same type and/or density following a significant or total loss of improvements.

Choosing Coverages

You must, of course, decide which risks you want to insure against. Some decisions, however, are made at some level of government or as the result of a contract.

As examples, if you operate a motor vehicle on public streets you must be able to prove that it is insured at least to some minimum requirements and mortgage lenders require the borrower to maintain certain kinds of insurance on properties being financed.

Choosing Limits & Deductibles

Insurance premiums can be a significant cost of property ownership, but insufficient insurance can result in financial disaster.  Therefore, property owners must strike a balance between over-insuring and under-insuring. Insurance is a complex and detailed subject, but a qualified agent, broker, or consultant can explain the options and help an owner decide the most important types of coverages, how high a deductible is acceptable, and how large the policy limits should be.

Minimize Insurance Claims

Although a landlord may have good insurance coverages, it is important for several reasons to reduce the likelihood of insurance claims through preventive measures. First, frequent
claims will likely result in the landlord and/or property becoming uninsurable at acceptable costs. Second, when it comes to liability insurance, no practical insurance policy limit is guaranteed to be high enough to cover what might be awarded by a jury. Third, reducing insurance claims will almost certainly reduce risk of damage and injury claims litigation. Fourth, dealing with processing insurance claims and being involved in lawsuits can eat up a lot of a landlord’s limited time, the latter having the potential of being particularly onerous.

Good health, safety and security measures, adequate maintenance procedures, certain property improvements, regular property inspections, special fire prevention measures, mold prevention
procedures, and requiring tenants to carry insurance may eliminate the need for some types of insurance or lead to lower insurance rates. Seek help from people who are experienced in identifying and dealing with risks or have reason to notice problems. One excellent resource is your insurance company’s safety inspector or your local fire department. Another approach is to ask your tenants to identify all safety risks no matter how small.

Many insurance carriers provide premium discounts for various property features related to safety and security.

Finally, it is the insured’s responsibility to immediately notify his/her insurance company or agent as soon as he/she learns about a claim or a probable claim.

Other Insurance Coverages

Insurance coverages that can be used to provide protection against some of the uncertainties of life in general and business in particular include life insurance, health insurance, disability insurance, retirement income, and key employee insurance.

Tenant Insurance

So far in this article we have discussed risk transfer by the landlord purchasing insurance. Transfer of some risk can be further accomplished by requiring tenants to purchase certain coverages that will also provide additional protection to the landlord. For example, commercial leases almost always require tenants to provide insurance including liability and casualty and specify the types nd minimum limits of coverages. Commercial tenants are also usually required to indemnify the landlord from liability claims related to their businesses. Tenants are usually required to have the landlord named as an additional insured on the policy.

Residential lease agreements usually only advise tenants that they should purchase renter policies because they will not otherwise be insured for liability or for loss of personal property.
Occasionally, residential leases do require tenants to obtain renter insurance as a condition of tenancy. It should usually be required when waterbeds, large aquariums, or other special risks will be brought into the rental unit. Although some states may have restrictions regarding which risks can be transferred to residential tenants, many, perhaps most states will allow a landlord to require
each tenant to provide a renter’s insurance policy.

Other Transfers of Risk

There are other ways that landlords can transfer risk besides purchasing insurance. They can transfer risk by having the lease agreement make tenants responsible for certain tasks related to risk
management. For example, although you will want to assure that smoke alarms and carbon monoxide detectors function at the time of tenant move-in and whenever you inspect units, the lease should make them responsible for additional testing and battery replacement (if applicable) during their tenancy.

Risk Management – Part 2

In this article we continue to discuss “risk management,” a subject that should be of interest to all landlords, considering the multitude of possible risks to which landlords are exposed.

As discussed in Part 1 of this series, some events resulting from inadequate risk management affect day-to-day operations only, others reduce profits, yet others result in hassle and stress, and still others can cause serious financial losses, even result in bankruptcy.

Although real estate investors should utilize both insurance and limited liability entity vesting to the greatest degree practical, they should be equally concerned with the more basic tactics related to risk management that will help protect against the many other possible liabilities with potential for loss.

There are, in general, a variety of other tools that offer protections beyond adequate insurance and proper vesting. Some are suited for an active business, but are not significantly useful for real estate investment. Others, even if useful to large investors, are costly to set up and not usually useful to the typical landlord. Some may not even work in all cases.

As mentioned near the end of Part 1, risk management can be divided into the four approaches of:

• Avoiding risks completely,
• Controlling (minimizing) risks that can’t be  completely avoided,
• Transferring risks to other parties, and
• Retaining risks of low probability and/or low  maximum potential cost.

In this article we will discuss the first two approaches, avoiding risks completely and controlling (minimizing) risks that can’t be completely avoided.

One principle that is the same in business as it is in personal life is that it is a good idea to avoid activities that are hazardous. A related principle is that, if you can’t completely avoid an exposure to risk, minimize it. For example, in your personal life, you can pretty much avoid the risk of drowning by staying away from water. If you wish to go white water kayaking, you can reduce the risk of drowning by wearing a floatation device.

Similarly, as a real estate investor, certain types of risks can be avoided completely by eliminating potential sources of a particular risk and others can be reduced significantly with minimal effort, even to the level of being negligible.  Short discussions of some examples follow.

Locations of Property

Certain locations have greater exposures to certain risks than do others. For example, buying a property in a forested area usually increases the risk of loss due to a forest fire. This risk can be avoided by not buying in such an area. If buying in such an area, risk can be reduced by buying property having buildings of fire-resistant construction, clearing the land around the buildings, and providing extra fire protection equipment.

Risky Amenities

There are a number of liability risks and costs connected to a swimming pool on the property. Those risks can be avoided by closing and filling in the pool. In considering whether to do so, you must analyze how important the swimming pool is to your tenants and the extra rent amount they are willing to pay for the availability of the pool. If you determine that the pool is not economically viable because the extra rent produced by its availability is less than the cost of maintaining and adequately insuring it, you could fill it in. Of course, you would have the issue of those current tenants who are there because of the amenities you’d like to get rid of. This obstacle may be surmountable, possibly requiring financial compensation and/or allowing termination of the lease.

Similar risks are related to many other amenities including playground equipment, fitness centers, and other recreational facilities. Again, the risks can be avoided by eliminating the amenities.

However, such amenities, although creating additional liabilities, are often useful, sometimes even necessary, to attract and retain tenants. When elimination of such amenities is not an option, one must take steps to reduce the risks from those liabilities. Important considerations include:

• Well-designed facilities – quality equipment, adequate signage, first aid considerations, and instruction in proper use available to tenants,
• Regular and adequate repairs & maintenance of facilities and equipment, and
• Rules and supervision – time of use and age of users with/without parental supervision issues.

It is important that your insurance company or agent be aware of all such facilities and that they are adequately covered in your policy. Insurance companies will often require certain items related to such facilities. For example, they may have requirements for pool safety equipment, signage, and fencing and they will often prohibit diving boards.

Maintenance Supplies

Whenever possible, pool chemicals, paint supplies, cleaning supplies, mower gasoline, and any other items used in maintenance of a property should be kept somewhere other than on the rental property in order to avoid risks associated with the items. When such items must be kept on the property risks can be reduced by storing the items in secured locations in order to eliminate any possibility of tenants and/or their children being injured by them.

Know and Follow All Laws

Keeping up to date with and adhering to landlord-tenant, fair housing, environmental, and tax laws greatly reduces the chances of conflict with both tenants and governmental agencies. The degree to which related risks can be avoided or reduced depends on both the knowledge of the laws and adequate procedures to ensure they are followed.

Health, Safety, and Security

Many lawsuits against landlords are related to health, safety, and security issues. Landlords are increasingly being held liable for tenant (1) health problems resulting from exposure to elements in the rental premises, (2) injury caused by physical defects of the premises, and (3) injuries or property losses resulting from lack of reasonable levels of security. Liabilities will almost certainly be greater when the landlord has not provided at least the minimum level of protection for health, safety, and security required by law.

Tenant Screening & Selection

Adequate and legal tenant screening and selection procedures are arguably the most critical factor to avoiding discrimination complaints and to minimizing tenant related problems of every type.

Repairs & Maintenance

A good maintenance program is important for a number of reasons. First, good maintenance will minimize bodily injury and property and serious injury from falls can be reduced by being sure that balcony railings and stair handrails are properly maintained.

Second, relatively minor upgrades can further reduce risks. For example, installing low-cost carbon monoxide detectors, even when not required by law, will greatly reduce the risk of poisoning as well as possibly provide a defense in the event of an incident.

Third, regularly and properly maintaining components of your property will reduce the cost of repairs and the chances of secondary damage resulting from an ignored problem.

Forth, an adequate maintenance program will help to minimize landlord-tenant conflicts. Failure of landlords to properly maintain their properties just to the low level required by habitability laws is a major source of landlord-tenant disputes. Inadequate maintenance can result in intervention by governmental agencies which will make it more costly to the landlord in the end.

Employees & Independent Contractors

Every worker hired to perform repair/maintenance work or be in any way involved in management of your properties, whether as independent contractors or employees, represents a variety of potential risks to the landlord. You may be liable for those workers’ actions if they are irresponsible or negligent or commit crimes against your tenants.

Minimizing the risks requires adequate screening and careful selection of employees and independent contractors as well as adequate supervision. If tenants complain about illegal acts by anyone, landlords must pay attention and investigate. Property owners should always make sure their insurance covers both negligence and illegal acts of their employees or contractors.

Minimizing risk of the IRS claims regarding classification of workers – employee or independent contractor – requires adequate understanding of and compliance with the law.

Adequate Documentation

Good risk management requires that you document everything in writing, utilize adequate forms and agreements, and retain everything for an adequate period. Everything means just that – everything.

Landlords need to keep records on all applicants, current tenants, and past tenants. A log should also be kept of all calls from prospective applicants, even if they never visit the property. Records should be kept that show periods when vacant properties were available. Make notes of all your phone calls including those calls from prospects. Use your prepared scripts (in writing) to convey the same information to all callers.

The retention time required varies because the time allowed for filing of a suit varies among states. It can depend on a specific state statute or by the general statute of limitations laws applicable to the
potential cause of action by a disgruntled applicant. The length of time typically varies from 2 to 5 years among states.

Tenant Treatment

Tenants want to know that landlords will enforce the rules and regulations fairly, objectively, and uniformly for all residents and not discriminate in their actions. Failure to address violations of lease agreements or house rules uniformly may cause problems for a landlord.

One of the issues that tenants often complain about is that landlords do not respect the property or privacy of tenants. Many states have enacted legislation that requires a specified minimum notice period – often 24 or 48 hours – or “reasonable” notice before a landlord can enter a tenant’s property without permission in non-emergency situations.

Being rude to others is not against the law, but doing so certainly will not do much for good landlord-tenant relations.  Landlords that sincerely respect others and act accordingly will usually
experience less conflict.

Communication with Tenants

If the only time you communicate with your tenants is when the rent is late, there is a good chance that neither you nor your tenants are happy. If you ignore your tenants, you will likely be looking for new tenants sooner than you’d like. Many conflicts that lead to financial losses result from misunderstandings between parties. Good communications between landlords and tenants can reduce
risks.

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Q1

An applicant has offered a cosigner. Is there a way for a cosigner to take on responsibility for only the one tenant for whom she is signing, if tenants are jointly and severally liable for full rent amount each month?

A1

There can be a difference between a cosigner and a guarantor, but pretty much the same issues relate to either.  Both agreements are contracts between the guaranteeing party and the landlord, so they can pretty much be written however those parties can agree. However, I would personally require the cosigner or guarantor to be jointly and severally liable just as is the co-tenant who needs the cosigner or guarantor. You must remember that co-tenants are usually made jointly and severally liable for the full rent amount so that the landlord can seek payment against all or any one individual. A landlord is usually likely to collect from the one who is best financially qualified and/or the one who is easiest to serve with a lawsuit if one or all of the tenants disappear. This may well be the cosigner or guarantor.

Hopefully, you are doing full screening on the proposed cosigner and utilizing the same qualifying criteria as you did or will do for the co-tenants. I will also mention that the agreement should make it clear that the cosigner is only providing a financial guarantee and has no rights to tenancy or other type of occupancy. This is to avoid the need to evict the cosigner before obtaining possession, an unneeded additional complication. Finally, I will mention that, for some states, it is important to have the spouse of the cosigner also sign the agreement in order to avoid the potential that in some states, one can’t collect from income or assets of a non-signing spouse. Accordingly, if only one spouse is signing in such a state, it is important to be sure that the income and assets on which financial qualification is based are truly those of the signing spouse.

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Q2

I do not understand the criteria regarding when a rejection letter is required for an applicant.

A2

Landlords using consumer reports for evaluation of rental applicants must follow the provisions of the Fair Credit Reporting Act (FCRA). 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 cosigner 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 or 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 hiring a tenant screening company or even if just looking at a credit report.

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.

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.

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.

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 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.

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Q3

How much can I charge for an application fee?

A3

The maximum application fee depends on a number of factors, including (1) the law of the state where the property is located, as some states specify the maximum, and (2) the number of qualified applicants you are willing to eliminate. The costs associated with changing rental units are significant for the average tenant and applicants sometimes must apply for more than one vacancy, so the application fee can prevent potential tenants from applying for vacant units when the fee is larger than usual. The effect of price depends on the particular type and location of the property and the financial status of potential tenants for that particular property.

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Would You Live In Your Rental?

We ask the question in the title of this article because we want to make a point. Most tenants spend just as much effort into finding a new home as you put into marketing your vacancies, perhaps even more. Some may even put as much or more effort into the task as you would if you were looking for a new place to live.

All landlords want good tenants, where “good” basically means those who will pay the rent on time each month, take care of your property, and not cause trouble for your other tenants or residents of neighboring properties. The type of tenant you want should not be willing to live in just any property. If he is so undiscriminating that he doesn’t care about the quality of his housing, he probably won’t care about how he takes care of your rental or how he gets along with others.

Those looking for a new rental home evaluate available rentals in the same manner as you would evaluate a place to live. At the top of their list when beginning to look for rentals are location and price. They want a location in a safe and attractive neighborhood that is convenient to their workplace or school, to shopping, and to cultural and/or recreational attractions. Price is equally important to most tenants and, for many, has historically been of more importance than location. However, with $3-$4 per gallon gasoline (with possibility of even higher in the future), location is becoming evermore important, because long-distance driving can result in commuting expense comparable to rent. When a tenant does the math, he sees that he is ahead financially to pay an extra hundred dollars in monthly rent rather than commute an extra 20 miles per day round trip, 5 days per week.

Also of importance to most applicants is the condition of the rental property. Few tenants want to live in a unit where windows are cracked; the carpet is badly worn or dirty; the walls haven’t been painted since 6 tenants back; the toilet runs continuously (particularly if the tenant is paying the water bill); or any number of other possible deficiencies. While all units must meet habitability laws, you would almost certainly be unwilling to live in a unit that only just barely meets the law.

When a potentially good tenant sees a property that the landlord doesn’t maintain properly, he assumes that the landlord is likely deficient in other ways, for example, doesn’t respond to repair requests.

On the other hand, bad tenants see a poorly maintained property as a plus. They figure that a landlord who doesn’t take care of the front yard or maintain the wooden fence probably doesn’t run screening reports or check with previous landlords. Such a potential tenant may even assume that the landlord manages the property so loosely that he won’t even notice when the rent is a week or two late. If the potential tenant’s assumptions were wrong regarding screening, the landlord will have wasted time when the applicant fails to submit an application upon finding out about screening. If the applicant’s assumptions were wrong regarding rent collection, the landlord will likely have to deal with a problem tenant.

The next priority may be size and/or floor plan of the living space. The number of bedrooms and baths can be a critical issue. For some applicants, particularly the physically challenged, the rental unit being single-story is often very important even if handicap design features are not needed. When it comes to amenities, there can be a wide variety of items that are of varying degrees of importance. Some tenants must have a pool, while others absolutely won’t rent a property having a pool. Some tenants want laundry facilities within their unit, while others are happy with common laundry facilities on the property, and yet others don’t mind using a Laundromat as long as it is nearby.

Assuming that you already own the rental property, there is little that you can do about most of the issues discussed above. You can’t change the location or change the floor plan (at least cost-effectively). You could rent units for less than market value, but most landlords prefer to get market rents for their rentals.

The things that you can control are the condition of your property and how you represent yourself and your property. Attracting good tenants requires that the property be in good condition and that it show well. The latter means that it has curb appeal. While interior condition may eliminate applicants, you may not even get phone calls if the first impression of a potential tenant driving by prevents him from getting an appointment to see the inside or even calling for additional information.

Accordingly, landlords should maintain attractive landscaping, keep the exterior adequately painted, replace cracked windows, and properly maintain fencing, carports, and other exterior components. You don’t want to give the potential good tenants a reason for not renting your property before they even get inside.

Good flooring, attractive window coverings, clean and undamaged appliances and plumbing fixtures provide a good first impression when they view the interior. Amenities such as dishwashers, microwaves, and, in many climates, ceiling fans also help. Even the age of the heating/cooling system may be of interest in view of increasing energy costs. Offering living space that is both in good condition and attractive attracts better quality tenants, allows higher rents, and reduces the length of vacancies. The bottom line is that you will usually get a good return on your investment in providing housing that you might be willing to live in. Always ask the question, if you wouldn’t live there, why would a preferred applicant want to?

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Q1

Can someone explain to me the Mom and Pop Exemption, specifically why it was ever written to excuse landlords with three or less houses to fall under Fair Housing Law?  I am curious as to why this exemption exists, and seemingly to protect landlords who do not have many houses in their name.

A1

The exemptions exists because they were required in order to get the necessary votes in Congress to pass Title VIII of the Civil Rights Act of 1968 (the Fair Housing Act), as amended by the Fair Housing Amendments Act of 1988. In other words, some Senators and/or Representatives felt it important to exempt landlords in certain categories from certain provisions of the Act.  As you will see from the following discussion, the often-called “Mom & Pop” exemptions are very
narrowly defined and have significant restrictions.  Accordingly, landlords must be extremely careful when utilizing them.

In review, Title VIII of the Civil Rights Act of 1968 (the Fair Housing Act), as amended by the Fair Housing
Amendments Act of 1988, (42 U.S.C. § 3601 et. seq) prohibits discrimination in housing and housing related transactions based on race, color, religion, sex, national origin, disability or familial status.

The Department of Housing and Urban Development (HUD) enforces the Federal Fair Housing Act. HUD’s regulations state that: “It shall be unlawful, because of race, color, religion, sex, handicap, familial status, or national origin, to restrict or attempt to restrict the choices of a person by word or conduct in connection with seeking, negotiating for, buying or renting a dwelling so as to perpetuate, or tend to perpetuate, segregated housing patterns, or to discourage or obstruct choices in a community, neighborhood or development. (24CFR Part 14, Section 100.70(a)).”

A protected class is a group of people who share common characteristics and are protected from discrimination and harassment. Federal Fair Housing laws prohibit discrimination on the basis of these protected classes:

• Race
• Religion
  – personal beliefs, faiths, practices
• National
  origin – association of ancestry, culture, accent, spoken language or
  surname
• Sex
• Color
  – characteristics associated with certain races and ethnic groups
• Familial
  status – having a child under age 18 in the household, whether living with
  a parent, a legal custodian, or their designee. It also covers a woman who
  is pregnant, and people in the process of adopting or gaining custody of a
  child or children
• Handicap
  (Disability) – a physical or mental disability (including hearing,
  mobility and visual impairments, chronic alcoholism, chronic mental illness,
  AIDS, AIDS Related Complex and mental retardation) that substantially
  limits one or more major life activities, having a record of such a
  disability or are regarded as having such a disability

In the Sale and Rental of Housing, no one (including Mom & Pop) may take any of the following actions based on race, color, national origin, religion, sex, familial status, or handicap:

• Refuse
  to rent or sell housing
• Refuse
  to negotiate for housing
• Make
  housing unavailable
• Deny
  a dwelling
• Set
  different terms, conditions or privileges for sale or rental of a dwelling
• Provide
  different housing services or facilities
• Falsely
  deny that housing is available for inspection, sale, or rental
• For
  profit, persuade owners to sell or rent (blockbusting) or
• Deny
  anyone access to or membership in a facility or service (such as a
  multiple listing service) related to the sale or rental of housing.

The Fair Housing Act covers most housing. In some circumstances (note underlined words in the 4 exemptions that might be included within the “Mom & Pop” exemptions), the
Act exempts:

• Single-family  housing sold or rented without the use of a real estate broker or  without the use of discriminatory advertising.
• Housing  that is intended for and solely occupied by persons 62 years or older or a household with at least one person 55 years or older. To qualify, at least  80% of the units must be occupied by at least one person 55 years or
  older. Qualified senior housing is exempt only from the Familial Status.
• The  rental of a unit in a multi-family dwelling with four or fewer units where  the owner (or a member of the owner’s family) lives in one of the units.
• The rental of a room or rooms in a private house where the owner (or a  member of the owner’s family) lives in the house.
• Lodging  owned or operated by private clubs which give preference to their members.
  Religious, charitable, or educational institutions or organizations which  are operated, supervised, or controlled by religious institutions or
  organizations that give preference in real estate transactions to their  members, provided the organization does not exclude members of a
  protected category.

Also, some other Federal Fair Housing laws, most state and local fair housing laws, and other civil rights statutes still apply to “Mom & Pop” landlords. None of the above housing is exempt from Section 804(c) of the Act which states that you cannot make, print, or publish a discriminatory statement. Any exempt housing that violates 804(c) has lost that exemption and can be held liable under the Act.

Furthermore, even if the federal exemptions are properly used, a landlord is not immune against lawsuits by either tenants or government agencies who think that there has been discrimination. Even those who meet all terms of the exemption and may win in a court or agency action, can end up spending a lot of money in defending themselves. In other words, the costs of defending against discrimination claims on the basis of the exemptions could be extremely costly even if the landlord eventually wins in court.

Finally, the Mom & Pop Exemptions discussed above apply only to Federal Fair Housing law. Fair housing laws of some states and some local jurisdictions define additional protected classes – such as sexual preference, gender identity, occupation, source of income, educational status, medical status, marital status, military background, political affiliation, or any other arbitrary reason – and provide even broader coverage of certain federally protected classes.

I would advise landlords against depending on the exemptions even if they are certain they qualify for the exemptions.

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Q2

My rental house is in CA. I have evicted the tenant and a lock-out by Sheriff was done on the 10th. The tenant left the house empty but left items in backyard and in the storage shed. Do I have to do a Belief of Abandonment or just store his property for 18 days? Not sure what is next?

A2

As for many states, CA has specific guidelines regarding “abandoned” property. The procedures a landlord must follow to avoid the possibility of being held liable for unlawfully taking or converting the tenant’s property depends on the situation.

There is a good discussion of the issue on the California Department of Consumer Affairs web site which is at http://www.dca.ca.gov/publications/legal_guides/lt-5.shtml.  The fact that you followed through on an eviction simplifies things a bit. From the information you provided, I think it highly likely that your situation is as discussed in “Situation 2” on the listed web page.

From my reading of the law, a landlord need not serve notice on any former tenant who was evicted under a writ of possession, as I understand to be your case. In this case the former tenant has 15 days after the landlord takes possession of the rental unit to pay reasonable costs of storage and to take possession of items left in the rental unit.

However, notice must be given to any other party who the landlord has reason to believe might have an ownership interest in some or all of the property. As examples, this would be the case if you suspect that certain furniture was rented from a leasing company or if you know that someone else lived in the house, even though having not having signed the lease, and this person was not named as a party being evicted.

I won’t further discuss the details of the law, as I think the listed web page is well written and covers the matter in greater detail than any discussion I would provide. I will mention, however, that you should document everything you do. If the former tenant claims the property, paying for the storage thereof, be sure to require his signature on a document stating that all property has been returned to him and is in the condition that it was when abandoned. I also recommend that you take photos of the property and that all documentation be retained for at least several years.

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Q3

I have a new tenant that has lied on their application. Can I move to evict faster because they put false information about their employment and eviction history?

A3

Although it is possible that your particular state has a different specific procedure related to this particular reason for an eviction, I’d be very surprised if such were so. However, as long as the false information was material to selection of the tenant – i.e., not something the judge would consider too minor for an eviction penalty or something that the judge might accept was a mistake if so claimed by the tenant – there can be an advantage of an eviction for lying on the application compared to many other possible causes. This is that it is unlikely (though not impossible) that the tenant would have a defense acceptable to a judge except as mentioned above.  However, I will mention that a judge might question why you did not discover that the information was false prior to selecting them as a tenant and this could be another problem that might require a reason acceptable to the judge if  the tenant, an attorney, or the judge think of raising this issue.

Whether or not you will need to serve a notice or can simply file for eviction with the court may depend on the law of your state, perhaps even with the specific court of jurisdiction. You may be able to get an answer by phoning the court clerk. Assuming you do not consider this issue to be curable by the tenant providing correcting information, if a notice is required you would want to use a “notice to quit” (if allowed by your state) rather than a “notice to cure or quit.”

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Risk Management – Part 1

Life is full of risks to health, safety, security, finances, and happiness. Investing in real estate adds a number of additional risks to one’s life. First, there is the risk of buying the wrong property, one that is in a bad location, in worse condition than you thought, and for which you paid way too much. Then, assuming that one purchases a good property at the right price, owning and managing that property has many categories of risks.

However, there are ways to reduce risk to acceptable levels. Reducing risk is basically a matter of having adequate knowledge and utilizing good risk management procedures.

With this article we begin a multi-part series regarding ways to manage the risks associated with rental property ownership.

Adequately managing risks of any business, including landlording, can be complex and time consuming, and can involve a number of components and potential complications. Good risk management is achieved through adequate organization and planning.

Risk management includes a variety of activities. Landlord-tenant relations, proper maintenance, adequate record keeping, formal safety programs, adequate insurance, and proper vesting of properties are some of the things that are part of a good risk management program. The goal of risk management is to anticipate and avoid future legal and other problems. When legal problems occur, the goal is to end them as efficiently as possible, which usually means obtaining an early settlement.

As for all businesses, landlords should have a risk management program in place. Some refer to such a program as asset protection. However, asset protection is actually only a part of risk management. Good risk management includes a number of issues in addition to asset protection. Asset protection becomes important primarily when all other risk management measures have not been totally effective. Considering that the goal of risk management is only to protect assets from creditors is a dangerously limited view.

Disaster planning is another part of risk management. Is your real estate investment business ready for a fire, a hurricane, a flood, or whatever other unexpected event might occur tomorrow, next week, next month, next year, and/or beyond? It is not only 9/11 or Katrina level disasters that should be of concern. Are you even prepared for a hard-drive failure that could occur at any time?

You may have already considered the most obvious risks, such as fire or injury related to your rental properties, and have bought insurance to protect against those risks. Unfortunately, there are hundreds of other liabilities with potential for loss that every landlord should consider, many of which are often overlooked or ignored.

Security deposits, lead-based paint, mold, and a bunch of fair housing items are only a few of the many potential land mines that landlords can encounter. Accordingly, it is important that, as a real estate investor, you (1) avoid being sued or becoming the subject of governmental investigation, (2) be the winner in any lawsuit or agency investigation that does occur, and (3) make sure that a potential judgment or penalty does not result in one landing in the poorhouse.

Exposure to lawsuits and governmental actions is minimized by having a good understanding of all the laws related to rental housing and following them all very carefully.

The odds of winning a lawsuit or being exonerated in a governmental investigation that does occur in spite of your best efforts are maximized by (1) not being having done anything seriously wrong in the first place and (2) having maintained adequate records to prove it.

Avoiding financial damage, even total ruin because of losing a serious lawsuit requires that one follow adequate asset protection procedures as part of a comprehensive risk management program. This includes utilizing proper vesting for all properties and carrying adequate insurance.

All risk management measures, including asset protection and disaster planning, require that you have to put things in place prior to occurrence of the catastrophe, not after the fact. Most attempts at after-the-fact maneuvering are usually ineffective. In fact, some methods of attempting to protect assets after the fact by transferring property are considered “fraudulent conveyance” and are illegal. You need to manage risks now, before the event occurs.

A few risks are predictable or at least are things that can be planned for and even controlled to some extent. Included in this category might be:

Death – “when” is sometimes somewhat controllable, “if” is never controllable

Taxes – second only to death in probability

Insurance premiums

Rents

Loan expenses

Employee costs

Operating expenses

Computer problems – backup, backup, backup

Other risks are unpredictable and usually beyond the landlord’s control. Included might be:

Illness, even permanent incapacity

Changing tastes in rentals

The local economy and its impact on the rental market

Actions taken by neighboring landlords

Actions taken by various levels of government or agencies thereof

Some events affect day-to-day operations only, others reduce profits, yet others result in hassle and stress, and still others can cause serious financial losses, even result in bankruptcy.

Risk management can be divided into the four approaches of:

Avoiding risks completely,

Controlling (minimizing) risks that can’t be completely avoided,

Transferring risks to other parties, and

Retaining risks of low probability and/or low maximum potential cost.

Some risks can be avoided or eliminated, others can be controlled or minimized, still others can be transferred to someone else, and some can and should be retained. However, before you can decide what to do about which, you need to identify and analyze them.

We will discuss each of the four approaches in future newsletters. A detailed discussion of risk management is provided in our “9 Steps to Managing Risks” Mini Training Guide.

Expenditures – Part 3 – Local Travel

In a recent newsletter (Expenditures – Part 2) we discussed some basic principles regarding expenditures including “travel expenses related to the property or management thereof.” In this newsletter we will discuss further a few aspects of this particular expenditure.

As stated in Expenditures – Part 1, to be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.

As also stated in Part 1, you can deduct the ordinary and necessary expenses of traveling away from home if the primary purpose of the trip was to collect rental income or to manage, conserve, or maintain your rental property. This will usually include educational costs related to managing your income properties. You must properly allocate your expenses between rental and non-rental activities. You cannot deduct the cost of traveling away from home if the primary purpose of the trip was related to the acquisition of a new property or the improvement of your existing property. These costs would be recovered by taking depreciation.

In this article, we will discuss only local transportation expenses in the normal course of managing rental property, leaving the significantly more complex issues related to other categories of travel (e.g., cruise ship seminars) for future discussions. Very few landlords utilize public transportation for travel related to management of properties reasonably close to their place of residence, so local transportation almost always means use of a private motor vehicle of some kind. This usually means a car, SUV, van, pickup truck, or panel truck. In most cases this vehicle is owned rather than being leased.

All landlords utilize one or more motor vehicles in managing their income properties. However, few landlords fully comply with the IRS requirements regarding the deductibility of vehicle use and many do not even come close.

You can deduct your ordinary and necessary local transportation expenses if you incur them to collect rental income or to manage, conserve, or maintain your rental property. Generally, if you use your personal vehicle for rental management activities, you can deduct the expenses using one of two methods: (1) actual expenses allocated to business use according to the percentage of miles driven for business compared to total miles driven for the year or (2) the standard mileage rate for the business miles.

Actual expenses can include essentially everything related to operation of the vehicle, including repairs and maintenance, insurance, and fuel. Depreciation or, with certain restrictions, Section 179 are also applicable to the business share of usage. For 2011, the standard mileage rate for a car, SUV, van, pickup, or panel truck is 51 cents a mile for all business miles. Changing from one method to the other is restricted by the IRS.

The IRS says that to take a business deduction for the use of your vehicle, you must determine whether the use was business or personal. If the answer is personal, no deduction is allowed.

Travel between home and an office where business is conducted is considered commuting and commuting miles are not deductible. However, for any business, travel is not considered commuting when your home is your principal place of business and the travel is to another work location in the same trade or business, regardless of whether that location is regular or temporary and regardless of distance. However, if you have an office where you perform a substantial part of the work related to the business, with this office being located other than at home, travel between home and that office will usually be considered non-deductible commuting even though you also maintain a home office.

To deduct vehicle expenses under either method, you must keep records that follow the rules in chapter 5 of IRS Publication 463. In order to determine the percentage of vehicle expenses or mileage that are business related and support the percentage in an audit, it is important that a log be kept. The log should include beginning and ending odometer mileage for each business related trip.

The IRS expects all business use of vehicles to be documented and your documentation may be required in an audit. Most tax experts interpret IRS requirements to be a written detailed log showing dates, times, purpose, and beginning and ending odometer readings for each trip driven. Whether or not such detail is really necessary, we mention the fact that one IRS publication states:

“….. to claim the deduction, keep adequate records, such as a written travel log with complete and accurate mileage records for each business use of your car. If you are unable to produce a clear and accurate business mileage record, the IRS may disallow the deduction.”

Does the language “such as” mean that there are other options? Whether a log is the only option or not, in order to be certain of the mileage deduction surviving an IRS audit, one who takes a deduction for business use of vehicles will be on firmer ground if able to produce a mileage log. While some may be able to reconstruct a log if needed from receipts and day-planner records, a contemporaneous log is best and is what the IRS means by a log. That is, writing down each trip including the date, time, destination, and the starting and ending mileage.

Although simply the miles for each leg or a round trip may be adequate in some cases, it is best to log starting and ending mileage. Although the trip meters available in most modern vehicles may seem a simpler way to keep track of a trip distance, recording only the trip meter results will not be nearly as convincing to an auditor as recording starting and ending mileages.

Logging in the day’s travels in the evening is doable if odometer mileage notes are kept throughout the day, but trying to recreate your travels at the end of each week (or longer) is next to impossible to do while remaining consistent with personal trips and fuel fill-up mileages so as to avoid discrepancies that might be discovered in an audit.

It is almost certain that the majority of self-employed individuals fail to keep a contemporaneous log with odometer readings for each stop, as the IRS would like to see, and it is likely that the percentage keeping any type of log at all is relatively low. Many simply roughly estimate their business mileage each year when doing their returns, some simply using a number that significantly reduces their taxable income.

Most know that only 1 to 2 percent of small business owners are audited and, even then, certain types of businesses are targeted whereas others are essentially ignored. For example, cash businesses are more likely to be audited than businesses where there is a bank record for most items of revenue. Furthermore, all audits won’t touch on the auto mileage issue anyway.

Therefore, in practice, the chance of being caught without a needed log is extremely low. For various reasons, all of the deduction taken is unlikely to be disallowed to begin with because there are ways to prove certain usage. For example, the mileage for driving to a landlord seminar in a distant city can be proven and various receipts would show that one made the trip, including those for buying gas along the way.

Most understand these facts and also know that the worst that will happen is that they will have to pay the taxes (plus some penalties) on a non-allowed portion of the deduction for one year in question. Many probably figure that they earned many, many times that amount for the hours that would have been spent on maintaining proper mileage logs during the 20 years that they were never audited.

However, considering the relatively little time and energy required for maintaining an adequate log, there is really no excuse for not doing so. As with other items related to a possible audit, having detailed records regarding a particular item being looked at by the audit can reduce the chance that the auditor will look at other items. Having inadequate records regarding your business auto deduction may encourage the auditor to look more closely at your records for other items, both income and expenses.

This article summarizes certain issues related to business use of a motor vehicle. For more detailed information regarding significantly more issues, see the appropriate IRS publications. For tax advice consult a competent tax advisor.

Some Questions & Answers

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Q1

Do you have information about the location where the mandatory “carbon monoxide devices” are supposed to be installed in the CA single-family home rentals per the new SB183 that is effective July 1, 2011? Some people recommend installing them on the ceilings while others say to install them on the lower half of the walls. My rental property is located in San Jose, CA.

A1

The text of the subject SB 183 can be found on the Web. Although I will provide some discussion regarding my understanding of the law, you should read and understand the law yourself, at least those portions that are relevant to your particular properties.

In brief summary, effective July 1st, 2011:

1)   All existing single family dwellings that contain a fossil fuel burning heater or appliance, fireplace, or an attached garage must install carbon monoxide alarms. In other words, unless you live in an all-electric home not having a fireplace with a detached garage and you don’t use a hibachi, you are covered by this law.

2)   All other existing dwellings (multi-family) shall comply by January 1, 2013.

3)   CO alarms must be either battery powered or plug-in with battery backup.

4)   CO alarms must be installed outside of sleeping areas and on every level of a dwelling, including the basement.

5)   If the device is a combined smoke detector and CO detector, the combined device must comply with the law for each type detector and the combined device must emit an alarm or voice warning that clearly differentiates between a carbon monoxide warning and a smoke warning.

6)   The devices must be ones that have been certified by the State Fire Marshall. It will be illegal to sell detectors that have not met the Fire Marshall’s certification requirements.

7)   With respect to the number and placement of carbon monoxide devices, the devices must be installed in a manner consistent with building standards applicable to new construction for the relevant type of occupancy or with the manufacturer’s instructions. Manufacturers must have their instructions approved by the state.

8)   The law creates disclosure requirements with respect to carbon monoxide detectors upon sale of a property.

As you are aware, there have in the past been differences in opinions and instructions among manufacturers and “experts” regarding which living spaces should have CO detectors and where they should be installed within a particular room, with opinions regarding the where to install them varying from “on the wall close to the floor” or “on the ceiling.” This has always been an important issue regarding combination smoke and CO detectors because some experts have considered that the two types have different optimum locations.

As seen in item 7 above, SB 183 does not itself provide installation instructions, but basically leaves it up to the State Fire Marshal. In general, past recommendations have been that CO alarms be installed on every level of a dwelling, including basements, and outside each sleeping area in the immediate vicinity of the bedroom(s). However, it is important that you obtain correct information for both the new state law and for any more restrictive local ordinance.

In my opinion, your best choice for obtaining correct information on this aspect of the subject is to inquire of governmental entities which are responsible for enforcing the state law and any local ordinance for San Jose with the issue and/or are responsible for enforcing the law. I would further suggest that you consult more than one agency that might provide such information in hope that the same answer from all or at least a majority of those consulted provide you with the same information, giving some confidence that you have the correct information. You should include the city (or county) building department, a couple of fire stations in the area, and any local rental housing agency. You might also see what kind of information you can obtain from your local landlord association(s) or any property management companies who are willing to respond to your request. I would also suggest that you attempt to obtain for your files printed materials regarding the subject from anyone providing information.

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Q2

I have a tenant who is a foreign born US citizen. Since he moved in, he married a young lady for whom he is trying to acquire citizenship. She has a social security number, but the credit reporting company could not find her. Is there any documentation I should ask for prior to signing her up on a lease amendment?

A2

The fact that a person has a social security number does not mean the person has a credit history with TransUnion, Experian, or Equifax. Reasons why a person will not have a credit record include:

• They have never obtained credit from a merchant or lender who reports to credit bureaus. Even if a credit event is reported to one credit bureau, it may take time before all credit bureaus have the information.
• A person may have always utilized cash or checks and never borrowed money (at least from a lender who reports to credit bureaus), obtained a credit card, or rented from a landlord who reports to credit bureaus (few landlords do) and, hence, may never have a record with any credit bureau.
• It may take months for a first credit event to appear at any credit bureau for someone who has only just recently obtained credit.

One may need to obtain a Social Security Number or Individual Taxpayer Identification Number for employment or tax reporting reason, but may never obtain credit. For example, someone who has significant interest income in the U.S. would need either a SSN or ITIN.

The above being said, “no record found” reports sometimes results from the fact that the SSN or ITIN and name that were provided were not correctly entered. It’s even possible that an applicant mistakenly provided an incorrect number. However, incorrect SSNs will often result in a report that indicates the number and name do not match.

Regarding documentation that should be required, all applicants (all co-tenants of legal age,  including spouses) should be screened using the same procedures; including verifying identity (potentially the most important item) and screening reports – e.g., credit reports, eviction records, criminal record reports, employment or business history, and previous landlord checks. When there is no information from one or more of the reports, landlords must evaluate the applicant from information received.

Finally, you should not hesitate to ask applicants why they have no credit record.

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Q3

As a landlord in the state of Washington, can I restrict my rental properties to be no smoking?

 A3

I cannot state that a particular rental property location is not subject to some unusual local ordinance related to prohibition of non-smoking rules, but I’d probably bet a lot of money against there being one. Nationwide, the trend has for years been to limit smoking. Many states have passed laws and many local governments have passed even more restrictive ordinances against smoking in public places. Some jurisdictions even prohibit smoking in bars.

Most basically, there is no law that prevents landlords and property managers from regulating smoking on the premises, whether inside individual units or outside in common and private use areas. This is because (1) there is no constitutional right to smoke and (2) smoking is not protected by federal Fair Housing laws and is very unlikely to be protected by any state or local laws. HUD does not prohibit non-smoking policies in affordable housing. In fact, in 2009 HUD released a memo that encourages public housing authorities (PHAs) to implement non-smoking policies.

In Washington State a number of PHAs have adopted non-smoking policies including those in King County Housing Authority, Wall Walla Housing Authority, and Clallam Housing Authority.

There is now increasing action against smoking by owners and managers of properties. Tens of thousands of apartments and condos have gone smoke-free in the past five years, including those managed by the owner and those managed by management companies. Some municipalities are passing ordinances related to smoking prohibitions, not only in public places, but also in multi-unit housing.

Many landlords prohibit smoking in their units rather than discriminate against smokers per se because it is the act of smoking in the unit rather than the fact that a tenant is a smoker that is important. Most, perhaps all experts feel that owners have the right to protect their properties against damages from smoking and to protect other occupants from secondhand smoke. However, now the problem becomes one of detecting violators without running afoul of privacy rights. The solution is to both prohibit smoking inside of units, as well as on associated patios and balconies, and to make tenants responsible for damages resulting from failing to adhere to the prohibition.

This requires that applicants first be made aware that the unit is a non-smoking one in order to avoid wasted time and money in processing applications for those who might be unwilling to sign a lease that includes non-smoking provisions. Upfront notice can be accomplished in advertising, in an information sheet attached to the application form, or within the application form itself.

The lease agreement should, of course, contain very specific clauses related to the non-smoking issue. In addition to a clear statement of the prohibition, acknowledged by the tenant upon signing the agreement, the lease should also set out in some detail a list of damages resulting from smoking for which a violator will be responsible. The list would include items such as burns or stains on any component of the unit, odors, smoke residue on any surface, and potential other liabilities such as damages resulting from smoking-related fires.

The lease agreement should clearly make the tenant responsible for the cost of repairing, cleaning, painting, or replacing any items so damaged. Of course, the tenant must be initially provided with a unit that has no evidence of previous smoking-related damage or such previous damage must be noted in the move-in checklist.

For multi-unit properties, prohibiting smoking inside units and in common area hallways and within some distance of residents’ patios, balconies, doors, etc, can actually reduce the risk of problems

Because second hand tobacco smoke is often considered a nuisance in the same way that loud noise would be considered a nuisance, if tenants are complaining about drifting tobacco smoke, landlords must take action to protect them. Landlords and property managers who fail to accommodate non-smoking tenants who complain about secondhand smoke may be exposing themselves to lawsuits. If a resident or prospective resident has a disability or chronic illness which is made worse by exposure to tobacco smoke, Fair Housing Laws will require a ”reasonable accommodation.”

Holding Deposits

Sometimes, when the rental market is tight, applicants may offer a holding deposit to take the rental unit off the market until the applicant’s screening and verification is complete. Other times, a holding deposit may seem appropriate when an applicant appears committed to the rental, but must make arrangements for the move-in funds. The holding deposit is not a security deposit, but is to compensate the landlord for damages suffered for holding a unit off the market in the event that the applicant fails to meet screening qualifications or rescinds his/her agreement to rent the unit.

It is best to avoid the use of holding deposits, particularly now that most verifications of qualification can usually be done within a relatively short time utilizing today’s technology. Although holding deposits may be legal in your state, they often lead to misunderstandings or even legal hassles. A major problem is that most states do not cover the subject adequately, if at all, and it is often unclear regarding how much of the deposit may be retained by the landlord in the event screening results are unsatisfactory or the applicant cannot come up with the necessary funds or simply changes his mind about wanting the unit.

Some states that cover holding deposits by statute specifically allow a landlord to retain an amount related to the landlord’s cost of holding the unit. This might include the costs of additional advertising, prorated rent for the holding period and perhaps a reasonable charge for the time related to paper work and inconvenience to the landlord, but holding a larger amount puts the landlord at risk for a lawsuit. Some states specifically require that there be a written contract that states the terms and provides a receipt for the amount.

Although holding deposits are best avoided, sometimes they are helpful because of market conditions. If allowed by your state, it might be better to utilize a holding deposit rather than lower qualifying standards or reduce the rent. For the landlord’s protection, holding deposits should always be in cash, cashier’s check, or money order and for the protection of both parties there should always be a written agreement detailing the conditions related to the deposit even if not required by law.

When the landlord holds the rental unit for an applicant, it should be considered off the market and unavailable to other qualified prospective tenants who may have to be turned away. If the applicant later changes his/her mind, the landlord may have suffered financial harm. In such a case, the landlord is justified in retaining all or part of the holding deposit within the limits allowed by state law. However, be sure that this scenario is discussed in a signed agreement.

The amount of the holding deposit should be reasonably related to the rent of the unit and should take into account the potential inability of some applicants to immediately put up significant deposit funds in addition to application and/or screening fees.

The written holding deposit agreement should be in accordance with any applicable state law and unambiguously cover the following issues:

• The address of the rental unit,
• The names of landlord and applicant,
• The amount of the deposit,
• The length of time (including exact ending date) the landlord is willing to hold the rental, taking into account the size of the deposit and other qualifying information,
• The basic terms of the lease agreement,
• The conditions under which the landlord will rent the unit to the applicant – e.g., verification of identity, a fully completed application form, satisfactory results on all applicable screening reports, verification of employment, and full payment of the security deposit and first month’s rent by the end of the holding period,
• What will happen to the deposit if the applicant signs a lease agreement – usually, that the full holding deposit will be credited to the security deposit,
• What will happen if the applicant decides not to rent the unit before being notified whether or not his/her application has been approved,
• What will happen to the holding deposit if the applicant fails to pass screening – usually the full deposit should be returned if the failure is evident within a couple of days after the landlord has accepted the holding deposit, and
• What will happen to the holding deposit if the applicant defaults on the holding agreement – specifically, how much the landlord will retain, this being in accordance with any applicable state law, and when and how the portion not being retained by the landlord will be returned to the applicant.

Possible clauses in the agreement might be written as follows:

• After the applicant has been notified that he/she has been approved to rent the unit and the applicant fails to complete the rental transaction for whatever reason, then the amount of damages to be deducted from his/her holding deposit shall be $____­____ per day from the date he/she agreed to rent the unit (the day the unit was taken off the market) until the day he/she gives notice of his/her rescission plus an equal number of additional days to compensate for lost marketing time and additional advertising expenses incurred.
• If the landlord’s damages exceed the amount of the holding deposit, then applicant agrees to pay the difference, to a maximum amount of $________, within _____ calendar days of request.
• In the event the landlord re-rents the unit within the time frame for which deductions have been made from the holding deposit, then the applicant should be credited an amount equal to the daily rent stated above for each day that rent was collected for the unit, with when and how the portion not being retained by the landlord will be returned to the applicant.

In summary, landlords and agents must follow any laws of their states and they should use good judgment and be fair in their holding deposit policy. An applicant whose holding deposit is retained without adequate justification may well have a cause of action for damages against the landlord which can result in more time and expense than the deposit was worth.

Some Questions & Answers

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Q1

Is there any legal reason why a landlord would not be able to take a copy of a prospective tenant’s SS card and driver license?

A1

The shortest answer is No! A longer short answer follows.

A landlord can request and make copies of any documents considered material to making an informed business decision. I considered the two items you mentioned to be at the top of the list and the minimum of what should be required. That being said, however, there are at least a few caveats.

First, as with most issues related to landlording, it is important that the same procedures be followed with all applicants, at least for a particular vacancy. Better yet, the procedures should not be changed every time there is a vacancy, but should be followed for a significantly long period, with changes being justified by changing business conditions such as supply/demand in the rental market. The policies and reasons for change should be documented and retained for at least the statutes of limitations of relevant statutes, ordinances, and regulations related to fair housing and other discrimination issues.

Second, a landlord will be safer to ask for two (or more) ID items out of a possible list of four or more items. It is important however to choose items that are relevant and material to identity verification and any other misrepresentation or fraudulent activity against the landlord or others. There are potential legitimate reasons why an applicant cannot come up with a requested document.

Third, landlords must be concerned about security of any such documentation – both computer and paper records – to avoid potential liabilities related to identity theft.

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Q2

I have a tenant whose dogs destroyed the carpet….it was so bad I had to seal the floors and a portion of the walls because the odor was horrific. What can I legally charge her? The carpet was 2 years old when she moved in and her tenancy was almost 6 years. It was expensive carpet as I had previously lived in the house [like 20 year carpet].

The new carpet I put in is 10 year at the cost of $1750 plus $250 to tear it out. Can she be charged the full $2000 or a pro-rata amount? It looks like I will be going to small claims on this one…appreciate your advice.

A2

Technically, charging a tenant the full replacement cost for any major building component would be unfair because the landlord had some period of benefit for the component – in your case, 8 years as I understand the facts. Most states do not have a specific statute regarding the issue, but many tenants are aware of the issue and many judges would not allow charging full replacement cost if the matter went to court. Probably few, if any, judges would allow it if the issue were raised by the tenant or an attorney for the tenant.

You are correct that the charge must be prorated. The tenant can be charged only for the expected remaining life of the carpet had it not been damaged by the tenant. The tenant should be charged for the fraction of replacement cost calculated by dividing the expected remaining life by the expected useful life of the particular carpet being replaced. However, when replacing any component with one of lesser or greater quality, there are potential issues that can be raised, the most basic issue being charging the tenant for something of higher quality than what the tenant damaged.

For a 20-year expected useful life and 8 years of use, the tenant would be charged for 12/20 of the replacement cost. For a 10-year expected useful life, the tenant would be charged for 2/10 of the replacement cost. Hence, the manner of calculation is quite important.

However, in view of the fact that a 10-year life carpet is replacing a 20-year life carpet, the tenant or her attorney could raise some issues. First, one could reasonably question if the 12/20 fraction can be applied to the 10-year replacement carpet cost. One might argue that the 12/20 needs to be applied to the cost of the original carpet. One would almost certainly insist that using the 20-year life requires proof that it really had an expected life of 20 years. One might also argue that the useful life of a normal rental grade carpet is 10 years and that the tenant should not be penalized for the fact that a higher quality carpet was used because it was your personal residence at the time of installation. Accordingly, a judge might agree that the 2/10 fraction must be used. Finally, the tenant might claim that the carpet looked like it had a lot more than 2 years use at the beginning of her occupancy and you may need proof of condition such as the move-in checklist, photos, and/or a witness.

Since 2/10 of $2,000 is $400, whereas 12/20 of $2,000 is $1,200, there is a significant difference in the charge. The tenant is more likely to argue the issue for the greater amount compared to the lesser amount and the risk of you losing in court probably increases with the amount involved.

It is possible that you would get away with using the 12/20 fraction because the tenant does not contest the matter or, if she does, isn’t represented by an attorney, doesn’t herself come up with good arguments, and you’re before a judge who doesn’t care. You will need to decide whether to use the smaller fraction (that you can likely successfully defend in court) or go for the maximum, assuming that the worst will be the lower of the two fractions (not necessarily true if the judge decided you were trying to cheat the tenant).

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Q3 (continuance of previous Q2)

This one will go to small claims court. What can I charge for my time? I have spent approx 40 hours cleaning. All tile grout had urine stains and needed to be hand-scrubbed….couldn’t hire anyone to hand-scrub. Can this be reasonably accounted for?

 A3

What would be considered reasonable – assuming anyone raises the issue – will depend on the type of work (including skill level & physical requirements), the local economy, and the particular judge. I think $20 to $30 per hour would be considered reasonable in most jurisdictions, with CA being on the high side compared to MS. You could consider using a number in the high twenties, as it will not seem as high as $30. There’s a reason why most merchants price something at $29.99 rather than $30.00. You could use $27 or $28 so as not to appear too cute. You will also want to have a written log detailing your work, logging time in tenth-hour or 10-minute increments. The hourly rate is probably more debatable than the number of hours because data can be found supporting lower levels of pay than you would want to work for, whereas, it’s harder to prove the hours required for such work, particularly as cleaning time depends on a number of issues including the type of dirt/stains, the item and type of material that is dirty/stained, and the worker’s knowledge of cleaning products. Accordingly, a judge might look more favorably on billing for more hours at a lower hourly rate, particularly when you can show a realistic looking detailed log.