Adverse selection is a “term used in economics, insurance, risk management, and statistics. In a rental housing context it translates into a propensity of people with a history (and therefore greater likelihood) of lease violations to find landlords who fail to adequately vet prospective residents.
Professional property managers understand the importance of conducting thorough background checks and know that if they fail to do so, they are likely to pay a price in terms of resident profile, NOI and owner equity. Plus, they have access to quality tenant screening products.
Private landlords, however, may lack knowledge of leasing best practices and often lack access to quality tenant screening products. High risk tenants know (or quickly learn) that their odds of being approved for tenancy are better among private landlords. So guess what? If you fail (intentionally or unintentionally) to thoroughly screen prospective residents – the market will reward you with high risk tenants and potentially devastating financial consequences.
Why might a landlord knowingly accept (or consciously or subconsciously) fail to vigorously underwrite prospective residents? The answer is simple. It is because we are under a great deal of pressure to lease the property – so much so, that we are tempted to either relax our criteria or turn a blind eye (live dangerously and hope for the best!).
Independent rental owners tend to be more vulnerable to the temptation – due to a lack of experience or cash-flow pressures.
Don’t fall victim to the trap! Remember, you (as a private landlord) are being targeted! If you fail to carefully underwrite prospective residents – you are quite likely to pay a price – perhaps a devastating price. Evictions are time-consuming and very, very expensive – in terms of legal fees, lost rents and (often) damage to the property.
That said, it is really tough to strike the right balance between resident profile and occupancy. It helps to remember, however, that the
most common error (by far) is worrying too much about occupancy – not enough about resident profile. So if you think you are being too conservative – you are probably right where you need to be!
So what can you do to protect yourself? Here goes:
- Start by developing your own (rental) criteria – Rental Criteria Worksheet;
- Share your criteria upfront – and let applicants know that you conduct thorough background checks; and
- Conduct a thorough background check – including credit, criminal & eviction searches, rental and employment verifications
Consider a direct-to-consumer tenant screening service if you lack access to high quality (comprehensive) tenant screening reports. No signup is required. Applicants order reports on themselves. They then grant secure access to you – eliminating questions of authenticity, the hassle associated with certification (site inspections, membership fees, etc) and the legal and regulatory exposure associated with the traditional tenant screening model.
One final point: Rental verifications might be old school – but they are an essential part of any tenant screening process. Do them yourself or outsource them to your tenant screening company. Just do them!! There truly is no substitute.