(This is the first post in a new series aptly named “Landlord Basics”. This series aims to help the new landlord / investor understand some basics of tenant relations and property management. You can view the rest of the series here.)
You’ve done your homework and purchased a property or two that can provide you with positive cash flow. The broken has been fixed, the old has been renewed, and it’s time to place some tenants! After screening your tenants and drawing your lease, you’ll want to collect rent and security deposit prior to move in. But what exactly is a security deposit, and why is it important?
A security deposit is money given to you by a tenant (usually prior to move in) that acts as an insurance policy of sorts. This money can be used to pay for damages caused to the unit by the tenant during the term of their tenancy, and is a vital portion of the tenancy arrangement. Such items could include broken windows, holes in walls and carpets, and failure to completely clean the unit at the termination of tenancy. Keep in mind that security deposits should not be used to cover normal “wear and tear” items such as repainting, as this is pretty standard tenant turn over.
Security deposit amounts are usually based on the cost of the rental. For instance, many people choose to charge an equivalent amount of money for security deposit as they would for one month’s rent (ie: $500/month for rent = $500 security deposit). However, this amount could be more, perhaps the equivalent of two months rent. This is something that you will determine based on local market trends, and possibly quality of tenant. You should also write the amount of the security deposit into the lease, and if allowable in your area, state that the security deposit is not to be used as rent.
Security deposits have to be handled differently, and it varies from state to state. In some cases, you may have to handle a security deposit differently depending on how many units you have in a building. Your local board of Realtors, investor’s club, accountant, or a real estate lawyer can help you determine how exactly to handle security deposits. In many instances, security deposits will need to be held in a separate account (often interest bearing). In some states, you will be required to pay your tenants interest on the security deposit account.
There are also regulations regarding the time frame in which a security deposit needs to be returned to a tenant after they move out, if one is due. A good suggestion for any move out is to walk through with the tenant and mark damages / deficiencies on a standardized form. When the tenant hands you the keys, have them review and sign the form. Later you can deduct for the damages and send the tenant a statement showing deductions from their security deposit, along with a check for the remainder, or a request for payment on additional damages.
This primer on security deposits should give you some form of idea on how to collect, hold, and return security deposits. For more information, you can contact myself or any of the suggested resources in the article.