Why Our Tenants Keep Paying Rent During the Pandemic (and During the 2008 Crash)
On 10-15-2020 the Nevada eviction moratorium was lifted. Now, only if a tenant attests to specific conditions on a CDC provided form can eviction be delayed. The moratorium is not automatic, the burden is on the tenant to obtain a copy of the federal form, attest to the requirements and submit it to the property manager and or the landlord; it is not automatic like it was with the state moratorium.
I suspect that many tenants of C and B class properties will take advantage of this option, which will cause great financial stress for those owners. How are our clients' properties doing? To date, out of the 160+ properties we track (there are more but they are scattered out with multiple property managers and a few are self managed), 10 tenants have not paid the full rent on schedule at some point during the last 7 months. 5 of these tenants recently caught up on the rent or made arrangements acceptable to the owner. We expect most or all of the remaining 5 to catch up on the rent or make an arrangement acceptable to the owners. Why are our client's properties performing well when others are reporting major issues? The answer is the tenant pool we target.
Not All Tenant Pools Are the Same
In 2004/5 we spent a lot of time studying the behavioral characters of various tenant pool segments based on various factors including:
- Average tenant stay (years)
- Property type - (condo, single family, townhouse, multi-family, etc.)
- Configuration - (size, stories, number of bedrooms and garage, etc.)
- Rent range
- Distance from The Strip
- Crime levels
The result of this (long) study was both surprising and specific. For example, we discovered that tenant stay had a clear rolloff below and above a specific rent range, as dramatic as illustrated below.
We examined the tenants who occupy the area marked in green and came to some conclusions that applied to most of these tenants:
- They earned significantly more than basic hourly workers.
- The had more skill based jobs as opposed to general labor.
- They were families with children.
- 3 bedrooms and 2 baths were the minimum
- A standard sized driveway with street parking
- They did not live in areas perceived to be high crime areas
- The vast majority rented single family homes
- They lived in newer properties (>1985)
Based on what we learned about this set of tenants, we developed a property profile, which we used for property selection. It appeared we made the right selection but you never know until you test it in the real world. The first test of our assumptions came during the 2008 crash. I am happy to report that none of our clients had any decrease in rent and no vacancies. The market value of their properties dropped like every other property, but the income stream did not change. They continued to make money. We were greatly relieved to know we were right.
The next test took several years. The question was, would this tenant pool stay for multiple years, pay all the rent on schedule and take care of the property? The answer is yes! To date, our average tenant stay is about 5 years. In the last 12+ years, we've had 5 evictions out of a population of about 200 properties. And, the average tenant turn rehab cost is about $500. In comparison, my research showed that the average tenant stay in C class properties was a little less than 1 year and the average turn cost was about $1,500.
While we are confident we selected the right tenant pool, I did not believe that being evicted and having to move to another property was the full story. After further investigation I came to the conclusion that what compels our target tenant pool to perform was not the eviction itself but the after effects of an eviction, which includes:
- Credit hit - This tenant pool is heavily dependent on credit. They know that if they have a late payment, let alone a damage judgement, skip or eviction, their credit will be hurt for years.
- Replacement housing - It is unlikely that any property manager would consider renting an A class property to anyone that had an eviction, late payments or a skip. Tenants know that if they do not perform, they will have a very hard time finding future housing.
- Financial loss - With a heavy hit on credit they are going to have to pay much higher interest rates on any financing they obtain. This includes everything from credit cards, car loans, and even auto insurance will likely cost more.
- Stability - This tenant pool typically has one or more children and parents want to provide a stable environment. So, they tend to stay in the same property for long periods of time so that they do not have to move their children to a new school.
How Do We Target A Specific Tenant Pool?
The answer is simple, but not easy to consistently achieve. Using our data mining software, we select properties that attract our target tenant pool.
In 2004/5 I spent a lot of time studying how tenants select properties. I came up with a selection model I call the Tenant Property Selection Hierarchy (if anyone can suggest a more "catchy" name, I would appreciate hearing it). See the illustration below.
On the right is the order in which most tenants select rental properties. Expanding on the hierarchy.
- Price - The maximum a tenant is willing and able to pay is about 1/3 of their gross monthly income. And, since people generally want to live in the nicest place they can afford, they tend to rent properties priced at about 1/3 of their gross monthly pay. Knowing the rent range, we were able to translate that into property prices.
- Needs - Number of bedrooms, baths, size, etc.
- Location - People are willing to drive a reasonable distance to live in safe areas with acceptable amenities. What is reasonable depends on the metro area. We made some amazing discoveries on how long people will drive in Las Vegas. Beyond that distance, rents tended to drop and time to rent increases. This helped to define the location where we search for properties.
- Wants - Examples would include elements such as granite counters, nice appliances, property age, flooring, condition, etc.
Once we understood our target tenant pool's Tenant Property Selection Hierarchy, we mapped this to what we call a property profile. At a minimum, a property profile has 4 components:
- Type - Condo, single family, high rise, etc.
- Rent range - This must match the gross monthly income of the target tenant pool.
- Location - We were surprised to find "clusters" of desirable areas as opposed to gross areas like zip codes.
- Configuration - This has to do with the number of bedrooms, baths, garage size, SqFt, etc.
However, just because a property meets all these requirements does not mean that every tenant that it attracts is a good tenant. So we have common definition of a good tenant, we define a good tenant as someone who:
- Has stable employment in a market segment that is very likely to be stable or improve over time.
- Pays all the rent on schedule
- Takes care of the property
- Does not cause problems with neighbors
- Does not engage in illegal activities while on the property
- Stays for many years
Tenants that meet all the above characteristics are not the norm. This is part of the reason why we work closely with a very skilled property manager. It takes a skilled property manager to select the good tenants from all the applicants. Fortunately, properties that conform to our property profile are very desirable to a wide segment so the property manager generally has enough candidates from which to select a "good" tenant.
If you own C or B class properties, the risk that your tenants will not pay rent for the foreseeable future and you won't be able to evict them is a very real concern. However, if you buy properties that target the right tenant pool and you work with a very skilled property manager, your risk is greatly reduced. However, finding properties that meet all the necessary requirements to attract the right tenant pool is not trivial. There are too many factors to consider and very little time (good properties priced correctly are going under contract in days). Today, conforming properties represent less than 0.5% of available properties. The only reason we can find such properties is using the data mining software and processes we developed. Without such tools, processes and a highly skilled investment team, your odds of being successful are greatly reduced.
Thank you for your time. I welcome your feedback.