A landlord recently purchases a property with a vacant unit. Diligently, he advertises and weeds through a multitude of unqualified applicants (mostly due to lack of income, poor credit and/or them not showing up for their appointments). Finally, the landlord is contacted by a nice young couple who really wants the place… and even shows up for their appointment.

The landlord can tell from the questions he asks (see my prior post on questions to ask prospective tenants) they aren’t perfect applicants, but they’re not that bad either. Their stated gross income is close to four times the rent (Suggestion: look for income to rent ratios of 4 to 5 times coverage) and they seem like they want to rent for at least a couple of years. The landlord is able to verify their applications and the application fee check didn’t bounce (always a positive). Even their credit and criminal background checks come back with no major problems. Both applicants appear to be nice people and the landlord thinks he might finally have a good fit for the vacancy. Everything looks like a “GO!”

Since it is the beginning of the month and the tenants aren’t looking to move in until next month, the landlord now has three options that he considers:

1. The applicants sign a lease and put down the security deposit and first month’s rent.
2. The landlord takes a “holding deposit.”
3. The landlord just takes the applicants on their word that they will move in at the beginning of the next month, signing the lease closer to, or on, the “move-in” date.

Since he still has some repairs to make, the CO to pass, and the prospective tenants seem like really good people– the landlord makes a decision to take the tenants at their word that they will sign the lease and move in at the beginning of the next month. They agree to meet in a few weeks, after the CO is obtained, and sign the lease at that point in time. The landlord then goes about his job of filling out all of the paperwork with the township and paying all the fees necessary to move these new tenants in. He has also has his repair men make the necessary repairs he thinks are needed to pass the Rental CO.

A week before they are due to move into the property, the landlord gets the CO and happily contacts his “new tenants” to arrange a meeting, sign the lease and collect the rent and security deposit. To his surprise, the prospective tenants apologetically inform him that they have been “meaning to call” him. They are withdrawing their application and have decided not to rent the unit after all!

Outlandish scenario? Not at all. Unfortunately, the landlord is now out the following:

• A few weeks time of actively marketing the property and resulting extended vacancy rate;
• The time and expense of applying for the CO, which may now have to be reapplied for;
• The cost of repairs which now have to be paid for “out of pocket” rather than out of “cash flow.”

How could this landlord have protected himself? There are at least a couple of ways. He could have had the tenants sign the lease and provide their first month’s rent and security deposit much sooner after he accepted them. Sometimes, though, this isn’t practical. For example, what if he still had a couple of things to verify on their application, but they wanted him to “take the rental off the market” so that they would be first in line for the unit. Or, what if they didn’t have the deposit and first month’s rent until their next pay period, etc.

To bridge the gap, some landlords use Holding Deposit Agreements. This agreement, in essence, states that the landlord will “hold the unit off the rental market” for a certain period of time in consideration for the prospective tenant putting down a deposit. If they sign the lease and subsequently rent the apartment, this holding deposit usually gets credited towards their first month’s rent. On the other hand, if they agree to rent the apartment and later decide not to sign the lease or rental agreement, they will lose at least a prorated amount of the deposit to compensate the landlord for the valuable time and expense lost by not advertising and showing the unit to other applicants. This at least would have helped the landlord in the example above defray some of the extra costs he had to bear after the tenant backed out.

I have spoken with other landlords to find out what kind of holding deposits they take. It seems to vary from nothing (ie. they don’t use them) all the way up to landlords who collect half of the first months rent as a holding deposit. In other words, some landlords like using them and some don’t.

If you decide that utilizing a holding deposit might be a worthwhile part of you property management procedures, you should consider the following:

1. Some states allow holding deposits and some don’t. Consult your state laws and/or a local real estate attorney to find out if you can use Holding Deposit Agreements in your state and how to best structure the agreement. For example, in many states the laws are unclear with regard to how much of a holding deposit a landlord is entitled to and under what circumstances. This could result in the applicant filing a lawsuit in small claims court, especially if the holding deposit amount being withheld by the landlord is significant to the tenant. Consulting an attorney or using a Holding Deposit Agreement specific to your state is probably a prudent idea.
2. In what situations will you take a holding deposit compared with just getting the tenant to sign the lease and put down the first month’s rent and security deposit? Or, as an alternative, would your state laws allow you to charge the successful applicant for the cost of the Certificate of Occupancy and other township fees related to them renting the unit rather than use a holding deposit?
3. Make sure the Holding Deposit Agreement clearly shows the name of landlord and applicant, address of property, amount of deposit, dates you will hold the property vacant, term of the rental agreement or lease, conditions that applicant needs to fulfill, what happens if the applicant doesn’t sign the rental agreement or lease and the amount you will keep if the applicant backs out (ie. is it prorated amount based on days it was off the market, etc.)

Holding Deposit Agreements may be a good property management tool for landlords, at least in select cases, if your state laws allow. Some landlords that I have spoken with almost always use them, while others don’t use them at all and either get leases signed ASAP with the security deposit and first months rent. Whatever YOU decided to do… read, research and decide for yourself. Successful landlords know their options and adapt things that make their business more efficient and effective.

I’d be interested if any fellow landlords would like to share with readers their comments as to whether they use holding deposits and why or why not they make sense.

None of the things discussed on the Landlord Business Insider should be construed as legal, accounting or professional advice. Please seek out qualified professionals in their chosen areas of expertise should you have any questions specific to your situation.

Steve Boorstein

Author/Landlord

https://www.managerentalproperty.com/
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