We all know the drawbacks of security deposits.

Because they can be so large, prospects are struggling to pull together the necessary funds to secure a simple lease. In fact, Zillow’s 2019 Consumer Housing Trends Report found that 49% of adults say they would not be able to cover an unexpected $1,000 expense. Broken down into a demographic perspective, 46% of Millennials, 40% of Gen Z, 52% of Gen X, and 62% of Boomers and the Silent Generation are not able to cover that $1,000 expense.

Beyond the steep cost of a security deposit, residents are virtually guaranteed to be upset with the lesser-than-expected amount of their deposit refund. Their anger can lead to nasty online reviews, and require that associates devote a hefty amount of time managing departed unhappy residents.

As an alternative to security deposits, many apartment communities have turned to surety bonds – only to find that bond pools present their own brand of headaches.

Surety Bond Primer

Apartment operators have opted to offer optional surety bonds as a way to increase conversions and occupancy rates at their communities, however, these same operators have experienced low adoption rates of surety bond programs, negating their prospect as a wider solution.

Surety bonds are a three-party system that typically consist of the resident, the property, and the bond guarantor. The resident pays a portion – usually 17.5% – of the total deposit amount at move-in as a non-refundable fee. So, instead of paying a hypothetical $1,500 security deposit, a resident might have to spend – using the above example of 17.5% – $262.50 to purchase a surety bond.

If the apartment community needs to make a claim against the resident for damages to the unit or unpaid rent, the bond company will pay the community up to only the total original deposit amount. The bond company will then go back to the resident to demand reimbursement of whatever amount it paid to the operator. Unfortunately, the resident is often not expecting this expense, as residents sometimes mistakenly believe that the non-refundable and relatively large upfront fee represents their sole financial responsibility under a surety bond program.

One of the Primary Problems

Perhaps the most notorious drawback to surety bond programs is their use of bond pools. When an apartment community offers its residents this type of surety bond as an alternative to security deposits, those funds go into a pool that the community draws upon to cover unpaid rent and damages; and that is only after the bond company takes up to 30-40% to pay itself a fee, while only the remaining 60-70% goes into the pool in such case. So, the property starts out with much less than the original 17.5% charged to the resident for future losses.

Furthermore, operators find these pools difficult to track and manage, and often run out of money because a community may be forced to allocate a large portion of the pool to pay for the damages that only a handful of units’ residents caused. This allocation may leave little or no funds to cover subsequent rent losses or damages. In this situation, a community is forced to wait until more residents move in and replenish the pool with their surety bond fees before it gets reimbursed for additional losses. And when it's time to file a claim against a resident, it can take up to 30 days for the bond company to reimburse the community.

More recently, several surety bond startups have entered the market explaining that they pool their funds or cover their claims at a higher carrier level rather than at the property level. These bonds are backed by reinsurers who are contracted to pay all claims, even if the surety bond company becomes insolvent or finds that the dollar amount demanded of them in claims is continually greater than the premium or fees paid into the program.

While this temporarily keeps properties covered for losses, the surety bond math still applies. To recap, if claims paid out from the pool are larger than funds coming in, this leaves the reinsurer to absorb 100%+ loss rates, which reinsurers will not sustain indefinitely. Reinsurers in this field target 40-60% loss rates, so after absorbing loss rates over 100% they may terminate future coverage, leaving the property without a program or protection moving forward.

A Better Way

More and more apartment operators are realizing that security deposits need to go. They simply cause too many headaches: residents can’t afford them, lease conversions remain slow, and there’s a whole array of administrative hassles for operators. In addition, they set the stage for the inevitable conflict between properties and residents.

Replacing security deposits with surety bonds is not the answer. Although surety bonds offer a deposit alternative at move-in, they can still be pricey for the resident, and create a financial nightmare down the line for the operator. Properties that dare swim in the surety bond pool will eventually need a lifesaver.

The modern, tested, and true solution to eradicating security deposits lies in lease insurance. With lease insurance, all residents simply pay a reasonable and truly affordable, low flat monthly fee that generates more than $5,000 in coverage for the property on every lease and every unit, multiples greater than what a surety bond or security deposit would have covered. And as a result, operators are spared the endless hassles involved with managing both security deposits and surety bonds.

By eliminating all forms of security deposits and surety bonds, operators can increase occupancy and revenue by converting more leases, and they will make life easier for everyone—a lifesaver if you will.