Property managers are turning to security deposit alternatives as a way to mitigate bad debt, get ahead of regulatory trends and increase efficiency.

A security deposit alternative is essentially the replacement of a standard security deposit with a one-time premium that covers losses in the event that a resident leaves a unit in shambles or walks out on his or her lease prematurely.

Employing a security deposit alternative does two main things: eliminates bad debt and lowers move-in costs.

According to Tom Schickel, vice president and general manager at DepositIQ, a subsidiary of RealPage, multifamily operators will continue to show interest in security deposit alternatives as the old way passes away and more municipalities put restrictions on how much properties can take for a security deposit. The most recent example comes from New York City where Comptroller Scott Stringer has been kicking around the idea of implementing a one month's rent maximum for security deposits. This adds complexity to a property manager's job, and security deposit alternatives have quickly established themselves as a viable solution for the added complexity.

“If you take the current standard refundable deposit, from an owner’s standpoint, you are taking the deposit; you are depositing it into the bank; you are having to pay interest in a lot of jurisdictions, refund or return interest, sometimes on an annual basis even if the resident still lives there; and then the vast majority of the time you’re returning the deposits,” Schickel told HousingWire.

“So that whole transaction didn’t really do anybody any good. So, when you go with a security deposit alternative, you eliminate the management of that program, the burden of returning the deposit, paying interest…[and] it provides more flexibility to the resident,” he added.

Right now, Schickel says he’s seen about 10% of the rental market adopt security deposit alternatives in some form or fashion and thinks that in the next two to five years, that percentage could reach 20% to 30% market saturation. This is driven in part by the regulatory climate in some of the major multifamily markets like Seattle and New York City where governments are implementing limits on the amount of money a property manager can hold as a security deposit.

Schickel said there were marked upticks in interest and adoption of his product in markets where the regulatory climate is moving the market away from traditional security deposit practices.

“I would definitely anticipate seeing more of this [legislation]. In states like California where they already have requirements on capping the move-in costs…I can see them following in Seattle’s footsteps. Obviously, the surrounding states and boroughs around New York might follow what they’re doing,” Schickel said.

“There are a lot of different iterations already, but I don’t see it getting easier. I see it getting a little bit more difficult for property management companies to manage this process,” he added.

So far, Class-B and Class-C properties have been the quickest to adopt security deposit alternatives as these properties can compete where it matters most for their potential residents with lower move-in costs than the typical property might have. But, more and more Class-A property managers are realizing that potential residents also want the option to reduce move-in costs, perhaps a function of the overall squeeze rising housing costs are putting on just about everyone.

Either way, it looks like security deposit alternatives are here to stay.