Dialing Back Screening Thresholds in a Soft Market
Despite negative projections at the beginning of 2017, the apartment market didn’t exactly stall in 2017. In fact, even as recently as the end of Q3, REIS reported that asking rents grew by 1 percent.
That, however, doesn’t mean a downturn will never occur or that it isn’t happening in specific submarkets. It will, and when it does, owner/operators should be prepared to address occupancy challenges. One of the most effective ways, according to experts on the Dialing Back Screening Thresholds in a Soft Market panel at the 2017 NMHC OPTECH conference in Las Vegas on Thursday, is to adjust screening thresholds before reducing rent or introducing concessions.
“There are the four Ps of business — product, people, promotion and price, and the last thing I want to mess with is price,” said Jim Kjolhede, president and founder of Satterton Enterprises, a multifamily consulting firm. “You want to make sure your leasing effort is strong. You want to make sure you have enough ready units. You want to make sure you’re advertising well and getting prospects in the door. You have to make sure those things are working before you start lowering your price or your screening standards.”
After determining that product, people and promotion are in order, there may be a need to adjust screening thresholds to shore up occupancy issues in a soft market. That requires striking a delicate risk-reward balance that mitigates the risk of increased skips and ultimately bad debt.
Pinnacle and Alliance have both made adjustments to their screening models since the start of the Great Recession in 2008 to address occupancy challenges at communities. Specifically the two companies adjusted their requirements regarding bankruptcies, foreclosures and account balances, while also putting a greater emphasis and value on new automated tools, such as rental payment history.
“Alliance had fairly stringent criteria in place prior to the downturn,” said Rachel Davidson, senior vice president of performance management for Alliance, which manages mostly Class A assets. “For example, we automatically declined anyone with a bankruptcy or a foreclosure prior to the downturn. During the downturn, we changed that setting so we no longer automatically declined, but it did move them into a conditional status.”
For Pinnacle, which manages a more varied portfolio that includes affordable and market-rate properties, the changes to screening thresholds are more nuanced and require regular maintenance on a need basis. Including adjustments to bankruptcy and foreclosure requirements, Pinnacle has eliminated outstanding balances of less than $100 or $500 depending on the community classification from the screening scoring models.
Underlying the changes is the assumption that having bankruptcies, foreclosures and small outstanding balances on their credit reports don’t necessarily mean the applicant won’t pay their rent every month. Rental payment history that is gathered electronically from a provider like Experian RentBureau might be a better indicator of that, according to Davidson.
“We’ve actually become much more reliant on rental payment history, especially as a lot more people have begun participating in it,” Davidson said. “I would love to see more companies share rental payment history.”
Manually calling on rental and even employment references, on the other hand, is starting to be removed from the process at some owner/operators. Davidson and Alliance found in a recent case study that these manual checks don’t actually work. Communities that conducted the manual checks, according to the Alliance review of internal practices, actually experienced more evictions than those that didn’t.
That’s most likely because the information gathered wasn’t accurate, making the practice a waste of valuable on-site team member time, according to Kjolhede. That’s especially true in a soft market where owner/operators want to secure the prospect as a resident before they find another place to live.
“I do not want my site people looking into any of that,” Kjolhede said of manual rental and employment checks. “I want my screening provider to get the information and put it into the model that we agreed on. Prospects have a good score for a reason, because they pay their bills. Manual screening processes slow down the leasing process. Being fast and locking the prospect in and not letting them find another place is good customer service.”
That’s why it’s important for owner/operators to maintain close relationships with their screening partners, which not only improves their screening practices, but also helps them keep a pulse on market trends. Regular conversations with screening providers might actually help owner/operators get ahead of downturns and adjust screening thresholds before the soft market hits and occupancy challenges arise, Kjolhede said.
Screening partners are often also able to run scenarios for owner/operators to determine what impact an adjustment to thresholds might have to bad debt.
“They can run a lot of scenarios for you,” Kjolhede said. “If you were to lower that cut point, they can tell you what the risk reward changes would be. They can do the autopsy for you.”
That autopsy and subsequent threshold changes might just help an owner/operator limit rent reductions and mitigate occupancy loss in the next downturn, which is inevitable at some point.