A few thoughts on tenant defaults…
August 18, 2010
One of the first questions I usually get from a new real estate investor is: what is your track record with tenant defaults? I think this is a great question to ask and everyone should ask this question.
As many of you know, we’ve been in business for over 4 years now. In the beginning, we made a lot of mistakes. Since rent to own was practically a non-existent industry in Canada, we made up the rules as we went along. Not many of you know this, but I actually was the investor in the first two rent to own tenant deals. And, boy oh boy, did I pick the wrong tenant… (I actually lost money on both deals). Hindsight is 20/20 and I had to use this as a learning experience and not dwell on the negative side of things too much.
I know I am getting a little off topic here, but I think it’s important to provide perspective when looking at this topic. So, what are our default rates? I define a default as a tenant who is behind in rent payments, equal to one month or more.
So, here is, in percentage, the number of tenants that defaulted in each of the following years of being in business:
Year 1: 46%
Year 2: 38%
Year 3: 21%
Year 4: 15%
Last 6 months: 6%
So, what can we grasp from these numbers? In the first two years of business we made a ton of mistakes. We took in tenants with 2-3% deposits, income was so-so and our policies and procedures were terrible.
I was sick and tired of taking in the wrong tenant, so I took it upon myself to analyze what went wrong with each default. The results were staggering – there was an identifiable pattern with over 90% of the defaults! With this information, we made some drastic changes to how we underwrite each deal. While our number of defaults dropped significantly, our default rates were still too high for my liking.
So, about 8 months ago, we want back to the drawing board. We spent a lot of time analyzing and identifying who was the ideal rent to own tenant was. At the same time, we streamlined our internal processes to make sure no steps were missed and all checks and balances were in place (btw we’ve got a super admin team in Emely, Rachel and Parm).
So if you look at the last 6 months, we have a default rate of 6% (or a success rate of 94%, depending on how you look at it). I am really proud of this number. Some of you skeptics are probably thinking… “Yeah… but 6 months is such a short amount of time”. While, that is true, in my experience a default is most likely to occur within the first 6 months. I really do believe that a tenant’s payment patterns don’t really change.
So there you have it, these are the numbers. While we can never guarantee success, we work very hard behind the scenes to get it right and it is my goal by the end of the year to have a default rate of less than 5%. There, I said it.
I hope you enjoyed my little blog here – I’m also going to post this on our investor site: www.RentToOwnInvestor.com. You’ll be hearing more from me next week!
To investments that change lives,
Alex