Dealing with renters after foreclosure

Many apartment professionals view the growing number of foreclosed mortgage holders as a potential gold mine--a rapidly expanding pool of potential residents who could help decrease vacancy rates and drive up rents.

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As property managers get caught up in trying to fill units, many communities are changing their resident screening criteria to accommodate former homeowners who have fallen on hard financial times. Communities are isolating mortgage foreclosure events and either eliminating the events or minimizing their weight during the screening process. Such approaches pose serious financial and legal risks for multifamily housing communities.

Memphis, TN-based CLK Multifamily Management recognizes these risks and sees no reason to change its screening practices in a knee-jerk reaction to the influx of foreclosed mortgage holders to the rental market. The firm, which owns 58 properties located in 13 states totaling 16,300 residential units, currently uses First Advantage SafeRent’s statistical scoring model to evaluate potential residents. According to vice president Davy Johnson, “Changing the screening process would skew an otherwise consistent screening practice and the history CLK has established. It would introduce new screening rules used exclusively for subprime mortgage foreclosures. If we step outside of our established practices it creates potential Fair Housing compliance issues.”

A foreclosure is one of many financial events that are reflected in a person’s credit file. The way in which it is judged today should be no different than they way it was judged a year ago.

For example, how would a rental community differentiate between prospective resident A’s foreclosure in 2002 and prospective resident B’s foreclosure in 2007? What makes A less creditworthy than B?

Making arbitrary adjustments to resident screening takes multifamily communities back to the days before statistical scoring models were available. Who has the wisdom or authority to rate individual financial hardships? It is simply too subjective to be done with any degree of accuracy or certainty.

It is Johnson’s experience that “generally, as people go into a financial crisis of this magnitude, they will have a series of negative financial events because people will do anything they can to keep their homes.”

All of the negative financial events leading to foreclosure are independent and interdependent. Collectively, these events can be quantified through statistical modeling to accurately predict how a prospective resident will perform on a future apartment lease obligation. Multihousing professionals should keep in mind that a foreclosure is not a bankruptcy. The debts and liabilities that have accumulated (i.e., the dominos preceding foreclosure) are still in place and are still creating the opportunity for additional financial challenges.

To test Johnson’s theory that a foreclosure isn’t an isolated event, and that risk accumulates prior to a foreclosure, First Advantage SafeRent studied a sample set of rental applicants with foreclosures. These applicants were screened through a statistically valid scoring model that predicts and rank orders the risk associated with each prospective resident. The foreclosure group was then compared to the average applicant profile across a number of predictive risk elements. The research indicated that foreclosure applicants are, in fact, financially stressed and have more derogatory information in their credit files (see side bar) then the average applicant.

All of the variables included in the screening process, and the inter-dependency of those variables, paint a vivid picture of each applicant’s risk. When these variables are evaluated within a statistically valid scoring model that is designed to predict financial performance for rental housing, they become highly measurable and quantifiable.

At CLK, leasing decisions are always made based on the resident screening score. The staff doesn’t review credit reports or any other background information. If they were to make manual leasing decisions, there would be no way to ensure consistency. Credit reports, foreclosures, eviction records, and many other factors all must be considered. If decisions are made manually, a prospective resident would always try to paint the best possible verbal picture of her or his past. Leaving a leasing manager to determine whether or not that story is true could lead to a bad financial decision and could open up the property-management company to charges of discriminatory credit decisions.

By applying a statistically valid scoring model to each rental application, decision making becomes dispassionate. Judgment is not clouded. Motives are not questioned. Financial risk can be minimized and legal exposure is virtually eliminated.

“Over the past 4 or 5 years, since I have been using a statistical scoring model, I don’t know how many people with foreclosures have applied to live in CLK communities,” said Johnson. “But what I do know is that my collections are up and my delinquencies are down. And I have year-over-year experience that tells me that the statistical model is giving me good direction towards making my screening decisions. Why would I adjust it now?”

Author: Nevel DeHart