If you were to step back and look at the self-storage industry, you’d see a specialized real estate service that covers more than 2.3 billion square feet in rentable space and creates a combined annual revenue of more than $38 billion. For such a relatively young business, it remains one of the strongest sectors in real estate.
As the industry has grown and matured, it has begun to use some of the techniques learned over the years by owners of commercial and multi-family properties to enhance their operation and improve revenue collection. One of those is to use a point-of-sale credit screening and reporting system to weed out customers with a history of delinquency and lease default. That system can also be used to report payment activity back to the credit agencies, potentially motivating timely and reliable payments by tenants who are focused on maintaining their credit score.
Checking Credit as a Condition of Tenancy
On the front end, self-storage operators need to ask themselves, “If I know a tenant is a bad credit risk, will I still rent to him?” The answer would typically be “no.” Why? Because they recognize that time spent dealing with late payments and enforcing the lien process distracts facility managers from the more profitable side of the business—renting units to tenants who can pay.
It’s true that if a tenant doesn’t pay, there’s a statutory remedy for addressing the default. However, if you have the choice between renting to a good-paying tenant and one for which you might need to invoke your lien rights, the answer seems obvious.
Although there has been very little effort to bring credit checks into the self-storage industry before now, the main reason was because the verification process was time-consuming, paper-intensive and costly. Essentially, using a credit check in the process of renting a unit drove up the cost per lease.
These days, with Internet capabilities, a credit check can be almost instantaneous and the cost is negligible. It’s certainly low enough to outweigh the potential costs involved in dealing with a delinquent tenant and a possible lien sale. Not to mention, there’s the “contingent liability” associated with selling tenants’ units.
There’s an opportunity now—with the customer’s consent—to pull a credit score and determine the payment risk. Subject to an operator’s discretion, a system could be put implemented in which a credit score of 720 to 850 would clearly be “green,” a score of 620 to 719 would be “yellow,” and a score of 450 to 619 would be “red.” Those traffic-light colors signify the potential risk of renting to that person. Based on the information provided and the corresponding credit score, you could still decide to rent to him even if his score is low; but you would maintain the right to adjust the rental rate accordingly.
This concept of “risk-based pricing” is already in use in multiple businesses, such as those specializing in credit cards, mortgage rates and car loans. With its use, you could balance his risk of a rental based on independent information. In other words, rather than potentially turning away a customer based on the belief that he’s homeless or appears to be a payment risk—which may open a challenge of discriminatory rental practices—the third-party credit-check method creates a consistent, unified approach to measuring the risk, with all tenants being treated the same based on this financial data.
This is separate from the benefit of weeding out customers who might offer false identification when entering their lease. You could learn immediately if a name, address or Social Security number is valid. With all these benefits of doing a credit check as part of the rental process—immediate verification, low cost, risk-based pricing and increased validation of tenant identity—why would you not take advantage of this service?
Monthly Credit Reporting
A tenant’s understanding that the timeliness of his self-storage rent payments will impact his credit score has been shown to dramatically reduce delinquencies and associated costs, including intangible ones like manager frustration and stress arising from tenant defaults. Facility operators who report their tenant’s monthly payment activity to the credit agencies elevate the importance of those payments to the same priority as mortgages, auto loans and credit cards because the customer’s credit score is at risk if there’s a failure.
Data clearly shows that monthly credit reporting by property landlords influences payment behavior by tenants who wish to avoid a negative credit history. It also allows you to determine at point-of-sale if an applicant has previously generated a delinquent account. The use of credit reporting reduces bad debt because of the effect of late-payment reports on customers’ credit scores.
Under the current system, a self-storage tenant can wait indefinitely to pay, even up to the time of the lien sale, with no impact on his credit. At the end of the day, the enforcement of a lien on his stored goods and even their sale may not be as impactful to him as a lower credit score. By understanding his rent payments are being reported, a tenant can avoid defaulting to protect his credit.
Adding credit reporting to a self-storage operation should increase operational cash flow, which directly increases the net value of the business. Similarly, there are benefits for customers, namely higher credit scores for those who create a record of timely payments. On-time payments are rewarded with positive points, whereas late payments result in a negative impact.
An additional advantage of the credit-reporting approach concerns past uncollected debt. If you’re carrying unpaid rent deficiencies after conducting lien sales, those can also be uploaded into the credit system. This enhances your ability to recoup the unpaid debt, especially when those tenants seek to update and improve their credit record. A customer can’t apply for a new credit card, or obtain a car or house loan with a bad credit history. He might even be denied employment. Your credit reporting can motivate him to pay off his self-storage account and obtain a release letter, which would clear the tradeline for a delinquent report.
As a model of success, we can look to the impact credit reporting has had on other industries, such as homeowner’s associations. Associations using ongoing credit reporting identified a decrease of as much as 58 percent in past-due membership balances in the first three months, and a decrease of as much as 74 percent over a 12-month period. Clearly, providing monthly payment records to the credit-reporting agencies can positively impact a self-storage facility’s bottom line.
Scott Zucker is a partner in the law firm Weissmann Zucker Euster Morochnik & Garber P.C. in Atlanta, which specializes in business litigation with an emphasis on real estate, landlord-tenant and construction law. He’s a frequent speaker at self-storage industry events, author of “Legal Topics in Self Storage: A Sourcebook for Owners and Managers,” first and second editions, and a partner in the Self Storage Legal Network, a subscription-based legal service for storage owners and managers. He’s also the deputy general counsel for the Self Storage Association. For more information, e-mail [email protected]; visit www.wzlegal.com.