What Real Estate Investors Should Know About Security Deposits

I had questions about this, so thought others might be interested as well. It sounds like you have to find out what your state's regulations are, because there are no clear cut answer that apply to everyone. If anyone has any links to specific state's rules, please feel free to post them in the comments.

Thanks,
Matthew

Charging a security deposit to cover potential damages a tenant might inflict on a unit is part of rental income property ownership inherent to smart real estate investing.

There are rules, however, and not unlike other landlord-tenant issues, there are state limits and exemptions regarding deposits that real estate investors should be aware of.

Should You Charge a Security Deposit?

Real estate investors who do not charge a security virtually let in tenants who have nothing to lose by damaging the unit.

Yes, you should charge a security deposit—the bigger the better. You inherit less of a financial burden if the tenant leaves owing you rent or if you have to repair damage, and the tenant who has money at stake is more likely to respect the property.

How Much Deposit Can You Charge?

Many states limit the amount that can be charged for a security deposit.

Alaska, for example, exempts income property owners from security deposit laws when the rents are above $2,000. Hawaii and Massachusetts restrict the security deposit to no more than 1 month’s rent; Iowa and Virginia to no more than 2 month’s rent; Nevada to no more than 3 month’s rent.

Sometimes, the state limit is based on other factors such as the age of the tenant, whether the unit is furnished, what kind of rental agreement is being used, or whether a pet or water bed is being permitted.

The best advice is for real estate investors to learn what state limits are and to charge as much as the legal limit and the market will allow—though it is not uncommon for the market to dictate a security deposit below the legal limit set by state and local law.

The Importance of Remaining Consistent

If you charge different security deposit rates to different people you can be headed for trouble–a claim of discrimination could be held against you in a lawsuit.

Whatever deposit you charge, therefore, just be sure that your security deposit policies remain consistent with every tenant and avoid even the appearance of discrimination.

Can You Increase a Security Deposit?



Let’s say a long-time tenant obtains a pet—can you legally increase the security deposit? Yes, but it depends on the situation.

If you are using a fixed-term lease, you cannot raise the security deposit during the term of the lease unless the lease allows it. Otherwise, you must wait for the lease renewal date to increase the security deposit.

If you are using a written rental agreement in a month-to-month tenancy, the security deposit can be increased the same way that the rent is increased—by giving the tenant proper notice, which is typically 30 days.

If your rental properties are under rent control, raising the security deposit may have even more restrictions. In this case, real estate investors who own rental property under rent control are advised to understand the restrictions before raising deposits.

Must You Pay Interest on Security Deposits?

State laws vary regarding security deposit interest requirements.

Whereas some states impose no regulations, many states require that landlords accrue and pay interest on deposits.

Washington, for example, unless it is specified in the lease or rental agreement, permits the landlord to keep any interest accrued; Iowa lets the landlord keep the interest for only the first five years of tenancy. New Mexico requires payment of interest if the deposit exceeds 1 month’s rent; Minnesota requires the landlord to pay interest, period—accruing the month after the security deposit was paid.

Conclusion


Real estate investing consists of layers of nuances particular to real estate investment property important to successful investing—like security deposits.

Whereas a smart real estate investor will charge a tenant a security deposit before use and occupancy of a rental property to insure payment of rent on time and responsible care of the unit; the prudent investor will also understand state and local regulations where the income producing properties are located, and above all, abide by them.
Whether you are seasoned or beginning real estate investing for the first time, if you are unsure about these issues, do not hesitate to consult with legal and other real estate professionals for advice.

Gathering sound investing real estate information from reliable and knowledgeable sources is what a smart real estate investor does.