The promise of Security Deposit Alternative (SDA) can be pretty appealing— get rid of cash security deposits and eliminate a significant administrative hassle while ensuring damages, unpaid rent and utilities are all covered (oh, and have happier residents with more cash in their pocket, too). But after seven years and nearly $350MM in venture funding, just an estimated 10% of industry rentals have active SDA policies in place today. What’s going on?
While security deposit alternatives will continue to play a role, the multifamily industry has learned they’re not enough on their own. Why? Most renters still prefer refundable cash security deposits, SDAs are increasingly paired with cash security deposit automation platforms to provide a complete deposit solution.
Here’s why cash security deposits are here to stay.
Renters have not jumped to replace their cash security deposit with an SDA for several reasons. Here’s what we’ve learned from our industry research and interviews and surveys with hundreds of renters.
The traditional cash security deposit is a known quantity, with laws and protections that have existed for many years. In most jurisdictions, tenants still retain the right to pay a traditional deposit if an SDA has been added to local regulations.
Because the security deposit alternative is a new product, some renters are suspicious of the property’s motive or don’t want to invest the time to understand how SDAs work during the chaos of moving.
With a cash security deposit, renters don’t have an additional credit check or a new set of terms and conditions to sign. And if they follow the rules and have no damages or charges at move-out, they already know they’ll get their money back and can use it for their next rental.
Many security deposit alternatives companies pay a commission to the property for selling the deposit alternative bond. Some renters know this and are frustrated that they’re being marketed at.
With the increasing number of add-on fees in recent years—from utilities to wifi fees to mandatory amenity packages—many tenants are wary of anything extra or different. With more than 30% of their income already going towards rent, they perceive landlords as trying to find more ways to get the little they have left.
Security deposit alternatives often require renters to pay a monthly fee or premium. This can trigger what behavioral scientists call the pain of paying—a negative emotion associated with spread-out payments, especially when those payments are for a purchase perceived as unfair.
For example, “Why am I paying a monthly payment for the life of the lease when that money will not be refunded and won’t go towards any of my damages at move-out?”.
Even though a cash security deposit requires more money at move-in, scientists say the consumer's mental accounting of upfront payments is perceived more favorably and is preferred.
Furthermore, when tenants earn interest on their deposit throughout their lease, they may see the upfront deposit payment as more of an investment.
To meet most properties' move-in requirements, renters need an upfront cash security deposit.
And if tenants fail to have money set aside in the form of a cash security deposit from their former property, it’s a lot harder for them to come up with enough money for the next one.
While some renters won’t get a cash security deposit refund, most will at least get some. Based on Roost data collected from partner properties across multiple asset classes, 80% of cash security deposits are fully or partially refunded.
For residents who’ve already paid their cash security deposit, most decline to cash it out and sign up for an SDA instead.
This may have to do with “mental accounting”—a behavioral science theory which explains that we tend to put money into different categories depending on its source and intended use. In the case of the cash security deposit, the fear of shifting money from a “savings'' bucket to a “cash-on-hand or unexpected gain” bucket, is a risk.
Why? Once someone has cash in hand, that money becomes a barrier to savings because the temptation to spend it is greater than the mental energy to re-invest or save that money for better use.
While many security deposit alternatives are upfront and helpful, some products and selling practices have come under significant scrutiny. A series of class-action lawsuits have accused landlords or providers of trying to lure renters into homes they can’t afford or of misleading advertising
Earlier SDA products often advertised themselves as deposit insurance, and renters wrongly believed they wouldn’t owe anything more than their monthly payments regardless of damage charges. In response, some states have gone so far as to ban certain providers from operating in their jurisdictions.
Security deposit alternatives have aspired to eliminate cash security deposits while maintaining property protections.
Unfortunately, after more than seven years in the market, that aspiration hasn’t become reality for multifamily owners and operators.
Most properties offering SDAs see a take rate of less than 20%. Even some of the largest property management companies with finely-tuned leasing and marketing engines don’t expect the property take rate to exceed 50%.
This number will likely decrease as SDAs continually increase their monthly premiums to cover losses. And, as residents realize they are still on the hook to pay damages at move-out, the deposit bond may be a harder sell.
Since the take rate of the security deposit alternative is relatively low per building, property management companies maintain the overhead associated with the traditional deposit process AND the cost of managing a new security deposit alternative claims process.
The leasing staff is responsible for selling the product, and the accounting staff has to manually submit each claim in a separate portal for third-party approval.
Because the re-insurance provider must approve each claim, the owner/operator no longer has the same level of control. Depending on the provider, they may exclude back rent, utilities, and certain damages. Owners have reported frustration with a lack of transparency regarding what is covered and frequent policy changes.
As the SDA market has matured, so has the pricing. Initial deposit bond payments were pretty low-cost. Early advertisements offered bonds for as little as $5/mo (and called it security deposit insurance). Today, payments are higher, as much as 34% of the traditional security deposit. The premium charge typically ranges from 15-17% but on the equivalent of 1.5 - 2 months of coverage. High loss ratios and re-insurance requirements have forced SDA companies to increase fees.
Owners and operators are constantly struggling to manage reputational risk and combat the greedy landlord stereotype. Many properties have avoided deposit alternatives for fear of further feeding this stereotype and because of increasing deposit alternative-related lawsuits and news stories.
landlords want to avoid any misconception that they are trying to lure renters into apartments they cannot afford or that they’re trying to skirt cash security deposit regulations and renter protections. (Unlike cash security deposits, most states do not have specific protections for renters using a security deposit alternative product.)
Coverage mechanisms vary by security deposit alternative provider, but many are built on a “claims fund” concept.
This means damages are covered up to the bond value or life of the fund; when it runs out, so does the coverage. The models fundamentally rely on breakage to survive. In addition, there is the risk that the reinsurance carrier backing the surety bond will change.
The reinsurance carrier may decide the payment-to-loss ratio is insufficient and won’t renew the policy. Nonrenewal disables the surety bond provider from issuing new bonds unless they find a replacement reinsurance carrier and creates risk for multifamily operators deploying bonds across their portfolio.
The benefits and risks of each protection mechanism vary. Here’s a summary of the differences:
Resident
Property
Though Security Deposit Alternatives provide an additional option for renters and properties, cash security deposits are likely to remain the primary protection mechanism for the multifamily industry. Automation can make cash deposit management much more cost-effective, and pairing traditional deposits with SDAs may give properties the most complete deposit solution.
