Should I let my residents pay rent in advance?
At first glance, letting renters pay rent in advance can seem like a no-brainer for apartment investors: Why would you ever say no to money? After all, you invested in multifamily real estate to generate steady income at limited incremental cost. What better way to pocket more revenue than to be paid rent upfront?
But while it may seem like an attractive prospect, accepting rent in advance carries risks. Let’s take a look at some of the pros and cons.
The potential benefits of advance rent payments
Cash in hand. Getting a lump sum of rent payments can help alleviate cash flow problems for real estate investors. That might make it easier for you to pay for property management services, maintenance and repair providers and other expenses.
Simpler rent collection. If you collect rent manually, the more monthly payments a renter makes at once, the fewer times you might have to nudge that resident to collect rent. Of course, if you’re looking to simplify rent collection, an easy solution is the auto-invoicing function in Story by J.P. Morgan. Story’s automatic invoicing provides configurable payment reminders.
Guaranteed rent payment. Collecting rent ahead of time can provide you some assurance if you don’t have confidence your renter can reliably pay rent every month. This might be the case for those who haven’t provided you proof of income, have become unemployed or have little or no verifiable rental history.
Sign of good faith. A rental applicant who is willing to pay for multiple months in advance is likely to be serious in their commitment to living in the unit.
Risks associated with advanced rent payments
You could be breaking the law. If you’re considering accepting rent payments upfront, always consult with an attorney who is familiar with your applicable local and state laws. For example, some states may limit the amount of prepaid rent a property owner can require upfront. That doesn’t necessarily mean a renter can’t volunteer to prepay rent.
“In most states, it’s safest for landlords to not demand advance rent payments, but it’s OK for them to accept them if the renter proposes it,” says Ann O’Connell, legal editor and attorney at Nolo.
But there may be additional rules governing where you keep that money and how you use it. Some states require property owners to keep advance payments in a separate bank account until the month when it’s actually due, or post a surety bond in the amount of the advance payment.
You might have to pay interest on prepaid rent. State and local rules vary when it comes to prepaid rent. Some jurisdictions treat certain rent prepayments the same as a security deposit, meaning you might have to pay interest to your renter on their advance payment.
There’s no safeguard against broken leases. If a renter breaks their lease and has prepaid their rent, you might have to refund them for the remaining months. If you’ve already spent their payment, you could run into a cash flow problem.
Almost every state requires a property owner make a reasonable effort to fill a vacancy left when a resident breaks a lease, O’Connell says. If the owner finds a new renter before the prepaid rent runs out, they would have to refund the difference. There’s “no double-dipping on the rent,” O’Connell says.
Keep in mind that if the money paid upfront is designated as advance rent, it can only be used to cover rent, not other costs required to find a new renter, like advertising the unit, O’Connell says. Those expenses must be covered by the security deposit. In addition, advance rent payments can’t be used to cover damages unless the lease says they can be. In that case, they would be treated as a security deposit and subject to any state or local limits on security deposits, she says.
Tax implications. For tax purposes, the income you report on rent payments is typically balanced by business expenses. But if rent is paid in advance during one tax year rather than spread across the following year too, you could end up paying significantly more tax in the year when you accept the prepayment.
Accounting headaches. If you let one renter prepay, others might ask for the same arrangement. Grant the request, and you might find it hard to keep track of who paid what and when, and when you can use the funds. Refuse, and you could be faced with a discrimination complaint, unless you have a solid business reason for handling renters’ payment arrangements differently, says O’Connell. She recommends allowing prepayment for all residents or none.
No matter what you decide, Story by J.P. Morgan can help you track rent payments easily. Story lets you accept payments by ACH, credit and debit card, and even autopay. Story handles recordkeeping for checks, cash and money orders, and it and provides integrated reports for leases, security deposits, receipts and payment history.
The bottom line
Every property owner’s situation is different, and so is every renter’s. But accepting rent in advance presents several significant risks, which is why many owners don’t do it.
The good news is if you’re ready to streamline rent management and collection, plan ahead, and stay in tune with your renters’ needs, Story by J.P. Morgan is here to help.
By Avi Jacobson from Story by J.P. Morgan