Should I let my tenants pay rent in advance?
“Never look a gift horse in the mouth,” says the old adage. Landlords sometimes feel that way when considering whether to let tenants prepay their rent. At first glance it can seem like a no-brainer: 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 up front?
But while it may seem like an attractive prospect, accepting rent in advance can be a riskier venture than it seems.
Let’s take a look at some of the pros and cons.
On the plus side...
Cash in hand. Getting a lump sum of cash can help alleviate cash flow problems for landlords, potentially making it easier for you to pay ahead for property management services, maintenance and repair providers, and other expenses.
Simpler collection. The more monthly payments a tenant makes at once, the fewer times you will need to run after that tenant to collect rent. Of course, if you’re looking to simplify rent collection, one simple solution is the auto-invoicing function in Story by J.P. Morgan. Story’s automatic invoicing provides configurable payment reminders, reconciliation at the property and unit level – even the option to block a payment if accepting it would place you at risk!
Security buffer. Collecting rent ahead of time could provide more security when dealing with a high-risk tenant – for example, one who has not provided you with proof of income, has become unemployed, or has 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 property.
But on the other hand...
You could be breaking the law. If you’re considering accepting rent payments up front, take the time to carefully research your local and state laws before you do. For example, some states require that advance rent be deposited in an escrow or trust account until the month when it’s actually due – so you gain nothing by collecting it early. Others allow you to collect no more than first month, last month, and a security deposit equivalent to one month’s rent.
What happens if the tenant breaks their lease? We all wish tenants never broke a lease, but they sometimes do. And if they’ve prepaid, you’ll have to refund the remainder. If you’ve already spent it, you’ll be in the hole.
You won’t be able to raise the rent. If you end up wanting to increase the rent to keep up with the market, you’ll be out of luck. Accepting an advance payment locks you into the old rate for the duration of the prepaid months.
You may have to extend the lease. If a tenant prepays beyond the remaining term on their lease, they have effectively extended it and you cannot terminate it until the prepaid period has elapsed.
Thinking of selling? You may have to wait. Buyers and sellers are required to honor existing lease agreements. Because a prepayment beyond the remaining term extends the lease, you will have a tough time selling, since buyers typically want to move in immediately after the purchase has closed.
Tax surprises. 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 spreading into the following year, you could end up paying significantly more tax in the year when you accept the prepayment.
Accounting headaches. If you let one tenant prepay, others are likely to ask for the same favor. Refuse, and you could be faced with a discrimination complaint. Grant the request, and you may find it hard to keep track without an outside property management company or bookkeeper. No matter what you decide, Story by J.P. Morgan can help you track rent easily and improve rent collection. Story lets you accept payments by ACH, credit or debit card, even autopay. Story handles record keeping for checks, cash, and money orders – and provides integrated reports of leases, security deposits, receipts, and payment history.
You may 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 may have to pay interest to your tenant on their advance payment.
False security and buffer backfires. Remember that security buffer we mentioned earlier – accepting prepayment from a risky tenant to help mitigate the risk? Well, the flip side is that the tenant could be just as unable to pay once the prepaid term has passed. The better choice may be to screen rental candidates before signing the lease. You may also wish to opt for certain requirements that may reduce risk – such as only accepting tenants with high credit scores. With Story by J.P. Morgan, landlords can get access to discounted TransUnion tenant screening reports within minutes.
The bottom line...
Ultimately, there is no simple answer: Every landlord’s situation is different, and so is every tenant’s. But in the balance, accepting rent in advance presents multiple significant risks that make it a bad idea for most landlords – which is precisely why most landlords don’t do it.
If you’re eager to streamline your rent management and collection, plan ahead, and stay in tune with your tenants’ needs, sign up free for Story by J.P. Morgan. Story is an all-in-one digital platform for the commercial real estate industry, including apartment property owners, investors, and tenants. Request a demo today!
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