When a tenant defaults on a lease, the problems are numerous — from losing income to finding a new tenant to having a vacant space for an extended period.

Similar concerns apply to property damage. Security deposits may fall short of covering repairs and getting relief can mean extended legal proceedings.

But residential property owners and operators can protect themselves. Risk management and insurance can prove effective against the costs of default and damages to rental units. And captive insurance arrangements can take that one step further, producing revenue for residential property owners.

Defaults and damage hamper owners and operators in multiple ways

Defaults are expensive for many reasons, including lost income, the cost of leasing the space again and court costs to recover back rent or to evict tenants. Those costs erode profit margins and disrupt cash flow.

Property damage from departing tenants will always be an issue — that’s why security deposits and renters' insurance exist. However, security deposits don’t always cover the damage, and not all renters have proper coverage, even if it’s mandated by the lease.

Most landlords require tenants to produce a certificate of insurance (COI) upon signing a lease to prove the tenant can cover damages or defaults. But beyond the initial COI, real estate owners and operators rarely are able to confirm that tenants’ insurance remains current.

Residential property owners can minimize the damage of tenant default through strong risk management and insurance. For instance, tenant default insurance will cover lost rent when a tenant defaults on their lease. To limit the cost of tenants leaving their units in disrepair, landlords can improve their screening of tenants, conduct periodic inspections for damage and purchase tenant liability insurance.

Captive solutions can produce income for residential properties

Tenant default and liability captive insurance take risk management a step further. In a tenant liability captive, property owners charge tenants a small, non-refundable monthly fee (typically $15 to $20) that goes to the captive. Landlords can then dip into this pool of money for insured losses, including loss of rental income and the cost of eviction.

A tenant default captive works much in the same way. Instead of a tenant paying a security deposit upfront, a landlord will charge an additional fee (typically $12 to $14 a month) in exchange for a $100,000 waiver of liability.

Not only does a tenant default captive collect money for damages and other vacancy costs, but it also eliminates the need to collect and manage security deposits. The captive also widens the pool of potential tenants, including those who can’t pay a full security deposit.

In addition, captive solutions can provide a revenue stream for well-managed properties. When there’s a low number of claims, property owners and operators can take the excess from a captive as income.

Note that these programs are not applicable for all residential property owners and are best suited for portfolios of at least 1,000 rental units.

Contact a HUB real estate expert for more information on how tenant captive insurance can help reduce your risk and generate revenue.