Thoughts from David Goodale on Credit Card Processing for Short Term Rentals

Short Term Rentals: How to get paid sooner.

Understanding future delivery chargeback risk, and how to lower the amount of collateral held by your payment processor.

By David Goodale, CEO Merchant-Accounts.ca

Short term property owners often wait a long time to get paid.  What can we do about that?

Many vacation rental owners have learned that their guests prefer to pay using a credit card.  To accept credit card payments, you need a merchant account from a payment processor.  There are many companies that offer these accounts, but what merchants often don't realize is the funding terms offered (how much, how often or how quickly you receive your funds) are not all the same.

What you want to avoid is a situation where the payment processor holds back a large portion of your funds when a transaction is processed.  When funds are held back it's called having a "reserve" on the account.

For the uninitiated, a "reserve" means that the payment processor will hold back a portion of your funds for a period of time after each transaction is processed.  This is usually specified at the point of approval when your account is setup.  The percentage of funds held, and the length of time held will vary depending on both the processor itself and the criteria of your rental business.

The impact of this is important because your guest will have paid the money, but you may not receive access to all your funds until a point in the future.  This is something that is obviously best to avoid, or at least minimize as much as possible.

What is "future delivery" and how does it impact my cashflow?

In order to build a strategy to reduce or avoid reserves, and ultimately get paid sooner and improve your cashflow, we need to understand the risks as perceived by the processor.  For example, right now Coronavirus is spreading across the globe.  From a business perspective almost everyone is being hard hit, but travel-based businesses particularly so.

With a rash of cancellations, travel bans, and a poor near term outlook for the short term rentals market, we can easily see the risks associated with accommodation based businesses.  From the payment processors perspective, they are worried about chargebacks where a cardholder has paid for something that they will no longer receive.  These risks are why many payment processors require holdbacks, rolling reserves or other forms of financial collateral.

A chargeback occurs when a customer (a credit card holder, your guest) calls their bank, and requests that they forcibly reverse a transaction.  This is a serious dispute and can occur for a number of reasons.  Sometimes it's fraud, where the cardholder did not authorize the purchase; in other cases it can be because an item received might not be as described.

However, for travel merchants, the big risk is for undelivered services.  In other words, something could prevent the purchaser from being able to use or stay at the accommodation they have paid for, so the service was not provided as promised.  For example, consider the travel bans currently in place because of Coronavirus.  Under the card rules, if the cardholder does not receive what was promised – which they can’t, since the government is prohibiting travel or short-term rentals – they are entitled to receive their money back no matter what.

This is the concept of "fulfillment" in the credit card industry.  One of the principal protections built into credit card processing is that cardholders are guaranteed to receive what they have paid for.  With that in mind, consider a typical retail merchant.  If you sell pencil crayons and coloring books they'll ship out shortly, and the cardholder will receive their product soon after ordering.  However, with vacation rentals the customer may be paying months or even years in advance of their arrival.  This is the general concept of "future delivery" - the cardholder pays for something today, but the order remains unfulfilled until a future date.

Why are hotel and short term accommodation merchants considered a high risk sector?

The challenge with hotel and short term rental merchants (and broadly the entire travel sector in general) is that things can unexpectedly disrupt the supply of the service, and the payment processor will be left holding the bag for refunds that become due.  For example, if a prominent group of hotels were to go out of business, then all of the people who had paid to stay there in the future would need to receive their money back.

The problem, if a company goes out of business, is that they won't have the money to return to the cardholder.  Per the Visa and Mastercard guidelines, the cardholders are entitled their money back under a service-not-rendered dispute.  If the money has to go back, but the hotel is out of business, where does the money come from?  The credit card processor.

As the trading volumes become larger the risk becomes greater.  This is called the "Future Delivery Risk" in the payments industry.  In terms of the accommodations sector, payment processors could be worried about the following:

• The establishment goes out of business.
• Guests no-show (and are completely responsible for their failure to arrive) but still try to issue a dispute to get their money back, even if that dispute is unreasonable.
• The establishment suffers damage and isn't suitable to be used by the guest. For example, flooding, fire, damage from previous tenants, mold, insects, Godzilla attack, etc.

The risks start to get more remote as we read down the list (Godzilla does most of his fighting out in the deep ocean fortunately) - but the point is that any perceived risk is a risk to the processor.  The more real and likely the risk, the more likely a merchant is to have a reserve (or some type of collateral requirement) put on their merchant account.

Are private rentals as high risk as hotel rentals?

This question sounds simple but is actually complex.  A single property or a business with a small number of short term units might be considered lower risk than a hotel because a lot less money is being traded.

However, consider the Hilton for a moment.  Hilton Hotels have a lot of properties, a lot of assets, and a lot of rooms.  If a room was damaged, or even if a whole building was damaged or unusable, it would be very unlikely to affect the entire chain – many guests could just transfer to a different Hilton down the street, and even if not, Hilton has plenty of cashflow to pay for the refund.  To the payment processor, they just want to make sure someone is there to backstop the promises made to the cardholder and cover the refund if necessary.  In that way Hilton Hotels is obviously low risk, because they are not in any danger of disappearing suddenly.

As we are discovering now, there are some unforeseen circumstances where even large entities can be vulnerable.  For example, during this Coronavirus outbreak, Hilton Hotels could conceivably represent far, far more risk than a smaller short term rental business.  If nobody can travel, then nobody is going to stay at any Hilton hotels anywhere at all.  With no income whatsoever, a previously stable company might suddenly be in dire straits.  And if Hilton were to go out of business, many millions of dollars would need to be returned to cardholders, for which the processor, at least conceivably, could become liable.

That is why the question of risk is specific to your business. Processors couldn't reasonably have predicted the Coronavirus, but they could conceive of a similar event occurring.  What they can only try to model is the potential risk.  From there, they can apply their models to different types of businesses.

That is why different processors have different terms of approvals.  One processor might prefer to work with a large brand like Hilton because they feel it's rock solid, where another would prefer a smaller merchant because it's less money flowing through the account overall.  It's very situationally specific, based upon the processors risk tolerance and attitude, and also the unique merits of your own business.

Now that we have a good grasp of the risk concepts, we can explore what you can do to lower the amount of collateral held by the payment processor for your account.

Controlling your own fate: lower your collateral by in influencing your payment processor with your business policies and business history.

The biggest thing you can do to impact the amount of collateral held by the processor, is to minimize your far-in-advance deposits.  I will admit, it may seem counter-intuitive to improve your cashflow by reducing the amount of money you collect upfront. However, if you can reasonably minimize the percentage of the deposit, you lower the perceived risk to the processor.  This strategy may help with getting through the door with good terms of approval that won't put a hamper on your business.

For example, if you can live with only taking a 10% deposit upfront, you'll vastly reduce the future delivery and chargeback risk for the processor.  This should only be a relatively short term thing though, as you can improve on this over time, which we'll explore below.

Another part of the process is to have business policies that stop disputes from occurring.  For example, if you want to have a strict cancellation policy with no refunds, it's almost always better to have the cardholder call you than go straight to a dispute.  In the refund area of your booking agreement the policy could say that, in the case of special or extenuating circumstances, refunds can be given at the discretion of management.  This way, the customer will usually call you first rather than going straight to the bank and filing a dispute.  It is to your benefit it you can work something out with the guest to keep disputes down.  Generally speaking a refund is always better than a chargeback, unless you have a rock solid case or it involves a lot of money.

Perhaps the most important part of the strategy is understanding that it will take time to improve your situation, by building the relationship with your payment processor.  As they get to know you, and as you become known to them, they will trust you more since they see you continuously operating in good standing.  If a rental merchant has been with a processor for 10 years, they certainly should be getting more comfortable with your business.  Over time they should be okay releasing more or all of your funds without a reserve.  You may not get everything you want on day one, but you can and absolutely should work towards it.  Working towards it involves several elements, but one of the most important is consideration of the financial picture.

With our Hilton Hotels example, the processor was much more comfortable because they knew Hilton was a large group with a lot of financial strength.  You don't have to be a member of the Hilton family to get good terms of approval though.  If you operate a business with a solid set of financials, or if you personally have a high net worth and are willing to sign a personal guarantee, you can provide these to the processor to ease their concern.  For example, if you run 5 short term rental properties, all of them owned mortgage-free, and all of them having a regular set of guests who have been coming for years, wouldn’t this be lower risk than a new rentals business that is mortgaged to the hilt?  Of course it would!  These are the type of things that your financials will demonstrate.  If you have a good financial story, you should be telling it to your processor, and if you have a good processor they will listen.

That communication with the processor should be an ongoing thing.  It's a good idea to write a report annually on the status of your business.  It should be very short (underwriter attention spans are short), but it needs to address the important points.  This part will be highly specific to each individual business, but for example:  pretend that you own 5 cabins in a rural nature setting.  If these 5 cabins were of a similar build, it would mean that if one was damaged you could simply move guests to another cabin without affecting a booking.  If you compare this to someone with just one rental unit, their probability of an issue or problem causing a cancellation of bookings is much higher.  Think of the intangibles that they might not be aware of, but that they should be, and tell them.  Just be sure to keep it succinct.

Also, it's no good if you are working with a payment processor that isn't receptive to this information.  This tends to be hit or miss depending on the payment processor.  Some are quite receptive and appreciative of this information, as it helps them to underwrite and monitor their book of business more accurately.  Others, particularly large and slower moving processors may not be able to action this information as effectively.  That's why it's important to find a processor that is specialized at working with travel and accommodations merchants, like we are at Merchant-Accounts.ca.

As you build your case with annual reports, an improving financial position, keeping disputes low and as they get to know you, you should be asking for improved terms.  If they have collateral on your account, then ask to have it removed.  If you are only taking 10% upfront, ask them if you can change it to 25% upfront, especially if you have the same returning guests year over year.  Most of all, don't be afraid to ask the question, especially over time.  It should be an ongoing and evolving, to your benefit.  Of course, if your business is in rough financial shape, or if things aren't going well (for example during Coronavirus) it might not be the best time to ask for a review.  So make sure you are putting your best foot forward, be honest, be concise, and be confident.  If you operate a good stable business they should be willing to work with you.

Closing Thoughts

This discussion has been mostly about reserves, but there’s one final point to make:

Don't ever let your payment processor raise your rates.

Unless interchange fees have increased there is never a reason to increase a rate on a merchant, except in exceptional circumstances where your business performance has deteriorated or you are getting a lot of chargebacks.   If anything happens that causes your costs to go up from your credit card processor, you should challenge it in the strongest possible way.  If they still insist on raising your costs, you should switch payment processors.  This is especially easy if you are Canadian, since the code of conduct for the credit card industry allows a merchant to move processors at any time if a cost is increased to a merchant.  (Again, except where interchange as set directly by Visa or Mastercard has increased – that applies to everyone equally and your processor has no control over it).

Mostly, this discussion has been about arming you with the knowledge to be able to negotiate with your payment processor.  The processor should want your business, and accommodation-based merchants can make excellent clients.  If you can look through the processor’s eyes and adjust your policies to address some of their concerns, then you should be able to work together to reach a good agreement.  Perhaps most of all, remember that it's an evolving partnership and that you should be able to continue to improve your terms over time.  You are bringing something to the table and they should be happy to have your business.

If they aren’t, reach out to Merchant-Accounts.ca to get a quote, particularly if your business is based in Canada, the UK or the EU.

David explaining future delivery risk and the travel industry:

About the Author

David Goodale is CEO of Merchant-Accounts.ca and has 20 years of expertise in online payments.  David often works with travel merchants and related businesses that have particular challenges when it comes to payment processing, both in terms of rates and reserves or holdbacks.  If you have a question David can be reached at david.goodale@merchant-accounts.ca.