As more and more young Canadians feel the dream of homeownership slip through their fingers amid skyrocketing home prices, one startup says it’s enabling aspiring homebuyers to step onto the property ladder without a six-figure down payment or a gargantuan mortgage.
The company, Toronto-based Key, is one of a number of newly-created firms experimenting with new ways to enable Canadians with modest savings to access the real estate markets as owners or investors.
Key, which is advised by former Bank of Canada governor Stephen Poloz, says its unique model offers would-be homebuyers the ability to co-own and live in a property with a down payment of just 2.5 per cent.
Based on the current price of the downtown Toronto condos the company is currently offering up for co-ownership, buyers need only around $15,000 for their 2.5-per cent ownership share, the company says.
The company says nearly all of the 60 suites in its inventory are occupied, and around 100 people per day are joining the waiting list for new units. And despite just launching in Toronto, the company’s co-founders, CEO Rob Richards and Dubois, say they have worldwide ambitions because rising housing costs are an issue everywhere.
But some real estate experts warn the details of the company’s offering contain some red flags. Its complex model may not leave young homebuyers better off, they warn.
Key did not share a sample copy of its co-ownership agreement, but it did agree to answer a list of questions submitted by Global News in consultation with three real estate and mortgage professionals. Here’s what emerged.
How it works
The company calls co-owners who live in the units “owner-residents.” Every month, they pay a amount equal to the market rent of a comparable unit, from which the company sets aside a minimum of $50 per month as equity contributions that gradually build up the resident’s equity stake.
In a city where home price appreciation often outpaces people’s ability to save up for a down payment, Key residents have an equity share whose value will increase as fast as the home appreciates, Dubois says.
By doing so, residents are “attaching themselves to the price, so that if the price continues to go up, at least they’re not missing out of that potential,” Poloz said in an interview with the Canadian Press (CP).
Poloz added he is “passionate” about helping people who are yearning for flexibility and the chance to own equity in something tangible, even if they aren’t wealthy or don’t have plenty of money squirrelled away, CP reported.
Also, as residents’ equity stake increases, the monthly amounts they pay to live in the unit decreases proportionally, the company says.
Another perk: residents have the ability to “customize and renovate” the unit they live it, the company says. Key also promises residents will pocket the full value of any appreciation from upgrades they financed.
After three years, residents have the option of buying the unit, but there is no obligation to do so. After one year, they’re free to walk away at any point with two and a half months of notice and cash out their equity. Key says it will return all equity contributions plus any appreciation based on the current value of the suite as assessed by an independent third-party appraiser.
In this respect, Key’s model differs significantly from traditional rent-to-own agreements, where tenants often have an obligation to eventually purchase the property and may lose all or part of the down payment if they aren’t able to do so.
Resident-owners are not on title
Resident-owners aren’t on title, the company says. Rather, the occupants of the unit and the investors who own the property sign an agreement that comes with an encumbrance, or a claim against the house, Key told Global News via email.
“You have an enforceable contract that that spells out your rights and your obligations,” Key CEO and co-found Rob Richards says.
Still, all three real estate experts consulted by Global News said one of the key questions to ask when considering co-owning or rent-to-own contracts is who will be on title.
If you’re not on title, you’re not really a homeowner, warns John Pasalis, president of Toronto-based Realosophy Realty.
So-called owner-residents “may have an option to buy the property at some point in the future under certain terms, but that doesn’t make them a homeowner today,” he said via email.
The company maintains its residents meet what it calls “the real tests of ownership:” having equity that appreciates if the home value increases, sharing in the maintenance costs (proportionally to their equity stake), and having the ability to customize and renovate.
Down payment is not held in a separate trust
When looking at rent-to-own agreements, one of the key questions to ask is whether the tenant’s down payment will be held in a separate trust, says Melanie McLister, co-founder of intelliMortgage.
Rent-to-own is typically an alternative route to homeownership for those who can’t obtain financing due to poor credit or because they don’t have enough money for a down payment. The idea is that a tenant will rent a home for a certain period of time with the goal of buying the property at the end of the lease.
Key says it offers a co-ownership, rather than a rent-to-own model, noting its residents’ down payments appreciate along with the value of the property, unlike in many rent-to-own arrangements.
Still, when it comes to the down payment, the company said the money, along with subsequent equity contributions by the resident, flows to the investors who are on title on the property.
Investors are “obligated to return equity upon the resident’s move-out and have the option to refinance or sell the property if required,” the company noted.
But when asked about what would happen if a resident fell behind on their monthly payment, Key called the resident’s down payment a “deposit” equivalent to six or seven months of rent, which allowed “for much more flexibility to deal with income interruption or other reasons for late payments than the standard rental situation.”
The company added that it works with residents “to understand their situation and give them time to repair it.”
Not holding residents’ down payment in trust is “a significant red flag,” says Romana King, director of content at online real estate marketplace Zolo.
The risk is that residents will lose the money if Key “goes belly up,” King warns, adding that the company’s business model is untested.
Key says even if it ceased to exist, the agreement between the resident and property owner would continue to exist.
“Property owners are contractually obligated to return the owner-resident’s equity (and) any appreciation,” the company said via email.
In traditional rent-to-own agreements, a situation in which the landlord keeps the deposit rather than holding it in a trust can compromise the tenant’s ability to qualify for a mortgage from a mainstream lender, McLister previously told Global News.
A 1% fee
For its services, Key charges residents a fee equivalent to one per cent of both lump-sum and monthly equity contributions.
The payments help with “keeping the lights on,” says Richards, noting that the amount is charged in addition to the equity contribution and not subtracted from it. For example, a resident contributing a $15,000 down payment would pay an extra $150 in fees.
As part of their monthly payment, residents contribute a minimum of $50 toward their equity share (they are free to put in more if they wish). On that transaction, the fee amounts to 50 cents, Richards says.
The fee is significantly lower than the costs sometimes involved in rent-to-own models, which can be as high as 20 per cent, the company said.
A margin account
Key also charges interest on what it calls a Co-financing Benefit, a matching equity contributions that residents have the option of borrowing through the company.
For example, a resident with a $15,000 down payment can choose to borrow another $15,000 to boost their investment in the condo. If the price of the property rises, they stand to pocket the gain from the appreciation on $30,000, instead of $15,000.
The company described the debt as a margin account, saying it comes with monthly interest charges but does not require principal repayments.
A margin account allows investors to invest with borrowed money. While the strategy amplifies the investment returns in favourable market conditions, it also magnifies the losses in a down market.
Key acknowledges residents take on the risk of their real estate investment depreciating, a risk it say is inherent to homeownership.
And with Key, “the risk is limited to invest in equity,” Richards says. “You don’t have this massive mortgage hanging over your head — and that’s the problem with a down market with so much household debt going into mortgages that people get underwater with respect to their mortgage and the bank winds up owning the whole house.”
The company also noted that because residents pay lower monthly residency fees as their equity stake increases, borrowing to increase one’s equity stake decreases the residency fee, the company notes.
The company charges an interest rate equal to the Bank of Canada’s prime rate plus one per cent, currently equal to 3.45 per cent, on any leverage residents choose to take on. The rate varies based on movements in the prime rate.
The rate is higher than the rate well-qualified borrowers can currently get on both variable and fixed rate mortgages.
King warned that the cost of servicing that debt is likely to increase soon, as the Bank of Canada is expected to start raising interest rates in 2022.
“If the debt portion increases and the costs of servicing that debt increase then you’re stacking on debt and debt costs on the assumption that residential real estate prices will continue to appreciate at the same rate as the last five years,” King said via email.
“This is highly speculative and assumes that rising rates won’t impact (real estate) sales activity, which is highly unlikely.”
Does the model help aspiring homebuyers?
Both Pasalis and King challenge this idea that Key residents are, in fact, co-owners of the unit they live in, since they are not on title.
Instead, both described the arrangement as more akin to an options contract, which gives residents the option to purchase the home at a future date.
While Key says its monthly residency fees are equivalent or lower than the market rent for comparable units, King questions whether would-be homebuyers wouldn’t be better off seeking cheaper rental options in older buildings or further away from a big city’s downtown core so they can save faster for a down payment.
“These are individuals that are struggling to save up. I don’t know if the best strategy is to increase your housing costs at a time when you’re trying to become a homeowner by taking on a nice rental property,” she says.
The idea of having an equity stake that appreciates as the value of the property increases is appealing, King says. But prospective homebuyers are facing many unknowns, she adds.
This holds even for residents who are confident about what their job, income, neighbourhood preference and family structure will look like three years down the line, she notes.
“What is the (real estate) market going to look like? What are the mortgage rates going to look like?,” King says.
And then there the question of the fees and interest residents may be paying, she adds. People may be better off saving more aggressively and parking the money in a low-risk investment like a money market fund, she says.
Pasalis also questions whether models like Key’s contribute to exacerbating the real estate market conditions that shut out many first-time homebuyers.
The real estate investors who own the properties made available to Key residents, he says, “are part of the reason people can’t afford condos.”
“First-time buyers save their down payment from earnings and qualify for a mortgage based on their income,” he says. Large real estate investors, on the other hand, “raise millions from wealthy investors and buy 60 units in one shot.”
— with files from the Canadian Press