Lesser together

On May 15th, Moody’s downgraded all the big Canadian banks on fears of a potential housing crash. (Six days later the same ratings agency did the same thing to all the major Australian banks. Same reason.)

Yes, the banks have huge mortgage portfolios making them vulnerable to a real estate correction of, say, 30%. But they’re also financial behemoths. If the credit crisis of 2008 couldn’t bring ‘em to their knees, a property plop won’t either.

Wish I could say the same for the credit unions. Smaller, less regulated, more aggressive, these guys have been major players in many markets, spinning off unconventional and weirdo mortgages that the Big Six would shun. Vancity, Meridian, Duca – outfits like these could pose more risk going forward than a Home Capital Group ever did. And look at all the spray HCG shot on everyone.

Take Duca, for example. The credit union has 15 branches on Ontario now and about 60,000 members. Like its peers, it’s absolutely addicted to residential real estate. Currently it has a portfolio of $1.14 billion in outstanding residential mortgages, of which more than half ($595,741,000 worth) are not insured. No CMHC. No Genworth coverage. If house prices in its key markets – Brampton, Mississauga, Burlington, Orangeville, Whitby or Newmarket – take a hit and borrowers find trouble, then a company with only $13 million in earnings could be in the soup, too. (The Big Six banks together will pocket about $40 billion this year.)

Well enough about Duca’s financials. Let’s talk about its misguided clients.

One of the up-and-coming loan products is apparently the More Together Mortgage. Like Vancity in YVR, the credit union is actively pushing the idea of real estate crowdfunding. In this case the crowd can contain up to seven people, all of them on title and mortgage. Is this a cool idea in a world where Millennials think a ‘sharing economy’ works, or are the kids just idiots?

Well, it’s good for the lender, of course. When six or seven people take out a loan together, each is entirely responsible for the whole amount should one or all of the others default. So, presto, Duca has seven chances to collect a debt, instead of just one or two. Clever.

Anyway, here’s the sales pitch:

Home prices in Ontario are skyrocketing, seemingly putting ownership out of reach for many potential homebuyers. Not all hope is lost! There are alternatives to consider such as real estate co-ownership. Real Estate co-ownership allows you to share the cost of buying a home with friends, roommates, co-workers, or family members.

The key benefits claimed: buy a house with others that you couldn’t afford yourself, sooner. Get a bigger down payment to avoid mortgage insurance. And be able to split the substantial costs of owning among the other people wandering around your house.

Co-ownership is catching on for exactly these reasons. These are people, after all, who share cars, jobs and bicycles. Why not property? Well, there are good reasons, all of which fall under the longstanding GreaterFool rule: Never buy Real Estate with Anyone you do not Sleepeth With.

For starters, there’s the borrowing obligation factor mentioned above. If anybody walks, the other owners are immediately shackled with more debt and higher payments. And what is somebody loses a job, gets sued, marries a Kardashian or befalls another personal tragedy?  They might want out, meaning the other partners would have to buy that equity (for which financing would be difficult to find) or sell the property itself. Messy.

And taxes could be a tough go. Unless the whole gang lives in the place and claims it as their own personal residence (good luck with that) any gains upon the sale would be tax-free to the residents but a taxable capital gain for the others. The same applies to losses, of course. If the house is disposed of at a loss, then the resident-owners would be out of pocket entirely while the others could claim a capital loss and use it to offset taxable gains.

What if someone stops paying their share of property tax, insurance, maintenance, utilities or refuses to chip in for a new furnace? There has to be a locked-down co-ownership agreement in place with strict financial obligations set out. But if your roomy-owner doesn’t have a lot of assets, what’s stopping her from declaring bankruptcy and yet still living there? You can’t just throw her out, unless you really like cops.

Renewal? What happens if one of the six or seven people decides they can’t afford the higher rate, and bails? The lender might refuse to renew without more security, forcing a sale under miserable circumstances. And do you really know the history of your co-owners? What if one of them has a jilted spouse who makes a claim against the property over spousal support? Then Tiffany becomes everybody’s problem.

This is a lame, dangerous idea. There’s a reason the big guys wouldn’t touch it.

Where do you bank?