Why innovation is key in residential real estate and how investors can benefit [podcast]

Investor Mindset Podcast, Let's talk residential real estate investing - Episode 5

In today’s episode, you’ll hear from Key's Co-founder and CEO Rob Richards. Rob covers why innovation is needed in residential real estate, how investors can profit from better real estate investment decisions, plus more.

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In This Episode We Cover:

• How Rob got started in the real estate industry

• The evolving market and investor dynamics, along with the challenging environment for aspiring home buyers that will negatively impact the communities we live in

• The case for innovative new models

• How Key is helping address the need with the world’s first all-digital, on-demand co-ownership platform

• Aspiring homeowner's feedback on Key's ownership program

• How investors can benefit while also helping to shape stronger communities

The live video version of this episode can be found here. View all Investor Mindset show episodes here.

Full transcript:

John Asher: Hello and welcome to another episode of The Investor Mindset. My name is John Asher, Co-founder and President of Konfidis. Today we're going to have a real treat. So please welcome as our guest, Rob Richards, CEO of Key Living. Rob, how are you today?

Rob Richards: Great. Thanks, John. Good to see you.

John Asher: Awesome. Today, we're going to be covering innovation and residential real estate. Before we begin, I have a lot of really good questions because I think you're right in the heart, in the middle of some really, really cool stuff. Rob, I really want to know, think early in your career. And I'm really looking for kind of, you know, what was the defining moment where you thought, Rob, real estate is where I want to be?

Rob Richards: It was late in life. Early in my career when I graduated from physics at Waterloo, I worked in the engineering, science industry, aerospace and telecom, and whatnot. But I own houses. So, I bought my first house within a year after graduating. I would renovate them, fix them up, sell and move on to a bigger property and in those days and for the baby boomer generation, generally, homeownership was such a great wealth building exercise. People build generational wealth with real estate and that has evaporated for far too many people in the millennial generation, forget about Gen Z. So, the lesson that I had in my tech career was real estate was a great investment and it was a good diversification from the risk of tech and from the risk of the public markets. I’ve gone thru a lot of recessions as you have John and uncorrelated investments are generally a good thing to have in a portfolio with some diversity. In real estate, even though it goes up and down like other markets, it’s generally always up into the right over time. You can count on that, and its real property. Humans need real property at least for now, maybe the metaverse is going to take over, we’ll all be bags of water attached to a central nervous system at some point like in the Matrix. But until then, you know, having a place to plant your feet and call home is really solid.

John Asher: It's funny, you mentioned the metaverse. I can't tell you the number of questions that I get on if I'm investing myself. But you mentioned something that's really kind of important and I think sets us off to start this discussion. You talked about early in your career what homeownership meant, what investing in residential real estate meant, and how that has changed for this generation. Talk to me about what are the challenges in the environment today from two perspectives. One is, what do you see as the challenges for homeownership, and the challenges from the investor profile?

Rob Richards: Great question. I come at this from my last 14 years running a venture capital firm and private equity investing inside a big real estate developer in Toronto. So, Toronto real estate and tech that's been my intersection. And observing through the 2008 recession and what happened when Wall Street blew up Main Street and it was a mortgage industry issue. Subprime mortgages got collateralized and default swaps and all kinds of funky derivatives brought down the industry and tightened mortgage rules and started to really disqualify many prospective buyers. Young people, people starting out, and people immigrating to Canada and the U.S. So new Canadians, millennials really got shut off the property ladder and I saw it in the condo business as we shifted from selling almost everything to end users to selling the preponderance of the product to investors, instead of end users. I really witnessed this firsthand from both sides of the equation. I know so many people, nephews and nieces included, the dream of homeownership is just faded. It's super important to look at the asset class and say, what's wrong here? How do we put in some systemic fixes for what appears to be a systemic market issue that’s not going to correct itself anytime soon? Prices are rising faster than wages. We don't see that changing anytime soon. Even if we have a drop that we're experiencing now it's still to levels that are way above what people can afford. So, how do we produce solutions? And so, I reached deep into my tech background where we innovated the software industry and change the consumption model from where you had to spend millions and build a data center and buy a big piece of ERP and get yours implemented so you could rent a seat for $20 a month. Right? It was a fundamental innovation when we went to as a service in the software industry. I thought can we do a similar thing in residential real estate? Where instead of this incredible challenge where you've got to save for a big down payment and qualify for a massive piece of personal debt. What if we could let you consume for $20 per seat a month kind of model to get in for a much lower entry ticket and not have this massive capital commitment. But consume that as you're able to as your income grows and as your savings grow? And we're just in such need of a new ownership model like this that's going to, I think unlock the residential industry for both occupants and make it a better asset class for investors.

John Asher: So, it's really kind of interesting. I mean, you see every single day the challenges for a first-time homebuyer, for somebody trying to upgrade, add more space. It's difficult. I mean, we've got double interest rates, and boundary tests for all mortgages. It's quite difficult. Over the years, let's talk about the investor side. Where do you see the big challenges in the investor environment and sort of getting into the asset class or expanding their existing portfolio?

Rob Richards: It's really about balancing risk and diversification. A lot of people have done well, you know, buying one condo and renting it out in Toronto. If you buy at the right time and you buy the right product where there's demand and it's a good market with low vacancy and lots of demand and demand exceeding supply. But it always goes through cycles, right? And so timing is so important in life, in all aspects of life. As an investor timing is critically important. And you can get in at a point where your timing hasn't been great and you can experience some cash flow issues. If you’re not prepared to weather those and just hang on to the investment as a return on equity for the long term, you can run into trouble. You just need to be financially aware and prepared for the cyclical nature of the real estate industry, as it is in all investments. And there's a lot of hassle in accessing the asset class. People buy a pre-construction condo and it's pretty easy to put down a deposit and then they give you a call months later for your next deposit. Well then all of a sudden, it's occupancy time. And you've got to take delivery of the product, and then you've got to find a tenant and do you hire a property manager. What happens if you get a bad tenant? Amateur investors that have had good tenants have done really well and they’ll probably tell you it's not that bad. That's the case for a lot of people, thank goodness. But what happens in a bad situation where you start getting eviction environments, you're getting missed payments, and it can really, really hurt you from a cash flow perspective? What happens when there's a pandemic? All of a sudden you have 20 and 30% vacancy rates in downtown Toronto. So, in the good times, when you've got a good situation and the place is pretty much managing itself then things are great. And managing itself, it's all about getting somebody in who is going to treat the place like their own.

John Asher: I think we've all had those stories of the one tenant situation that was not easy to deal with and it probably overshadows the many tenants that were great. Okay, so let's talk about business models. There's a whole host of different models that are starting to emerge that I've seen throughout North America, the U.S., and Canada. Thinking about those models, what are the ones that really begin to, excite you? Like, start to think about some of those problems that we talked about and are trying to solve those, some of those issues?

Rob Richards: We're seeing on the investment side a whole slew of new types of companies that offer small investments into a managed service. Which then becomes the real estate acquisition vehicle for 10,000 people funding it at $1,000 each, and then you've got $10 million and you go buy a building on Queen Street. And the building is cash flowing, that's a good property. The value is going to go up and the fund manages everything. So you're there as a passive investor in a piece of real estate. And we've had vehicles like that for a very long time where big pools of real estate like multi-apartment REITs. They've been around for many decades and people have done well, investing in REITs. But now, this new optionality lets you invest in a specific property or a small pool of properties. You can say, I like townhouses in Hamilton and you can probably find somebody that's pooled together some townhouses in Hamilton and making them available to accredited and sometimes even non-accredited investors. So we've seen some evolution in the rules of investing and crowdfunding. That's happened first and kind of venture in PE, now it's coming into real estate in a very big way, and it's more optionality for the investor to say yeah, I like the logistics asset class in Quebec and I could probably find a product that's investing in warehousing and data centers in Quebec. And so you're getting access to stuff you never would have had access to as an individual, which is pretty cool. And you're getting a fully managed experience that has different levels of diversification, which is pretty cool. So you can start to make decisions with that choice to suit your needs and likes. So that's one really good innovation happening that I think it's just starting to take hold. Frankly, it's a nascent industry, but it's going to become massive trillions of dollars of asset class made available to the everyday investor in a wide variety of personalized vehicles. Very cool. On the ownership front, so now investors are being well taken care of. What about that young person who's trying to get ahead in life? And, you know, plan to have family and want that family home, and how do you get there? How do you build wealth in today's very difficult financial market? The innovation there, I see more innovation in helping existing homeowners who have already built their wealth, unlock that wealth, or expand it to a second property. So, there are lots of start-ups that do the equivalent of a second mortgage, like a 21st-century version of a second mortgage product. Maybe a little bit less fee heavy and more flexible, but they tend to push shared equity in your home, you get to take the cash and do what you want. And those are cool. A bunch of start-ups now allowing people to go in on buying second homes together. Whether they do it as a group of friends in a co-ownership scheme or whether it's a managed environment for strangers like Pacaso. There are lots of these types of companies coming up. But that's for people who have already made it, they've already owned homes and onto their second or third or fourth home. What about getting people into the property ladder to begin with? We've seen rent-to-own models try to get traction over the years and it’s really, really difficult because of the asymmetric risks between investors and the occupant and they're pricing the thing at the beginning and so there are lots of stiff penalties if you don’t close. And these programs really have struggled to get any kind of real traction because they're trying to put a band-aid on fundamentally a real estate transaction environment doesn't work to get first-time homebuyers into the system. So I'm most excited about what we're doing at Key which is obviously a little bit different than anything you've seen in the market where it's a true change in the way that you can consume ownership on an incremental basis. But you're an owner from day one. It's not a savings account. It's not a rent-to-own program. You're an actual co-owner from day one, with equity, with the ability to make the place your own, and with shared responsibility. I think that last point is hard to overemphasize the psychological value and the economic value to both parties, the occupant and the investors who you know, share in the equity of the house. So, it’s this fundamental shift in the buying journey to an incremental co-ownership environment that I believe is going to change residential for the better, for the many, and allow millions of people who are stuck renting in North America to get on the property ladder.

John Asher: So let's talk about Key because I think what you're doing… Much like yourself, I love technology. I love data. I love, all of that kind of stuff. And I feel like that is the next step to either unlocking homeownership or unlocking investment quality residential real estate. I think what's really interesting about Key is you’re the first on-demand online co-ownership model that's out in the marketplace. You sit in an interesting sort of spot because you're creating a two-sided marketplace, you're bringing together the ownership piece, and also an investor on the other side, which I find very, very interesting. Can you talk to us about just a little bit more, you've talked about the early entry for an investor or for a homeowner to be able to come into the Key program, but just the next layer down now for Key like what is the big problems that you're solving?

Rob Richards: Well, now we’re solving for the investor, a way to ensure that they're going to have a worry-free tenant environment where they're going to have stable cash flows and way less management hassle and way lower risk. These are important things again, as we talked about early on, you know, in an upside scenario, somebody's had a good experience buying three condos and renting them out. Well, why just have that one bad tenant experience and it's a very different question, or go through a pandemic and see what happens. So, what Key is offering people who own existing homes for rent, is the fact that we're going to very quickly, very thoroughly find an exceptional occupant for you because it's going to be an aspiring owner. Somebody who really wants to take that next step in their lives and treat the decision very importantly. It's not a transient rental we're talking about. We’re talking about somebody that really wants to put down roots and build wealth where they live and take on shared responsibility for the property where they pay their pro-rata share of fixing a refrigerator or repairing a crack at a baseboard or changing the furnace filters. So, you're going to have a partner in there as an occupant, right? As opposed to some transient person. So, it's a much better experience, everything is managed by Key. We’ve automated background checks, integrated the entire fintech environment, link your bank account directly, payments are automated, and you never miss a payment. And you've got their capital investment on file, right? So they're committed and that money goes to you. So the way I talked about this is, that you can own 100% of four homes but you could own 80% of five homes. You still own the same amount of real estate but now you've diversified, you’ve lowered risk, and you have more upside opportunities. So that's step one, what we're doing right now for existing investors who own rental properties, for rental properties. Where it’s going to go is super, super exciting because we're going to see all kinds of, we call them Propcos, or organized entities funds essentially, attached to the platform. We already have one we have a privately held REIT in Toronto that buys condos for a living. We're going to see a lot more of those that will then offer investors an even more passive lower-risk way to get into the asset class. And now you're getting into an asset class that's powered by a strategy that's going to have owner-occupants. And it's going to get incremental liquidity and that's going to drive liquidity in the funds themselves and liquidity for the investors of these funds. Right now, that's the biggest challenge in real estate, and getting into a fund-type vehicle is how do you get out of that? It's not publicly traded and so where we're going to be going is we're going to be seeing all kinds of attachment of these vehicles and a growing secondary market applicability for units in all these funds. Right, they're going to start to trade on these digital exchanges. And so it's going to get super exciting for investors to be able to have a choice, be able to have a range of types of assets and geography and all kinds of interesting things coming along with liquidity and a fully managed low-risk environment. Can't wait for all that to happen in the next 2,3,5 years.

John Asher: Yeah, you know, I think what I find really quite interesting and you know, the process, the entire process, again, for an individual investor who might own a couple of condos, whether it be 5, 10, or 15. That a lot of the problems are always around risk diversification, loss of revenue from poor tenants or capital expenditure or eviction issues, and all those kinds of things. And every single piece of those, that process and all those problems become very, very manual. Like everything that must be done. It's a very intensive kind of work. I think what I'm, what I have seen with Key, and what I quite liked is so much of that process, the underwriting is automated, it's done. The programs themselves are set. And I do find it quite interesting. Can I flip over to the home? The prospective homeowners or the tenant side?

Rob Richards: Sure.

John Asher: What is their reaction? Like when they come in and they see the Key experience and they see the product that's on the other side? What's their response? Because you know, as an investor, we represent people when they're leasing. You know, the question is always who's on the other side? Right? Is this a quality tenant? And, you offer something totally different because the ownership becomes intertwined. You know, you're creating that moment where people can love the unit that they're in, which changes the dynamics. So can you talk to us about who are you seeing on the other side? Who are your prospective clients?

Rob Richards: John, it’s quite a broad demographic. We have 20 somethings, we have 50 somethings. There are people who have gone through a divorce, we have people just thinking about getting married, and having children. We have some young families. A real diversity of backgrounds. We have newcomers from four or five continents every possible line of diversity you can think of is well represented. It's one of the most diverse cities on earth. And I think what our residents share in common, the common thread is that they can't wait to own a piece of the rock. They have been thinking about it. They've been planning. We have one schoolteacher, who saved up 50 grand over the years and she watched as her 50 grand was lowered in value relative to how quickly she could add to it relative to the down payment that she needed to live in the city where she works. She wants to live where she can walk or use the TTC to get to work. All of our residents we’d say that the common theme is that they're at a point in their life where having an investment in the house that they occupy, that grows with that asset, that responds to their nurture and their care in terms of value creation of value destruction is just so important to them. And we have frontline workers in the food service industry. We have people in health care and education. We have people in finance and IT, architects, like all kinds of range of incomes from $60k to mid $100k. So very, very diverse, but the common theme is, these are all aspiring owners who really want to own, they want that financial success, they want the psychology of ownership, and that drives commonality for investors saying you've got really good, stable partners living in these units who will take great care. We have two move-outs only in our first 14 months of experience and both of those were because of a change of a job or family or they had to move cities and we didn't yet have products in Ottawa or Kitchener. We're working on both markets. And both of them also love Key and would gladly be in another Key home if we were in Kitchener and Ottawa. And we will be soon so you know, it's a very stable environment. And even upon those two turnover conditions, we didn't have to lift a paintbrush. These homes were spotless. When you’re a landlord and somebody is moving out, you're typically into a few grand of repairs. Whether it be painting, the floors or whatever, right so that cost of turnover, having to fill with a new person, maybe pay a leasing agent, these are real costs. So if you have more stable tenants that are probably going to be longer tenured they will cost you less if they do turnover, and they're going to treat the place like their own and share repair costs and keep costs down. That makes a big difference.

John Asher: Okay, I have two more questions. There has been news around the role of the investor in this overall environment, right between homeownership, renters, and investors and my view is…

Rob Richards: Blackstone is just investing in a new HQ in Toronto. The news is all over Twitter today.

John Asher: I saw it and I really kind of feel like there's an ecosystem here. When there's a balanced ecosystem everybody wins. But from your perspective as an investor and where you're sitting and really having the pulse of the tenant or prospective homeowner, how do you feel investors can help build stronger communities?

Rob Richards: Give people a chance. I’m not saying that in some kind of altruistic way that says, you know, give us your money and you make half the return but you'll be doing social good. No, do better economically too, do as well, or better economically. But use your capital in a way that people can work alongside it and be treated on kind of the same terms, like co-investors. If you're an investor in a fund everybody else who invested in the fund is treated equally to you. It just makes perfect sense. Why wouldn't that be the case? Well, why is it the case that most residential real estate capital isn’t aligned? That investor capital is actually keeping our people locked out of participation. So the message is to think about co-ownership. Think about where your capital now is letting the occupant invest a little bit, a little piece, and then you know, grow that piece over time which comes to you as you're getting incremental liquidity to expand your portfolio. So it's a good way to kind of sell incrementally on the way up and use those funds to reinvest. And when you do that, when you make the decision, conscious decision to say, “Okay, I'm going to put my home in co-ownership and I'm going to invest in a fund that's attaching to a platform like Key or something else.” When you give that chance to that person in the community, wait ‘til you see what happens to the community at large. It's a very different city when you have towers full of renters, and nobody knows who their neighbor is month to month, because they're renting to another person who’s subletting to someone else. There's no psychology of attachment and investment, and in community, and in place. When you change that to communities where everybody's an owner even if it's just a little bit of the pie. Wow! Community's much more vibrant, people spending more time and money and effort and volunteering wherever they live. We'll see talent being retained, as opposed to being hollowed out and going to other markets where they can afford to own. You'll see higher education outcomes, you'll see a more vibrant community fabric in the neighborhoods that adopt co-ownership and get more people on the property ladder and more people investing where they live. And I think we can really change the narrative of what's happened over the last few decades where we do have a massive hollowing out of community fabric in places like downtown Toronto. You talk to Generation Squeeze, talk to the Toronto Community Foundation, their number one issue…number two is affordability. Do you know what number one is? Isolation. People just feel isolated living in these 40-storey condos where everybody is a renter. And so we've got to change that narrative and you as an investor can drive that change and not sacrifice anything frankly, you'll do better economically. We'll show you that your net operating income will go up to six or seven points over time, and you'll eliminate the risk of bad tenancy and missed payment. So all of that plus you're doing this incredible, subtle at first, but eventually transformational thing in turning our neighborhoods back into communities of owners.

John Asher: I think that's a great message. I'm not even going to ask my last question. I think that's a great way to end off. I know we're probably up on time. I haven't even been watching because I've been enjoying this discussion. So, Rob, thank you very much for joining us today in the Investor Mindset. I’m going to be following up with you personally because I want to hear more. Well, everybody, thank you very much for joining us today.

Rob Richards: Thanks.

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