Lease guarantor Locnest finds a rental niche

By Kerry Gold | The Globe and Mail

People in search of a home but priced out of the market and unable to buy sometimes find different, but no less daunting, barriers to renting. Now, a company is introducing a “lease guarantee” product that offers tenants a way to avoid the upfront cost of a security deposit and landlords protection against delinquent tenants.

The idea of a rental guarantee, or lease guarantee, is established in parts of Europe, but in Canada, it’s a new idea whose success depends on how well it is embraced by property managers and landlords. Representatives for landlord and tenants groups in Vancouver say they are wary of the idea, citing concerns that it may place more burden on tenants. B.C., which has an estimated 1.5 million renters, has some of the lowest vacancy rates in Canada.

A lease guarantee is when a company provides assurance to a landlord up to a certain amount, covering them against rental loss or damages caused by a tenant. In B.C., it either replaces a security deposit of half a month’s rent, or it supplements it. The landlord doesn’t pay anything and the tenant pays a fixed eight per cent of the guarantee amount each year. For example, if the landlord wants a guarantee of $1,000 on the unit, the tenant would pay $80 a year to the guarantor company, Locnest. The tenant would not pay a security deposit. And once the tenant moves out, they wouldn’t be refunded anything.

The company bills itself as a financial service, “with a mission to improve housing.” As long as nothing goes wrong, the business model works. However, if the tenant does damage or leaves without paying rent, the guarantor would be on the hook for recovering the money.

“Obviously that’s not what we are hoping for,” says Joe Munster, executive director of the new Vancouver branch of Locnest. The Canadian company started in Ontario and Quebec last year, where it’s had some success because landlords are not allowed to collect security deposits in those provinces. It’s moved into Alberta and more recently, into B.C., where security deposits are often not enough coverage in case of damage to a property. As well, the vacancy rate in Vancouver is near zero, which means there’s more competition. Locnest says that the assurance it provides landlords could give a preapproved tenant an advantage.

“This is definitely a behavioural change where the mass public will have to get on board."

Joe Munster | Locnest

“This is definitely a behavioural change where the mass public will have to get on board. If you look at the origin of company, in terms of Switzerland, the guarantor model has a market share of roughly 30 per cent and there are several organizations operating with this type of model. So we are new and committed and we have grown across four provinces and tripled our growth in the last two years. But we understand it will take a lot of volume, because the profit per lease guarantee is a small fee.”

He says the rate of delinquency, when a tenant leaves owing money, is around 7 per cent to 7.5 per cent in Canada, but his company does enough due diligence to minimize that rate further. When a tenant applies and goes through preapproval, they have to prove income and undergo credit checks. But in markets where housing is difficult to find, he says that tenants are more likely to want good referrals and rarely incur damages or skip rent. And landlords are saved the administrative work of handling security deposits. However, in the event of a claim, the landlord would still have to go to arbitration in order to get paid out.

“We can protect up to $5,000, so that amount far exceeds the traditional damage deposit in B.C.,” Mr. Munster says.

Donald Mackenzie, who CEO of Bodewell, says the idea appeals to him, but more as a supplement to a security deposit and not in lieu of one. For example, in B.C., a landlord can request another half a month’s rent as a security deposit specifically for a pet, and in lieu of that, he might accept a guarantee instead. For new units, where the damage deposit is only $900, for example, he could see supplementary coverage being appealing to homeowners.

“Instead of having a cash deposit as security, I would have a kind of promissory note from this company that they will pay if the tenant defaults..."

Donald Mackenzie | Bodewell

He had never heard of a business model such as this one before and he’s been talking to Locnest for the past couple of weeks.

“Instead of having a cash deposit as security, I would have a kind of promissory note from this company that they will pay if the tenant defaults. Well, who are you and will you be here tomorrow? If they can satisfy all those things for me, I will recommend them to homeowners,” Mr. Mackenzie says. “But you don’t want a problem in five years down the road. As long as they are in existence – which I have no reason to think they won’t be – in a way they are helping people in a cash flow situation with their security deposit.”

For the property owner, the model is appealing because security deposits only offer small comfort in the event of major damage caused by a tenant, he says. The downside for the tenant, however, is that after many years of being a responsible tenant and paying an annual fee, they don’t recover any of that money when they leave. They are out of pocket, Mr. Mackenzie says. He equates this instant cash flow seeking behaviour to the use of payday lending.

“You are paying $80 or $100 a year because you don’t have the cash flow for a security deposit and in 10 years time you’ve paid the equivalent of the security deposit – and you have nothing to show for it when you move out. You go to get the next place to rent and you still don’t have security deposit saved up,” he says. “So it does have the same cash flow addiction for people in the low end of cash flow. I think it’s like a payday loan.”

Mr. Munster doesn’t agree with the comparison to payday loans and says they have a different demographic. It’s giving tenants a chance to use their cash for other expenses other than a security deposit.

“It allows the tenant to free up the money when moving into a home … it gives you more breathing room and of course we work on your behalf to help you get into that place to provide that confidence and assurance you need sometimes in today’s rental market, with a super low vacancy.”