With strict new federal mortgage regulations on banks coming in January, more borrowers – and investors – will be looking at alternative financing. Investing in alternative mortgage lending is already a fast-growing, multi-billion dollar industry.
Two key avenues for investors are Mortgage Investment Corporations (MICs) and syndicated mortgages. They both lend money to higher-risk borrowers, but investors must understand the pros and cons of each, and what makes them so different.
Mortgage Investment Corporation (MIC)
An MIC is a pool of capital that is raised through shareholders and is collectively lent to a diversified pool of residential and commercial mortgages. You are buying shares in a corporation that invests on your behalf.
Since you are investing in a pool of mortgages you can mitigate a great deal of the typical risk associated with direct private or syndicated mortgages.
An MIC has a team of professional mortgage underwriters who review mortgage loans every day and can determine the risk on your behalf.
It creates regular monthly cash flow that can be tax f ree savings account (TFSA) or registered retirement savings plan (RRSP) eligible.
If a mortgage goes into default, it is only one of many, so the MIC can begin the foreclosure procedure without having to disrupt monthly cash distributions to the investor.
Targeted returns are typically from 7 per cent to 8 per cent, annually.
The monthly payment is a “flow-through” from the pool of monthly mortgage payments back to the shareholders. There is no term; it is continuous.
A MIC will have an offering memorandum that clearly outlines the parameters and lending restrictions, including: maximum loan to value and percentage allowable for commercial real estate, raw land or development.
An MIC has higher overhead and, as such, charges a management fee. The gains are net after fees. Thus net returns are often closer to 7 per cent rather than the 10 per cent targeted by privates or syndicates.
Caution is required that the MIC does not do the following: allocate an excessive amount of loans to farmland, raw land or developments, since these are hard to foreclose on, and it can be difficult to recuperate the loan in the event of a forced sale; or loans lent to personal friends or management partners.
Check that the MIC you invest with has a third-party independent advisory board that oversees the nature of the loans and ensures that they are consistent with their operating memorandum.
This is the scenario in which two or more individuals lend their money to a specific project and borrower. The money could be lent on anything from a single-family house to a developer with a large project.
A syndicated loan is a direct loan to an individual with no fees to a middleman, so the return can be higher – typically above 10 per cent.
The syndicated group can be on title.
A mortgage broker who tends to “de-risk” the investment typically sources syndicated mortgages.
You know exactly whom you are lending to and what you are lending on.
It provides monthly cash flow.
The biggest downside is that you are lending directly to a single individual or developer.
Any individual can encounter problems beyond his or her control, which could cause a default on the mortgage, even foreclosure.
In the event of such trouble, the syndicated partners may not have the experience and/or willingness to foreclose, a process that can take months.
If you have to foreclose, your money, cash flow and return can be held in limbo for months. If you lent to a development that was half complete when foreclosed on, the syndicate could lose a large portion of its investment.
A syndicated loan can be re-paid early (depending on terms) and it may take time to find the next “deal” or person to lend to. The return on syndicated loans looks attractive but your money is not always at work for 365 days a year. Your real annualized returns over a five-year period may be closer to 8 per cent.
Not all syndicated mortgages are TFSA or RRSP eligible.
Investing through a syndicated mortgage will generate higher returns than an MIC, but in doing so you take on more risk.
There is always a risk that some people will default on their mortgage – remember, there is a reason they did not qualify at the bank. The single biggest difference between an MIC and a syndicated mortgage is that with an MIC, you bought shares in a fund that invests in a pool of mortgages, so if up to 5 per cent go into default, 95 per cent are still paying monthly. With a syndicated mortgage, if the person you lent to defaults, your income stops and your money is at risk.
Syndicated mortgages are more appropriate for the sophisticated investor who understands the risks associated and expects a higher return.
MICs are more suitable for the less-experienced investor who is willing to accept a slightly lower return in exchange for increased security.