Most people assume owning rental income property is the only option when it comes to investing in real estate. There are an array of options available to individual investors who want to passively invest in real estate. What are some of these options? MICs, REITS, and Private Mortgages may be terms familiar to the sophisticated investor reading this blog. But do you truly understand what separates each of these investment structures? Let’s take a closer look at how these products are structured, the different risks involved, and why certain investments work well for some clients but not for others.
Mortgage Investment Corporations (MICs)
MICs have been around since 1973 when the federal government enacted laws to promote private financing in Canadian real estate. A MIC is basically an investment company structured to allow individual investors to pool their funds together.
The strength of a MIC rests in 2 things: (1) the asset class it invests in and (2) the portfolio’s fund manager. A MIC’s assets class is typically made up of a mix of residential and commercial properties. Some MICs tend to focus more on residential development, while the portfolio of others may favour commercial development more strongly. When investing with a MIC you want to ensure its portfolio mix is diversified to cover different types of properties across various markets. MICs lend money to borrowers using contracts just like banks. The interest payments on these mortgages constitute the MIC’s earnings, which are then distributed to investors in the form of dividends. Interest rates of 7-10% on MICs are common.
An asset manager manages a MIC and he decides which properties and borrowers the MIC will lend to. When investing with a MIC, you are ultimately relying on the expertise of the asset manager. The investor is banking on the manager’s ability to find quality deals and complete due diligence processes in order to generate consistent returns.
What are the risks when investing into a MIC? The biggest drawback lies in control. What if the investor wants to lend to individual borrowers or participate only in certain properties (e.g., condos in Toronto)? Unfortunately in this structure, the manager of the MIC selects the properties on their behalf, whereas in private mortgages, investors have the ability to invest into a desired project. In a private mortgage, the individual mortgage lender will register a legally enforceable interest on the title. This is not the case when investing with MICs. A MIC, like any other company can and does go out of business, so approach this type of investing with caution.
In a private mortgage, clients invest in real estate by providing direct debt financing.
There are several unique features that a private mortgage possesses. First, private mortgages allow investors to select which projects they wish to invest in (one of the key differences between MICs and private mortgages). If the investor feels more comfortable with residential properties over commercial properties, then the client has the ability to select this. Since you as the investor have a direct contract with the borrower, you have the ability to negotiate your own interest rate and terms of the mortgage contract. Returns for the private mortgage investor are typically higher than MICs. Another unique feature of private mortgages is that it provides the individual investor with direct security by having their name registered on title as a charge holder against the property. This feature gives the investor security to their investment.
What are the risks associated with private mortgages? The most common risk involves a borrower who defaults on their payments. If this is the case, you can begin the power of sale process, forcing a sale of the property at fair market value to recover your capital. This where the loan to value (LTV) ratio is critical. You will want to make sure there is enough equity in the property you are lending so that there is enough room to recoup your capital. A tip is to avoid development investments and stick to lending in strong residential markets where real estate demand is high – a topic for next time