The Benefits and Drawbacks of Investing in Alternative Mortgage Lending
With increased prime rates and more government mortgage regulation, private lending has seen an increase in activity and market share. Private lending is a multi-billion dollar industry.
Outside of investing as an individual private lender; the two most common ways for investors to enter alternative lending is by way of a syndicated mortgage or in a Mortgage Investment Corporation (MIC). Both of these entities lend money to borrowers considered higher credit risk, but it is important to know which represents the better opportunity for your portfolio, as well as the key differences between the two.
Syndicated mortgages involve a combination of two or more individual investors lending their money to a particular borrower on specific real estate. The funds could go toward financing a condo, a single-family home, a sizable project for a developer, and anything else where real estate is being used as collateral.
- Syndicated groups can appear on the title
- Syndicated loans are direct loans to the borrowing entity without any fees for a third party, which means there is more return for the investor, usually above 10 percent.
- Mortgage brokers who are looking to reduce risk on investment generally look for syndicated mortgages.
- Investors know who is borrowing their money and what project their money is funding.
- Syndicated mortgages bring in cash each month.
- All of your investment is going to one entity.
- If the entity (individual or developing company) can’t pay the note, you could end up having to take him or her to foreclosure.
- If you are new to real estate investing, you may not have the will (or the savvy) to push the process to foreclosure.
- If you end up having to go to foreclosure, that cash flow comes to a halt and your eventual return can end up having to wait for months. If the loan went to a project that was still in the building phase at foreclosure, you might not recoup much of your investment at all.
- Borrowers can pay back their syndicated loans early, depending on the contract, which means that you may have your money sitting idle while you’re waiting for the next borrower.
- Not all syndicated mortgages are eligible for TFSA or RRSP.
- Mortgage Investment Corporations (MICs) are capital funds that shareholders raise and then lend to a pool of commercial and residential mortgages. When you invest in a MIC, you buy shares in the corporation, and it invests money for you.
Mortgage Investment Corporations (MICs) are capital funds that shareholders raise and then lend to a pool of commercial and residential mortgages. When you invest in a MIC, you buy shares in the corporation, and it invests money for you.
- Investing in a pool of mortgages eliminates much of the risk that comes from investing in a single project.
- MICs employ professional underwriters who review the applications and make decisions about whether those potential mortgages meet risk guidelines.
- MICs provide monthly income that can be eligible for TFSA or RRSP deposits.
- The monthly cash flow comes from a pool of payments that come in each month, which means that there is no term for the loan to expire; the money comes in continuously, so your money is not sitting idle between loans.
- In case of default, a mortgage is just a small percentage of the larger risk pool, so cash distributions do not undergo anything close to the risk associated with syndicated mortgages.
- Returns on investment average between 7 and 8 percent annually.
- MICs offer memoranda that indicate the general rules and restrictions, such as the highest loan to value ratio allowed by the project.
- MICs have more overhead, which means you will pay a management fee. This is why your return will be often 2 or 3 percent lower than what syndicate mortgages target.
- Make sure that your MIC has a third-party advisory board that reviews loans to make sure that they fit the parameters in the memorandum.
When choosing between a syndicated mortgage and a MIC for your investment, the key questions have to do with your experience in real estate investments and your capacity for handling risk. MICs offer significantly less risk because they have the personnel to screen mortgages, and the risk is diluted by investment in a pool of loans. If you are a partner in a syndicated mortgage, you and your group are responsible for pursuing foreclosure; if you invest in a MIC, you have none of that exposure.