Bricks & Mortar | What Are the Options Available to Investors in the Real Estate Asset Class?
By: Josh Will
Within the Canadian real estate investment space, there is an array of great products that individual investors have the opportunity to invest in, aside from owning rental properties directly. What other options are out there for you to offer your clients? MICS, REITS and Syndicate Mortgages are all terms that are not likely foreign to anyone reading this magazine. But do we truly understand the differences between each investment structure? We know that they are all real estate investments, and that they all seem to have great terms, returns, assets and managers. But what separates these types of investments from each other? Let’s look at the way these products are structured to determine what the differences are between them, the merits and risks involved in each and ultimately which ones are better for your clients, because we all know that certain investments work for some client, but not for others.
Mortgage Investment Corporation (MICs)
While attempting to position real estate investment, have you ever heard a client say: ‘I already invest in real estate, I just purchased a MIC.’ Did they directly invest in real estate? Or did they invest in more stocks? So how does a MIC work exactly? Does the client truly understand what is generating those returns? MICs have been around since 1973 when federal legislation was enacted to promote private financing and make it easier to invest in mortgages. A MIC is an investment company that is designed specifically for mortgage lending to (generally residential) developers or individual borrowers that cannot access a traditional mortgage. This investment structure allows investors to pool their funds together in the MIC. The managers of the MIC then loan the pooled funds out to people or companies that cannot access a traditional mortgage.
What is important to note is that MICs will have a focus on which asset class they are investing in. Some MICs focus only on residential and commercial development, whereas others focus solely on lending to individual borrowers that cannot access a traditional mortgage. The types of properties involved could include apartments, condo developments, malls, and other commercial buildings. Each MIC could include mortgages on a vast number of properties, thus providing further diversification within that MIC’s portfolio. When the money is lent out to the borrower (i.e. the developer, or individual) the terms of the lending contract are highly defined, much like all mortgage contracts. The interest payments that are made on that mortgage are then distributed to the investor and that is how the cash flow or income from the MIC is generated. Much like REITs, MICs are offered for investment via two distinct markets: the public market and the private market. When a company offers it’s security for sale in the public markets, this is often considered a positive due to the fact that (among other merits) there is liquidity for the investor.
MICs are typically managed by the best in class asset managers available. Asset Managers on a MIC fund should have a significant amount of insight on the properties and individuals they are lending to, and the due diligence process involved when selecting their borrowers is often very stringent. When an investor makes an investment into a MIC, they are ultimately investing into the knowledge and expertise of the fund’s manager. The investor is banking on the manager to find quality properties and quality developers to invest in and generate a solid consistent return for them.
Now this all sounds great so far right? What are some of the draw backs that investors could experience when investing into a MIC? What if the individual investor wants to participate only in certain properties? What if the client wants some decision making ability in which properties they want to invest in? Unfortunately in this structure, the manager of the MIC selects the properties on their behalf, whereas in syndicate mortgages, investors have the ability to invest into a desired project. This can be considered a strength or weakness of a MIC, depending on how you look at it and who the manager is. One of the main focuses of a MIC is to lend privately, thus not using conventional metrics to lend funds. Developers or individuals who cannot access bank mortgages often apply for higher rate mortgages via a 3rd party lender or a MIC. This is how the MICs are able to either provide substantial returns (by getting more interest for their loan) or experience higher default rates because they lend to parties that may not always be able to service the mortgage debt. This creates volatility within the MIC. Again, it is all about risk versus reward.
Real Estate Investment Trusts (REITs)
REITS are another form of real estate investing, or are they? Let’s take a closer look. As you may or may not know, REITs are companies that own and typically operate income producing real estate properties such as: commercial real estate, hotels, hospitals, apartment buildings, warehouses and shopping centres. REITs can either be private or public companies. Private REIT companies are similar in nature to public companies. However, they typically either lack liquidity or have provisions surrounding liquidity for the investor. Both public and private REIT companies benefit from low volatility of the underlying asset, real estate. Public REIT companies offer stock for sale to investors in the public stock market. This means that the only way for your clients to purchase these types of investments is to purchase them through an adviser that trades stocks in the public market (or use a discount brokerage). As most REITs are publically traded, this is often considered one of their positive attributes, the convenience factor. It gives the investor liquidity and the ability to ‘get out’ of the investment if they decided that they no longer wish to participate.
Investing in a REIT is much like investing in the equity market, where you purchase shares in a company. However in this case,
the driver of returns is the leasing or sale of real estate assets held by the REIT. In the equity market, investors profit from increased corporate revenues, but both are still subject to the emotional market volatility. Finally the disclosure that is available for the clients is very rigorous. Since this is a publicly traded company, there are accounting and financial disclosure rules that the REIT must follow. The client is able to see exactly how much money the REIT has made, lost, as well as all of the operating costs and fees associated with their investment. This is something that most private companies are trending towards as well. The power of full disclosure is crucial to building trust with your client. If you have a client that says they are invested in real estate, make sure that they understand that in the above cases they are actually invested in companies that invest in real estate, they themselves are not directly invested into real estate.
In a Syndicate Mortgage, clients can invest into real estate by providing direct debt financing on an asset, and the only way for investors to access this type of investment is through a registered dealing representative in the exempt market. A syndicate mortgage investment structure is a rather simple one. Just like a traditional mortgage, where you put down a certain amount of collateral like 20% and the bank lends you the remaining amount to acquire your home. A syndicate mortgage moves and acts very much the same way. In a syndicate mortgage, investors become the lender to a developer to build their desired project. It could be a high rise condo, low rise single family development or a commercial complex.
There are several unique features that a syndicate mortgage possesses. First, a syndicate mortgage allows investors to select which projects they wish to invest in (one of the key differences between MICs and Syndicate Mortgages). If the investor feels more comfortable with commercial properties over residential properties, then the client has the ability to select this. Another unique feature of Syndicate 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. Syndicate mortgages allow for the same fall-back scenario if a debtor neglects to service the debt.
A number of risks are associated with syndicate mortgages, the first of which is common amongst other real estate investment types: liquidity. Since you are the lender in a mortgage, you have a contract between yourself and the borrower. Typically the borrower will agree to pay you a steady interest rate and repay the full amount of the loan borrowed on a specific date. There are other risks associated with these types of development investments. What if the project runs out of funds and cannot service the debt load? What if the project does not get its required permits or zoning? What if the end result of the built project does not meet expectations financially? This is where you can act on your legal right as a charge holder against the land. If the borrower does not meet the terms agreed upon in the mortgage contract you can force them into foreclosure and sell the property to recover your capital. This is where the loan to value (LTV) ratio is critical. You have to make sure that there is enough equity provided by the developer so that if you were to push them into foreclosure there is enough room there to recoup your capital. Regaining full capital is not always the case; however having your name registered on title gives you security by providing you with ownership at the end of the day if the project doesn’t go as planned. When looking at investing into a syndicate mortgage, there are a few things that you will want to look for in the investment:
- Who is the builder/developer that is acting as the borrower? (This is who you are ultimately investing in).
- What is the borrower’s track record like? Have they experienced defaults?
- Diversity. Do they operate in multiple markets? (i.e. city, regions)
- Do they offer a product mix? (Commercial, residential, low rise, high rise etc.)
- Quality of client and advisor support. Do they provide you with the tools you need to make an informed decision?
When you have a client that wants to invest in real estate, make sure that you understand the differences between the many options available in the market place. And of course, if you have an investor that wants to invest directly into real estate financing, be sure to introduce them to Syndicate Mortgages.