In the world of investing, real estate has always been one of the most common ways for people to build wealth with a relatively stable asset class. There are many ways to do this from equity investment (buy, hold, rent, sell) to investing in real estate centered funds, to direct personal lending, to Mortgage Investment Corporations. Each of these investment vehicles have their own risks and benefits. Let’s explore what a Mortgages Investment Corporation (MIC) is, some of the commonly used terms, and finally what makes a good MIC.
At PHL we manage 2 MICs totaling $700,000,000 in Assets Under Management (AUM) as of the end of the last fiscal year. Each of these funds have different risk profiles and lending parameters, yet like all other MICs, they are investment and lending companies that allow investors to pool funds in a diversified and secured portfolio of residential and commercial mortgage loans. Furthermore, shares of a MIC are qualified investments under the Canadian Income Tax Act (Section 130.1) for RRSPs, RRIFs, TFSAs, or RESPs. The Income Tax Act requires that 100% of a MIC’s annual net income be distributed to its shareholders.
In real estate, there are some common terms that also apply to MICs. Loan to Value (“LTV”) refers to the amount of money lent on a specific property compared to its appraised value. For example, if a property is worth $1,000,000 and $600,000 is lent on this, the loan to value ratio is 60%. This is an important metric as it directly impacts the risk profile of the fund. The higher the LTV the more risky, as if there are ever swings in the market (such as we are seeing now) and prices drop, it could become more difficult for the fund manager to recoup the value of the loan in the event of a foreclosure. An example of this would be if a MIC lent out funds on a property at 85% LTV, there has since been a 20% price correction in that market, the borrower stops repaying funds and foreclosure begins. In this case the property is now only worth 80% of its original value, and there is a spread of 5% that the asset manager will have a more difficult time recovering. All this being said, higher LTV loans typically bring higher interest rates, which will mean a higher return to investors in the end. Investing within your risk profile and for the correct objectives is essential.
The next important metric is the position of the mortgages in the portfolio. A mortgage position refers to the priority of the loan for repayment, and is stated as first, second, third, and so forth down the line. A mortgage that is in the first position will receive repayment in the case of a foreclosure before a second or a third position, while a second position would wait until the first is paid out, but receive funds before the loan in the third position. Each MIC will have its own make up that will shift over time as loans are originated, as loans pay out and as they renew. This is another key metric of a MIC’s risk profile as well. A fund that lends predominantly in the first position is inherently less risky than one that lends in the second.
Liquidity is another very important factor to consider when investing. When equity investing in real estate, you have to either refinance or sell the property to gain access to the capital, and it may not always be possible to do this at advantageous terms compared to when you entered that individual asset. With a MIC, there are typically liquidity terms written in the offering documents stating when and how an investor can withdraw their capital from the fund. It is extremely important to read and understand these terms as not all MICs are created equal. Some MICs have lock up periods where investors cannot redeem the MIC shares, some offer only yearly redemptions, and some may even charge an early redemption penalty.
At PHL, we pride ourselves in the relationships we have built with our investors, our business partners (mortgage brokers, appraisers, lawyers), and the overall construction of our MIC portfolios. One of the key benefits of investing in a MIC compared to a single property or direct lending your own funds, is the diversification of risk. For example, if you are invested in shares of MortEq Lending Corp, our flagship fund managing $650,000,000 of mortgages, you are invested equally in all the mortgages making up the portfolio. This means that if a portion of the mortgage portfolio ends up in foreclosure, it is only that portion of your capital that is at risk due to foreclosure. If you are direct lending the funds and the property you have chosen to lend on goes into foreclosure, not only are you responsible for the proceedings, but all of what was lent could be at risk, depending on what happens with the proceedings. Our investors know they can count on our experience to ensure that everything is done to manage their money in a responsible manner, letting them sit back and focus on what truly makes them happy.
When determining if investing in a MIC is correct for you, you should read the offering documents, and there should be a Know Your Client process completed that then compares your risk profile with the risk profile of the MIC itself. Not all MICs are created equal, and many lend on different parameters. MortEq Lending Corp. has a 55% LTV, is 93% first position mortgages, provides quarterly liquidity with no lock up period or penalties and has a 16-year track record. When comparing this to our relatively new fund Oakhill Lending Corp., which has a 65% LTV, is 92% second mortgages, provides liquidity every 6 months after a 1 year lock up period and has a 2-year track record, it is obvious why the two funds have a different risk profile and are suitable for different investor risk profiles. There are always trade offs between the options, so it is important to obtain advice on what is appropriate for you personally and go through the investment process with the firm’s registered Dealing Representatives for a suitability determination.
While a MIC may not be appropriate for all investors, they can be a great option for investors looking to derive income from their investments, or let their capital grow via DRIP, compounding returns. Investors should always read the offering documents, consult the needed parties, and ensure that they understand what they are investing in.