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 (IPL); there are two other ways for investors to enter alternative lending is by way of a syndicated mortgage or in a Mortgage Investment Entity (MIE). The 2 most common types of MIEs are Mortgage Investment Corporations (MICs) and Mutual Funds Trusts (MFTs). Private Lending as a whole lends 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.

IPL Lending  is when an individuals lends their money to a particular borrower on specific real estate. The funds could go toward financing a condo, a single-family home, raw land, or any real estate is being used as collateral.

Benefits:

  • IPL can appear on the title, or can be in the name of an owned corporation, or by way of a Bare Trust (Example. Olympia Trust Company)
  • IPL loans are direct loans to the borrowing entity usually above 10% projected returns to 14% (and sometimes greater).
  • Investors know who is borrowing the funds and the security for the loan.
  • IPL mortgages are usually paid monthly unless otherwise agreed in the mortgage agreement.
  • IPL mortgages are eligible for TFSA,  RRIF, RRSP, LIRA, RESP, etc.
  • IPL mortgages can also be funded in personal name using non-registered funds.
  • IPL mortgages can be also funded in corporate name using non-registered funds.

Drawbacks:

  • All of your investment is going to one entity.
  • If the entity can’t pay the note, you could end up having to take legal action against the entity.
  • 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 take legal action, that cash flow comes to a halt and your eventual return can end up having to wait for months to a year depending on the equity and complexity. You might not recoup much of your investment at all.

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.

Benefits:

  • Syndicated groups can appear on the title
  • Syndicated mortgage are direct loans to the borrowing entity usually above 10% projected returns.
  • 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.

Drawbacks:

  • 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 Entities (MIEs) are capital funds that shareholders raise and then lend to a pool of commercial and residential mortgages. When you invest in a MIE, you buy shares in the corporation, and it invests money for you.

Benefits:

  • Investing in a pool of mortgages eliminates much of the risk that comes from investing in a single project.
  • MIEs employ professional underwriters who review the applications and make decisions about whether those potential mortgages meet risk guidelines.
  • MIEs 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.
  • MIEs offer memoranda that indicate the general rules and restrictions, such as the highest loan to value ratio allowed by the project.

Drawbacks:

  • MIEs 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 MIE has a third-party advisory board that reviews loans to make sure that they fit the parameters in the memorandum.

When choosing between an IPL mortgage, Syndicated mortgage and a MIE for your investment, the key questions have to do with your experience in real estate investments and your capacity for handling risk. MIEs offer a diluted risk, and you are dependant on the MIEs ability to properly manage the portfolio. Syndicated Mortgages is more hands on, but it entails ensure that you and the other investors see eye to eye on all matters of the mortgage including potential legal/foreclosure action if the mortgage goes into default. An IPL mortgages is also a hands on like a Syndicated Mortgage, but you assume the all the risk while also building a direct co-underwriting style relationship with the Brokerage. A good Brokerage that provides IPL mortgage opportunities will assist Investors with coordinating legal action should a mortgages go into default.