Owning vs. lending
As income-hungry investors gravitate to red-hot real estate, mortgage investment corporations offer alternatives
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Hey there, time traveller!
This article was published 04/03/2017 (1984 days ago), so information in it may no longer be current.
Real estate has undeniably been a very lucrative investment in Canada. Besides the obvious increases in value for on your home, consider this: If you held the S&P/TSX Capped Real Estate Index 15 years ago, you would have averaged more than 10 per cent per year of total return (capital gains and distributions). By comparison, the TSX Composite Index averaged about 7.5 per cent.
Outside of owning a home or investment property, most investors get exposure via REITs (real estate investment trusts). These portfolios of commercial, industrial, multi-residential and other properties offer relatively steady, inflation-beating income.
And in this low-interest rate world where bonds and Guaranteed Investment Certificates (GICs) pay about two per cent, investors have poured into them. The problem today is real estate has done so well for so long; the risk of a big correction grows by the day.
But investors have another way to play real estate without the risks that come with ownership.
Mortgage investment corporations (MICs) generate income by lending to the real estate industry instead of owning hard assets.
Providing mortgages to borrowers who don’t fit the mould of traditional lenders, MICs can charge higher rates and, in turn, pay out higher yields. And while some may argue that’s a reflection of risk, the head of one of Canada’s largest publicly traded MICs argues their higher yields are more a reflection of investors’ lack of familiarity with MICs.
“It’s really sort of ironic that a MIC would have a higher yield than a REIT,” says Robert Goodall, president and CEO of Toronto-based Atrium Mortgage Investment Corporation.
While REITs average about four per cent annual yields, MICs generally have yields exceeding seven per cent.
Yet, Goodall contends REITs actually involve more risk than MICs — at least those listed on a stock exchange — because MICs don’t directly own property. Instead, they provide short-term, high-interest mortgages to borrowers who already have at least 20 per cent equity — often more like 35 per cent — in the properties.
“If you’re a REIT and you buy a piece of real estate, and if that property loses $5 and you bought it for $100, you’ve lost five per cent of your value,” he says.
As lenders, MICs don’t assume that capital loss risk in the same manner.
“Our average loan to value is less than 65 per cent, meaning our typical borrower has 35 per cent equity in the real estate on which we’re lending, so we can handle a downturn far, far better than a REIT can, because we’re the lender.”
Losses are only realized when borrowers default, he says, adding that’s uncommon among MICs because they’re typically conservative lenders who keep loans on their books (they don’t sell their mortgages and let others worry about default.)
So why are MICs overlooked and undervalued? It’s not that they don’t have a long track record. They have been around since the mid-90s, Goodall says.
What’s kept them low profile is most MICs were private deals until about four years ago, so they weren’t traded on stock exchanges.
Moreover, the MIC market is relatively small compared to the REIT market.
For example, the market capitalization of the 22 largest publicly traded REITs in Canada is about $60 billion. By comparison the 300 or so MICs — public and private — are worth about $12 billion, Goodall says.
Yet MICs have quietly carved out a healthy niche in Canada over the last two decades.
“What MICs do is fill a lending gap because of the limited number of lending institutions in Canada,” says Goodall, who heads up one of three publicly traded MICs worth more than $300 million.
“There are basically six banks in Canada that control 70 per cent of the mortgage lending in the country, whereas 20 years ago there were probably 25 trust companies of good size that would provide secondary lending opportunities.”
When the trusts disappeared, MICs stepped in, providing mostly short-term mortgages — bridge financing — to borrowers who don’t qualify for financing from traditional lenders. In most cases, the borrowers are developers. But MICs lend to the residential market too. Because these borrowers don’t qualify for the typical financing, they turn to MICs, which can charge seven to nine per cent interest on a short-term mortgage (one to two years) as opposed to about 2.5 per cent on traditional mortgages.
This allows MICs to pay out high yields to investors.
“We have averaged anywhere from 8.5 to 10 per cent in dividends per year, in each of the 15 years, and that included 2008 and 2009 during the financial crisis,” Goodall says (though Atrium currently yields about 7 per cent).
Certainly MICs can be a good addition to investors’ portfolios, says money manager Doug Nelson, president of Nelson Financial Consultants in Winnipeg.
“A MIC can play a role as a more aggressive component of the defensive (income) side of your portfolio, or it could also be considered an equity that makes up the real estate component of your portfolio (growth),” says the author of Master Your Retirement: How to Fulfill Your Dreams with Peace of Mind.
For its clients, Nelson Financial usually recommends privately held MICs due to their stability, he adds.
“The distribution is very consistent and the capital value does not fluctuate,” says the certified financial planner. “This fits a role for part of our fixed-income strategy for clients.”
But private MICs are not for everyone, particularly because these investments are often illiquid, says portfolio manager Hardev Bains with Lionridge Capital in Winnipeg.
“So it can be difficult at times to redeem your shares when you want to,” he says.
“This doesn’t mean that a given MIC can’t be a good investment, but care should be taken regarding the amount and type of MIC exposure one takes on.”
Publicly traded MICs such as Atrium’s generally address this concern because they’re traded on a stock exchange, making buying and selling them relatively quick and easy.
The downside of listing on an exchange is volatility. Investors need to be comfortable with their investment going up and down in share price, as well as its yield.
Private or publicly traded, MICs bear consideration if you’re seeking to diversify your portfolio — within reason, Nelson says.
“There are many ways to generate income in a portfolio,” he says. “A MIC can be a good way to do so, but to manage portfolio risk, it needs to be in balance with your other income-producing strategies.”