Mortgage Investment Funds: How To Invest In Real Estate

A mortgage investment fund is a type of investment product that allows investors to pool their money and invest in a portfolio of mortgages. These funds are typically structured as mortgage investment corporations (MICs) or similar entities, which provide a way to invest in the real estate market while mitigating the time and risk associated with individual mortgages. MICs are special companies created under specific tax laws, allowing them to offer investors a diversified way to invest in mortgages and generate returns. The funds approve borrowers based on their lending policies and criteria, with the loans secured by real estate property. Mortgage funds have gained popularity among investors due to their stable cash flows, fixed income, and attractive rates of return.

Mortgage Investment Corporations (MICs)

MICs are special companies created under Section 130.1 of the Income Tax Act, a federal statute, to enable investors to invest in a pool of mortgages. Investors pool their money by buying shares in a MIC, creating an alternative fixed-income investment. The MIC's management is responsible for sourcing suitable mortgage investments, analysing mortgage applications, and negotiating interest rates, terms and conditions. They are paid a management fee, typically calculated as a percentage of assets under administration.

MICs are generally provincially registered and licensed, with the management of the mortgage fund under the direction of provincially licensed mortgage brokers and real estate agents. A MIC must have at least 20 shareholders, and no shareholder may hold more than 25% of the MIC's total capital. At least 50% of a MIC's assets must be residential mortgages, and they may invest up to 25% of their assets directly in real estate. MICs are tax-exempt corporations, and they distribute 100% of their net income to their shareholders.

MICs vs. banks

A Mortgage Investment Corporation (MIC) is an investment and lending company designed for mortgage lending, mainly in residential properties in Canada. MICs pool investors' money by selling them shares, creating an alternative fixed-income investment.

The main similarity between banks and MICs is that they both pool funds from investors and sell portions of the fund to investors. However, there are several key differences between the two.

Term Lengths

Mortgages through banks typically carry a term of 15 to 30 years. In contrast, MICs offer shorter-term loans, usually between one and three years. This allows investors to reinvest in new projects and not have their capital tied up for long periods.

Interest Rates

With bank-related mortgage funds, interest rates can change over the long term, and the interest made may be affected by fixed-rate loans. MICs, on the other hand, can more efficiently capitalise on rising interest rates and reinvest capital more readily due to their shorter-term loans.

Payouts

MICs often pay out dividends monthly, whereas bank stocks tend to do so quarterly. This makes MICs more attractive to investors seeking a passive income stream.

Focus

Banks deal with a wide range of investments and money-managing topics. In contrast, MICs focus solely on the real estate sector, allowing them to develop more expertise and experience in this niche market.

Regulation

MICs have more freedom than banks as they don't answer to the same regulatory agencies. This allows MICs and private corporations more creativity and flexibility to pivot with market trends.

Property Type

MICs and private mortgage funds are often involved with real estate development and construction projects. This is facilitated by the shorter approval times related to mortgage pools through MICs compared to banks.

MICs' investment strategies

Mortgage Investment Corporations (MICs) are pooled investment funds that invest in private mortgages on behalf of investors. They are a way for investors to gain direct exposure to the private mortgage market, providing an alternative to conventional portfolios composed of stocks and bonds. MICs operate similarly to mutual funds or exchange-traded funds (ETFs), but instead of stocks and traditional fixed-income securities, they are made up of carefully selected mortgages that produce income through the collection of interest and fees from borrowers.

MICs have become an important part of modern investment portfolios because the traditional 60/40 allocation strategy (60% stocks, 40% bonds) no longer produces the desired returns. Traditional fixed-income assets like government bonds are struggling to generate yield, with bond yields collapsing further in the wake of the Covid-19 pandemic due to monetary policy and central banks fixing interest rates near zero.

MICs provide quicker access to the real estate market, which has traditionally been a popular but inaccessible market for many investors. MICs also offer the potential for greater returns than traditional investment markets, with average returns between 5% and 8%, compared to a 10-year Government of Canada bond, which offers an average return of 1.5%.

MICs also provide greater protection and diversification. While no investment strategy is completely safe from market shifts, investing in mortgages offers the additional security of not owning the physical property in the event of market volatility. In the case of a borrower default, the lender takes the property as collateral, and the MIC handles recouping losses and selling properties.

MICs are designed for mortgage lending, primarily residential mortgage lending, in Canada. A MIC mortgage portfolio can include everything from small second mortgages on residential property to commercial and development mortgages on new projects. Every investment is typically based on a thorough investigation of the property, and a typical MIC loan should not exceed a specified percentage (generally 60-85%) of the current value of the property.

MICs are provincially registered and licensed, with the management of the mortgage fund under the direction of provincially licensed mortgage brokers and real estate agents. The MIC's management is responsible for all aspects of the company's operations, including sourcing suitable mortgage investments, analysing mortgage applications, and negotiating applicable interest rates, terms and conditions.

MICs' benefits and risks

Benefits

Mortgage Investment Corporations (MICs) are a way to invest in the real estate market while mitigating the time and risk of investing in individual mortgages. MICs are special companies created by Section 130.1 of the Income Tax Act to enable investors to invest in a pool of mortgages. MICs are managed by a team of professional underwriters who review and evaluate every mortgage transaction and determine the risks involved.

MICs offer investors a more passive form of investment, requiring less time and effort than buying individual mortgages. They also provide a more diversified portfolio of mortgages from different investors, and the opportunity for more income with higher annual returns.

Under Canadian income tax law, MIC shareholders are entitled to tax benefits that attract more funds to the Canadian mortgage market. MICs are tax-exempt corporations, avoiding the two levels of tax applied to regular corporations.

Risks

All assets carry risk, and MICs are no exception. One of the main risks is the fluctuation in real estate prices, which can affect the value of real estate used as collateral. If the value of the collateral decreases, it can adversely affect the MIC.

Another risk is liquidity mismatches, where MICs can be vulnerable if investors exit in a hurry. This situation occurs if the MIC does not have sufficient funds to pay its shareholders.

The success of the MIC also depends on the competence of its managers, their experience, expertise, judgement, and good faith. The rules allow MICs to borrow money, and while this can boost the ability to generate shareholder returns, it also increases risk.

Default on mortgages is another risk factor. While MICs perform thorough background checks on borrowers, they lend to a niche market that banks typically avoid, and at higher interest rates, which is associated with higher risk.

Types of mortgage funds

Mortgage funds can use various structures, including Mortgage Investment Corporations (MICs), Mortgage Trusts, and Limited Partnerships. While there are nuances between the structures, they are all fundamentally in the same business of providing private mortgages to earn a return for investors.

Mortgage Investment Corporations (MICs)

MICs are special companies created by Section 130.1 of the Income Tax Act, a federal statute, to enable investors to invest in a pool of mortgages. MICs provide a way to invest in the real estate market, mitigating the time and risk of investing in individual mortgages. Investors pool their money by buying shares in a MIC, creating an alternative fixed-income investment. MICs are generally widely held, with at least 20 shareholders, and no shareholder may hold more than 25% of the total capital.

Pooled Mortgage Funds

This type of fund pools money from different investors, which is then spread across multiple mortgage loans. An experienced investment manager selects the individual loans and manages the day-to-day operations. Investors receive the average interest from all the loans, less any management fees, but they have no control over the specific mortgages the fund invests in. Pooled mortgage funds typically have smaller minimum investment amounts, making them more accessible to a wide range of investors. The more liquid nature of pooled funds also allows for withdrawals soon after the initial holding period.

Contributory Mortgage Funds

Contributory mortgage funds, unlike pooled funds, focus on the performance of a specific mortgage. Investors choose which mortgages to invest in after reviewing the specific features and risks associated with the loan, such as purpose, location, term, and interest rate. The fund manager's role is to vet and scrutinise these investments. A contributory fund remains open until investors have contributed enough money to fund a mortgage loan. Contributory funds generally require a greater minimum investment than pooled funds and do not allow withdrawals until the loan is repaid. The risk associated with contributory funds depends on the quality of the borrower.

Frequently asked questions