Investing in real estate doesn’t have to mean tenants and toilets. It doesn’t have to mean carrying an illiquid asset or a liquid one subject to market gyrations.
Investors can explore real estate investing through a private vehicle called Mortgage Investment Corporations instead. Here you get exposure to real estate and benefit from an income stream without the responsibilities of owning outright.
Now, like every other kind of investment, it’s essential to do your homework when you are considering MICs.
I should probably introduce myself. My name is Roger Allinson, and I’m the CEO and co-founder of Nest Capital Mortgage Investment Corporation. I’ve been a real estate investor for well over a decade.
When I was first looking at MIC investing, there were several elements I discovered that were essential. We’ve used these to model our own business.
These are what we would use to evaluate investments in the sector.
Outside expertise pays dividends
First and foremost, when it comes to Mortgage Investment Corps (MICs), you should be looking for an experienced real estate team that relies on expert legal and real estate specific experience.
This expertise will help the fund avoid typical pitfalls of paperwork deficiencies and financial problems while providing additional guidance on each investment opportunity.
Experienced real estate investors running MICs need this outside counsel to provide feedback and perspective on investment decisions. Good feedback from trusted advisers can add a layer of risk mitigation to investment decisions.
Residential, commercial, construction
Now you should look at whether the MIC you’re considering a residential pure-play or combination of residential, commercial and construction loans.
Regulation requires MIC’s to invest a minimum of 50% of their assets in residential mortgages. The balance can be invested in commercial or construction loans.
Generally speaking, residential lending tends to be more secure in terms of default rates and collateral. Residential borrowers are typically very reluctant to walk away from their home.
Commercial and construction loans, however, tend to be highly cyclical and higher risk. These will add risk to a portfolio even when paired with residential mortgages.
Average size and LTV
Now, there’s also the matter of the mortgage size and the loan to value ratio.
As the size of the mortgage expands, so too does the commitment on the part of the MIC.
While the average mortgage carried across the industry is give or take $200 000, a lower average mortgage figure helps to reduce risk and diversify the portfolio.
Looking at loan to value, you want to make sure that number is under 75%. That gives you some cushion if there is an unexpected problem.
Regional focus matters
Now the next thing to consider is region. Some regions tend to be very cyclical and heavily reliant on specific resources or industries.
The recent challenges in Alberta demonstrate the risks of a focused economic region. Moreover, it also shows how policy decisions on the federal and provincial level can impact investment of all kinds. That includes real estate.
So when investing in MICs specifically, being mindful of the regional economic diversity and vulnerability to policy changes and mistakes is critical.
Second mortgages have great risk-reward
MIC’s will typically have a mix of first, second and third mortgages. Each mortgage class has different risk and return profiles.
Our research has demonstrated that second mortgages to the right borrowers result in excellent returns at a lower risk profile than one would think.
First mortgages will appear more secure and provide a slightly lower return. However, second mortgages with shorter durations represent the sweet spot of risk-return profiles in residential mortgage lending.
Ultimately you want to know how the fund manages risk. You want to understand the process that the manager uses to reduce those risks.
That might mean understanding the investment process.
- How do they deal with paperwork deficiencies?
- What criteria in terms of duration and size they consider?
- How is the final decision made, and who makes it?
Understanding the decision-making process will make clear how the fund makes money and what the pitfalls might be.
Good leads make the business
To find these qualified borrowers, you need an ongoing stream of leads.
Every MIC will have their source of leads, and it would be a good idea to understand how these leads are generated.
For example, MICs may rely on relationships with reliable mortgage brokers. Alternatively, they may be known for taking a lot of one-off deals. They may depend on a stream of leads from the relationships they have with experts in other parts of the business.
MICs that rely on long term relationships with mortgage brokers benefit from the broker’s record of probity and knowledgeable dealings.
Relationships matter, especially in the real estate investment game.
Skin in the game
Founders with their own money on the line will look at investments through a different lens. Understanding the incentive structure of the manager can help you understand the focus and risks that will be taken.
Having your own money on the line when making investing decisions sharpens the process and improves returns.
Investing is as important or more so than a big vacation or your next car.
Do your homework.
There are lots of ways to be involved in real estate, and one of them is as a private creditor through Mortgage Investment Corporations.
MICs are one of the few options for indirect involvement in the real estate sector without stock market volatility and direct banking exposure. You can invest through a fund with a residential focus in a well-diversified economic region, and get returns that reflect a well-balanced risk-return profile.
But you need to look at the managers, the region, the investment process, the kinds of loans and the class. The more you understand about the business, the better your investment decision will be.
Because having investments that produce healthy, low volatility returns while letting you sleep at night is the ideal.