This investment class offers premium yields over short duration

by Neil Sharma20 Sep 2018

Real estate is a solid asset class for investment, but in taking it a step further, commercial mortgages offer high yields and minimal risk.

For starters, institutional real estate investors like Ivanhoe Cambridge bring markets stability because of their funding abilities and commitment to long-term investment horizons.

“This enables them to invest in the assets in their underlying portfolios, as well as hold on during periods of uncertainty,” said Geoff McTait, SVP and co-head of debt strategies at Fiera Properties Ltd. “They have a sophisticated as well as global investment views, and this in concert with relatively conservative banking practices here in Canada keep it a disciplined process and maintains discipline with new construction, helping to limit oversupply.”

In tandem with strong market fundamentals—in Toronto, for example, office and industrial vacancies are the lowest in North America—going back 20 years, commercial mortgages have proven to be strong investment vehicles.

“Mortgages have very low loss experience, comparable to the loss experience of credit-quality corporate bonds,” said McTait. “Given the cyclical nature of economy, and real estate’s nature itself, at some point there will be a recession, but mortgages at this time represent reduced risk exposure to the real estate asset class. We’re lending on commercial real estate at cents on the dollar.”

Lending at precisely $0.65, a considerable cushion is in effect should recession or value reduction befall the real estate market. Compared to corporate bonds, investors should rest easy.

“We look at commercial mortgages as superior security but with reduced liquidity to corporate bonds, collateral being the first one. With real estate you’re getting a hard asset—the commercial property itself—as well as assignment of underlying rents. With corporate bonds, you’re getting a general claim on the corporate asset.”

Pooled commercial mortgage funds also provide investors with income-generating tenant diversity. Tenant income ultimately pays the mortgage’s interest.

“In terms of liquidity, mortgages are private,” continued McTait. “Amortization is another feature. Often times you can get amortization of 20 to 30 years where the principal is repaid monthly, as well as interest over the life of the mortgage term. From a risk rating perspective, mortgages are not publicly rated, but corporate bonds are.”

The yield premium of commercial mortgages is directly tied to the private nature of the asset class, meaning they don’t trade frequently, and the duration of the mortgages.

“Mortgage duration typically is going to be shorter than in the corporate bond space. Terms are usually, three-, five-, and seven-years. They commonly go up to 10 years. Given this private premium and shorter duration than bonds, you’re able to achieve this higher yield with lower duration.”

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