Private lending is rapidly expanding in Canada’s mortgage sector, providing borrowers with a transparent and equitable alternative to traditional borrowing while offering investors beneficial investment opportunities.
Private mortgage investments can be a lucrative alternative for investors seeking fixed-income opportunities outside of traditional avenues. In Canada, the landscape of private mortgage investments offers a diverse array of options, allowing investors to diversify their portfolios and potentially achieve higher returns. However, it’s an investment area not many are very familiar with.
What is Private Mortgage Lending?
In the residential real estate market, private lending refers to short-term mortgage financing primarily for borrowers who don’t qualify for traditional bank mortgages. These loans are usually provided by mortgage investment corporations and individual private lenders that include investors, conglomerates or high-net-worth groups.
In a competitive housing market, private lenders play a crucial role in providing liquidity and financing to borrowers who are looking for alternative lending arrangements to those offered by the major banks. Private lenders offer greater flexibility in the mortgage application process, often focusing on the borrower’s equity, cash flow and exit strategy, without the stringent stress tests and other requirements imposed by traditional mortgage lenders.
What are Private Mortgage Investments
Private mortgage investments involve individuals or groups lending money directly to borrowers in the form of loans backed by real estate.
Private mortgage lenders come in many forms and offer different programs to investors – mainly, they include whole mortgage investment programs and Mortgage Investment Corporations (MICs), which provide exposure to the residential mortgage market at varying risk/return levels.
Whole Mortgage Investment Programs
Whole mortgage programs are geared toward high net worth investors and are typically administered by mortgage companies that manage the entire investment process on behalf of the investor – including sourcing, underwriting, and managing each mortgage investment throughout its term. Whole mortgage programs save investors’ precious time and eliminate a great deal of risk and uncertainty from the lending process, especially if the investor doesn’t have expert knowledge of the private mortgage market or lacks experience in evaluating borrowers.
Whole mortgage investing allows the investor to have more control in creating a portfolio of mortgages that meets their preferences in terms of amount/size, location, loan-to-value, borrower risk profile and yield. Investing in mortgages is viewed as less risky than direct real estate ownership because private mortgages are debt investments that are backed by real property. Private mortgages usually have terms lasting between six and 36 months, with most being no more than 12 months. The lender receives regular interest payments from the borrower, who also bears all the transaction costs.
Mortgage Investment Corporations (MICs)
Non-accredited investors who don’t meet the net worth, income and capital requirements can invest in private mortgages through a mortgage investment corporation, or MIC. A MIC raises money from investors and uses those funds to originate mortgages to borrowers. When a borrower makes their regular mortgage payments, the fees and interest collected are used to pay dividends to investors, typically monthly. The MIC manages the entire portfolio and is responsible for sourcing, underwriting and managing all mortgage assets.
The best MIC providers offer a range of portfolio options that differ based on the risk and return profile of each fund, which is determined by factors including the average loan-to-value, duration and security position of the underlying mortgages.
MICs are subject to specific regulations outlined in the Income Tax Act to qualify for favourable tax treatment. They must be Canadian corporations investing funds in mortgages and cannot manage or develop real estate property, although they may own a mortgaged property due to foreclosure or sale agreement. They’re prohibited from holding property or debts outside Canada.
MICs must allocate at least 50% of assets to residential mortgages or cash and maintain a minimum of 20 shareholders, with no individual permitted to own more than 25% of shares. MICs must distribute 100% of their net income to shareholders. Annual audits of financial statements are mandatory.
How Do Private Mortgage Investments Work?
Mortgage investment companies act as intermediaries between investors and borrowers, managing the process of underwriting, servicing, and administering mortgage loans. Unlike major banks, private mortgage lenders have the flexibility to set their own approval criteria and charge higher interest rates than prevailing market rates. This allows more flexibility for investors and borrowers; investors can customize their investments based on their risk tolerance, time horizon, and return expectations. Typically, the higher the risk involved in a mortgage, the higher the interest rate charged. Historically, mortgage investments have delivered annual returns ranging from 6% to 16%.
MICs, on the other hand, constantly manage their mortgage pools, using newly invested capital and repayments to fund new mortgages. The management oversees all operations, including sourcing suitable investments, analyzing applications, negotiating terms, instructing solicitors, and handling administration. Similar to investment funds, the manager receives a management fee based on a percentage of assets under administration.
Who Should Consider Investing in Private Mortgages?
Private mortgage investments appeal to a broad spectrum of investors, including those looking to add a non-correlated asset class to diversify their portfolio beyond traditional stock and bond investments, or those seeking a reprieve from the volatility of public markets without sacrificing returns. Investors with a penchant for real estate may also find private mortgage investing a particularly attractive alternative.
Whole mortgages are suitable for accredited investors with at least $500,000 in liquid capital. For investors in Ontario or British Columbia, a minimum net worth of $1 million and a net income before taxes of at least $200,000 (or $300,000, when combined with a spouse) is usually required. A minimum net worth of $500,000 is preferred for all other provinces.
Non-accredited investors who don’t meet these net worth, income and capital requirements can invest through a mortgage investment corporation. MICs are also a good venue for less experienced mortgage investors or those seeking a much lower minimum investment.
Why Invest in Private Mortgages?
Private mortgage investments allow for more flexibility and can provide higher yields compared to traditional fixed-income securities. With steady income and minimal correlation with public markets, private mortgage investments act as a stabilizing force in portfolios. Consistent cash flow makes private mortgages an attractive fixed-income alternative that can be tailored to suit the risk-return profiles of defensive, moderate, and high-yield-seeking investors. The resilience of private mortgages to changes in monetary policy, coupled with their tangible collateral and short-term nature, makes them an attractive option in today’s investment landscape.
Furthermore, private mortgage investments can provide benefits to more than just the investor. According to Chris Baker, vice president, Investment Sales at CMI Mortgage Investments, “Investing in private mortgage lending allows investors to curate diversified portfolios and enjoy appealing returns, all while granting borrowers access to flexible financing solutions. These borrowers are often unable to otherwise get the loans they need to enter into home ownership or access home equity, for one reason or another, but are financially stable and responsible. This mutually beneficial relationship injects liquidity into Canada’s real estate market, providing an alternative funding avenue and fostering stability and growth.”
The Private Mortgage Market
The CMHC indicates an upward trend in the MIE (mortgage investment entity) Lender Types market. In 2020, there were 215,000 loans initiated, totaling $58.87 billion, with an average loan size of $273,920. By 2023 Q3, this momentum continued with 168,000 loans originated, amounting to $46.76 billion, and an average loan value of $278,140. Overall in this nearly four-year period from January 2020 to 2023 Q3, there has been a total of 816,000 new loans, resulting in $228.44 billion in lending.
The share of MIE loans compared to other types of loans has also been holding steady and even taking an increasing share of the mortgage market.
According to Baker, “As typical rental costs increase, more Canadians are hoping to move towards home ownership. However, as house prices are also increasing, while requirements for traditional mortgage lenders are tightening, many would-be home homeowners need access to alternative lending sources. This is especially true for some people who are self-employed, looking for a second mortgage, or otherwise aren’t good candidates for conventional lending.”
Key Considerations
Despite their advantages, private mortgage investments come with inherent risks and drawbacks. One of the primary risks is credit risk, as borrowers may default on their mortgage obligations, leading to potential losses for investors. It’s important to determine how the lender makes credit adjudication decisions and manages all risks and outcomes in their portfolios.
Before investing in a mortgage program, investors must consider the lender’s reputation, track record, investment strategies, risk management and due diligence practices, and terms and restrictions. It’s also important to evaluate whether the mortgage investment partner possesses in-house resources to manage the entire mortgage origination, underwriting and administration process.
Importance of a Trusted Private Lending Partner
Private mortgage investments provide a unique and potentially lucrative opportunity for investors. They can diversify their portfolios and potentially earn attractive returns backed by the Canadian real estate market. However, it’s important to research and find a professional private lending partner. Private lenders can not only provide access to a diverse range of high-quality mortgage investment opportunities, but the best firms also manage the ongoing administration of the mortgage(s), which enables a hands-free investment experience.
CMI Financial Group makes private mortgage investing easier, by making both direct and pooled opportunities accessible and transparent with their CMI MIC Funds and CMI Mortgage Investments program. CMI has emerged as a frontrunner in the alternative lending and investment sector. Since 2015, it has provided over $2.5 billion in private mortgage funds to Canadians, helping borrowers who fall outside the parameters of traditional lending and enabling investors to benefit from real estate-backed mortgage opportunities.
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