There are two types of syndicated mortgages. You can invest in a MIC (Mortgage Investment Corporation) or you can be in a private syndicate of a small group of lenders. The Financial Services Commission of Ontario “FSCO” has identified these deals as high risk. These are the reasons why it’s risky. What’s the difference between these two types of syndicated mortgages?
THE MIC (Mortgage Investment Corporation)
If you invest with an incorporated mortgage investment trust, you will be a shareholder or unit holder. All of the risk evaluation and normal underwriting is done for you and the average return is approximately 7%. The MIC usually originates loans from mortgage brokers. And the brokers will charge the borrower a broker fee, the MIC will charge a lender fee and of course the contract rate is interest only. So the MIC will charge out a bit higher than the private market rates but fix the rate for the shareholders. That means that the MIC may be earning as high as 20% ROI but the MIC shareholder is earning 7%. And the shareholders should ask if the MIC management are shareholders and how much have they invested? If they have skin in the game they are likely to be more risk adverse when underwriting. Many MIC’s will invest strictly in residential mortgages or a 50/50 split with commercial loans. The MIC’s usually pay out dividends once a year.
STATEMENT FROM A MIC
Under Section 130.1 of the Income Tax Act, taxable dividends paid to shareholders (other than capital gains dividends) are taxed as interest income. As a Mortgage Investment Corporation, we do not pay any income taxes, provided that we distribute all of our taxable income each year (and meet certain other requirements). In effect, we flow interest income that we earn on our investments in mortgages through to our shareholders.
DEFAULT RISKS: So what if the MIC invests too aggressively or loses money? Any time a loan is in default and requires legal attention, someone has to get paid to fix that problem. Typically the borrower is charged for legal fees out of the net advance on closing and hopefully the underwriters have kept enough room in the loan to pay those costs. But if there isn’t enough equity to pay the lawyers, do the shareholders get charged? Yes because they are shareholders in the company.
Unlike MIC investors, private lenders have the benefit of the Investor Disclosure Form 1 and 2. MIC shareholders do not get the investor disclosure, which spells out all the risks. Risks like credit, outstanding income tax arrears, property tax arrears, loan to value, appraised value, income, etc. So as an investor your totally trusting the MIC to underwrite risk adverse. Shareholders are sold on MIC’s because they are told that it’s less risky when the money is broadly spread out over a pool of mortgages and if the MIC loses on one deal, they are covered on other deals because the money is spread out. That’s basically how the reasoning works out.
INVESTORS RISKS: The biggest risk is the underwriting. Your totally trusting the MIC to make decisions.
BORROWERS RISKS: It’s a bit easier to qualify for MIC mortgages but the borrower will definitely pay higher rates and fees for a MIC mortgage than the regular market prices. MIC’s have large funds and they need to loan so they can earn for the shareholders. So when you’re dealing with a MIC they might be more liberal at underwriting and eager to lend. But if you run into a problem you will have to deal with the MIC’s staff and you will not have a one to one relationship with your lender. A small builder needs more attention in the loan process and might not have the same attention with this lender because your broker (in most cases) is off the deal the minute it closes. So it’s not a one to one, borrower to lender deal.
THE PRIVATE LENDER SYNDICATE
This syndicate might consist of 1-10 lenders and the beauty of this is you’re in control of the risk. Each lender is registered on title. The group of lenders will read the commitment and approve it. You will receive Form 1 Investor Disclosure and Form 2 if required. You order and receive the appraisal, visit the property and receive the mortgage application and credit bureau. You know the borrower; you may even have a phone conversation with the borrower. You’re in control of the risk, the negotiations with the borrower and the mortgage broker. And you can enforce solutions. YOU EARN 100% RETURN ON INVESTMENT
My conclusion is I would much prefer to place my borrowers in a private one to one lender syndicate. Although I can place my loans with MIC’s and I know many of them, I prefer the one to one deals because it reduces risk. The MIC’s can be excellent to deal with and very professional. MICS will go to high loan to values in second position and will simply payout the first if there is a problem. So for second mortgages this is good. I would use this money in certain situations, but for construction financing this is not ideal for smaller builders. I like being involved in the deal till the very end. The MIC’s typically prefer to manage alone in their deals.