There are dozens of different ways you can make your fortune in real estate, including real estate lending. Mortgage investment corporations (MICs) lend money to companies and individuals in Canada, often for a shorter term and a higher interest rate than banks offer on traditional mortgages.
Table of Contents - Are Mortgage Investment Corporations a Safe Investment?
When it comes to passive investments, MICs offer the opportunity to make money quickly—but the high potential reward doesn’t come without some risk. The key is to identify and manage that risk, so you’re poised for the best results possible.
How a Mortgage Investment Corporation (MIC) works
MICs lend money to people in exchange for collateral—often real estate that they already own or the one they’re purchasing. The MIC investigates the property, ensures everything is in order and places a lien against the property. The lending period tends to be a shorter one, ranging from several months to ten years, and have higher interest rates to make up for it.
MICs make money by charging those higher interest rates, as well as higher fees. In the event that a borrower defaults on their loan, they take over the collateral and sell it to recoup their loss. Investors, on the other hand, passively pool their money with the MIC. This offers significantly less day-to-day involvement than if you were to purchase individual mortgages.
Typically, a MIC lends no more than 80 percent of the collateral’s value, which makes it financially worthwhile in the event a borrower defaults. The higher the loan-to-value ratio, the riskier the investment is.
Since they’re a corporation, they don’t need to pay income tax under Canadian law. The net earnings (and income taxes) are passed on to individual investors—the Income Tax Act prevents the corporations from retaining any of their earnings, even to reinvest in their own business.
What makes MICs so appealing
It’s easy to see where the major appeal of MICs lies: the high-interest rates. Whereas banks offer mortgages at lower rates—usually under five percent—MICs require higher rates on shorter timetables. Most MIC interest rates hover around the seven to 10 percent mark but can be higher. Ideally, your money will grow without your involvement, and the returns are higher than you’d get purchasing individual mortgages.
Another benefit of MICs is the passive investment factor. Many people don’t have the time and inclination to actively invest in real estate or real estate lending. It requires a lot of financial and market knowledge, day-to-day involvement and higher financial risk. If you want to get into real estate lending while pursuing other opportunities, MICs offer a unique opportunity to make more money with less effort.
Understand the risks before you invest
But are MICs a safe investment? It depends. As with any investment, you’ll need to weigh the risks versus rewards, and only invest what you can afford to lose should the worst happen. Here are some of the risks involved when you work with a MIC.
Borrower credit quality. MICs primarily lend to people who cannot get bank financing—otherwise, they’d likely opt for lower fees and interest rates. MICs are good options to bridge gaps in funding, but that doesn’t make them foolproof. This raises questions about the quality of the borrowers and whether they’ll truly be able to make good on their commitment. While most MICs cap their lending at a percentage of the collateral, there are other ways it can go wrong.
High housing prices. Right now, Canadian housing prices are at a high, and experts have predicted they’ll continue to grow. However, if the bubble bursts and real estate prices drop, the MIC may not be able to recoup the default amount by selling the collateral property. In times of economic uncertainty, MICs may not be a safe investment.
Liquidity mismatches. What happens if a large number of a MIC’s investors want to cash out at the same time? This is referred to as a “liquidity mismatch,” and in the worst-case scenario, the MIC won’t be able to pay everyone at once. Your money may not be available when you need it, especially if any of the other factors on this list come into play.
Refusal to recognize underperforming investments. Sometimes the MIC is mismanaged. Owners may refuse to recognize underperforming investments, which could affect whether your money is available when you want to cash out.
Possibility of fraud. Finally, there’s always a possibility of fraud. Those who remember the 2008 United States mortgage crisis know exactly what happens when lenders give money to people without income, or otherwise cannot afford to pay their loan back.
Not every MIC is created equally, and there are plenty of reputable lenders to work with. However, understanding the risks is crucial when you’re putting up your own hard-earned capital.
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How to find the right MIC
The key to a safe investment is finding a well-managed MIC. No investment is ever 100 percent safe, but you’re more likely to keep your money—and make even more—by finding the right MIC. Look for a corporation that has a reliable borrower vetting process, and a long history of making good decisions on behalf of their shareholders.
When you’re researching and interviewing MICs, ask what their loan-to-value ratio is, and whether they offer second and third mortgages. The more mortgages a property has, the more likely it is that another mortgage company will get paid first—leaving little to no money for the MIC to recoup. You should also inquire about whether the shareholders get voting rights; if the MIC mismanages your investment, you’ll have little recourse without them.
The bottom line
The safety of a MIC investment depends on several factors, including the housing market at large. When you’re considering sinking money into passive investments, don’t let the promise of “easy money” blind you to potential risks. Use this list of risks—and rewards—to find the best company for your needs.
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