When individuals need a mortgage, they usually go to their bank and select the best option offered. More savvy buyers will shop around and visit multiple banks and other institutions. However, not everyone qualifies for a loan under the guidelines that these lenders must follow. The Mortgage Investment Corporation (MIC) is an answer to that, an alternative, in the sub-prime market.
Canadian ingenuity developed the MIC in 1973 to meet the growing demand for home financing options. They became prominent during the early 1980’s as the population grew. And yet, many investors today remain oblivious to a product that can offer attractive returns.
A MIC is a legal entity that gathers capital from individuals and issues them shares. It then lends the money raised in the form of mortgages and collects payments (principal, interest, and fees) on them periodically. Earnings are then given back to investors in the form of dividends.
There are several rules that MICs must follow according to the Income Tax Act. For example, a MIC must hold a minimum of 50% of its assets in residential mortgages and/or cash equivalents. It cannot operate construction or land development projects. It can, however, lend to developers with certain restrictions.
MICs available only to qualified investors
The Mortgage Investment Corporation does not pay income taxes. It distributes 100% of net gains to shareholders (as dividends), who are then taxed at the individual level. This is a similar structure to that of REITs since both are designed to avoid double taxation.
MICs are exempt market products. Only qualified investors can invest. They are attractive for those seeking superior returns for several reasons. Individuals can participate in real estate lending without taking on all the risk. Professionals take care of the complex mortgage administration. A key feature is their relative safety since the loans they grant are secured by physical assets. Plus they provide a regular stream of income.
Watch out for the risks
There are also specific risks. MICs provide residential mortgages to many borrowers who are turned down by prime lenders. This increases payment default risk, which the MIC mitigates by charging a higher interest rate. As a result, MICs are very sensitive to real estate market conditions. Mortgage rates are historically low today, which has an impact on returns.
These investments have low liquidity as they have no active secondary market. A challenge for MICs is the need to constantly find borrowers. That’s because the residential mortgages they provide are usually short-term (commonly 12 to 18 months).
There are other factors to keep in mind. One is that investors have no control over the lending process. They contribute capital before any mortgages are approved. So the trust factor is big. Is management operating wisely?
And who knows what impact the pandemic will have on the market? What happens if the economic crisis caused by the COVID-19 leads to a decline in property values? The collaterals might fail to protect investors from payment evasion and its consequences. Remember, the 2008 financial crisis was started by a cascade of defaults in the sub-prime mortgage market.
Investors considering participation in a Mortgage Investment Corporation should perform some due diligence. Are the managers also investors? Make sure they have some “skin in the game”. This aligns everyone’s interests and the risks are shared. It is better to choose a MIC with a track record of investing in a high-quality portfolio and steady dividend payments. Transparency means periodical reports and audited financial statements. It is important to make sure that both the property appraisal services, and the board of directors, are independent.
“Skin in the game”
MICs are a well-established wealth management vehicle for investors. Time spent in research will pay off. Choosing the right one is essential to improve a portfolio’s returns while avoiding the major pitfalls. As with all alternative investments, MICs should be part of a broader strategy.
(An investor needs to be qualified before buying alternatives like MICs through a broker. Either proof of net income or net assets are needed. The broker will gather the supporting documents and then execute the transaction.)
Legal Disclaimer: The contents of this article are for information purposes only and are not intended to provide any form of financial or investment advice.
Top image: Current Sotheby’s International Realty listing, Caledon, Ontario, @canada_sir