You Should Invest in Commercial Real Estate

A building is not valued on its brick and mortar but its cash flow. It is the subtlety in commercial real estate investing that “cash flow” and, ultimately, the net operating income of a property that is the hallmark of its value. Welcome to our investing in commercial real estate for beginners!

Key Points

  • The cornerstone of a commercial real estate investment is the cash that is generated by the commercial leases entered into by tenants with the landlord. 
  • Whether it be for office or retail space, it is the cash after expenses generated over the long term from commercial properties  that attracts the savvy investor. 
  • A building’s value is assessed by the size of its net operating income relative to other buildings in its geographic area.

So You’re Interested in Commercial Real Estate Investing? (Canada)

We’ve spoken before often about the need for diversification in one’s investment portfolio. Diversification attempts to mitigate investment risk by spreading one’s investment eggs in more than one basket. This helps grow your nest egg to help achieve your retirement goals. We’ve also spoken about how private market investment in real estate property can anchor anyone’s portfolio against the unpredictable headwinds of the public markets. We’ve often touted the benefits of private real estate investment, whether it be in residential properties, through private mortgages, REITs composed of commercial buildings, investment funds, etc.

The cornerstone of a commercial real estate investment is the cash that is generated by the commercial leases entered into by tenants with the landlord. Whether it be for office or retail space, it is the cash after expenses generated over the long term from commercial properties  that attracts the savvy investor. A building’s value is assessed by the size of its net operating income relative to other buildings in its geographic area.

Commercial real estate investing in Canada has many unique elements that investors should consider when readjusting their investment portfolios.

Different Ways of Investing in Commercial Real Estate (Canada)

Determining relative value is a function of what we refer to as the “cap rate.” The capitalization rate is used in the world of commercial real estate to indicate the rate of return that is expected to be generated on a real estate investment property. This measure is computed based on the net income which the property is expected to generate and is calculated by dividing net operating income by property asset value. It’s expressed as a percentage, i.e., the cap rate. It is used to estimate the investor’s potential return on their investment in the real estate market.  Established markets will determine cap rates for various market segments in various geographic locations at various times. It is a very fluid relative score of value. By mathematical operation, the lower the cap rate, the higher in value will be the cash flow and, in turn, the value of the property.

This is how we explain why a small coffee shop in Toronto’s Kensington Market is worth more than a vacant four storey building in Timmins, Ontario. There are lots of coffee shops in downtown Toronto. There is a regular market for folks buying and selling coffee shops. How much people are willing to spend to obtain a desired cash flow (and potentially a monthly cash flow) will be reflected ultimately in the sale price of the property. Therefore, if we divide the net operating income of a particular coffee shop by the purchase price, we arrive at the “cap rate.” When we do that repeatedly over numerous transactions in a given area, we will derive an approximate cap rate for coffee shops!

The lower the cap rate, the higher in value will be the cash flow and, in turn, the value of the property.

Let’s presume the cap rate for a coffee shop in downtown Toronto is 6%. This is actually a low cap rate suggesting that the coffee shop business is pretty lucrative. The coffee shop we want to buy is in a dilapidated house on a postage stamp size piece of real estate in a crowded corner of the market. It has an annual gross income of $300,000, less expenses (including property taxes) of 40% leaving us an annual net income of $180,000 per year. If we take the net income and divide it by the cap rate, the value of the property is $3,000,000! We don’t care what the house is worth; it’s the cash flow!

Our vacant four storey commercial building with thousands of feet of commercial space in Timmins, Ontario, has no income. Though the brick and mortar of the four storey commercial building may represent a million dollars of construction material, if it is not generating income, it’s worth is only the land and the salvage costs of the building.

Therefore, good commercial real estate investment is all about cash flow. And there are a variety of ways of getting into good commercial real estate. Real estate investment trusts (REITs) are the favourite way most Canadians invest in commercial real estate. Actually buying office space and letting it out on a “triple net lease” basis (i.e., the tenant is responsible for ALL costs of  the space) is one way a few individuals of high net worth enter the property market.

Good commercial real estate investing is all about cash flow.

Learning How to Invest in Commercial Real Estate the Smart Way

  1. Solid return over the long haul: Investors in commercial real estate typically receive steady cash flow for their investments, with income generally distributed annually, quarterly or even monthly. That’s because high occupancies and predictable rents often provide the steady cash flow that most investors are looking for. In North America over the last 25 years, average return in private real estate investment has hovered around 10% (National Council of Real Estate Investment Fiduciaries (NCREIF))
  2. No correlated asset: Private real estate investments do not correlate with the public markets. Performance is not linked to publicly traded stocks or bonds.
  3. Commercial real estate is a tangible asset: You can visit it, walk through it, run your hand over the walls. It’s real, and you own it.
  4. Leverage: Commercial real estate can be leveraged. The acquisition, in part, can be financed with mortgage debt, or, if the equity in the property is available, can be leveraged for other investments.
  5. Tax advantages: There might be unique tax advantages acquiring commercial real estate. If one has purchased well-located properties, those properties should go up in value over time. Yet, for tax purposes, one can depreciate the value of the buildings over time, which helps to reduce yearly taxable income. The net effect is that the investor is depreciating for tax purposes what should turn out to be an appreciating asset for investment. Not many asset classes provide this benefit.
  6. Inflation hedge: Commercial property investment is a common inflation hedge. As inflation forces prices rise, so do commercial leases as property rents can be repeatedly adjusted to with inflation. All other things being equal, the return on stocks and bonds will actually diminish in an inflationary environment.

Commercial real estate investment is not the type of investment for all real estate investors. We encourage people who want to learn more to pick up commercial real estate investing books and discover what the pros know. Anything that delivers a solid predictable return, is a non-correlated asset, is tangible, and has possible tax advantages is definitely worth a glance.

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Fundscraper Property Trust – The Village at Thunderbird Webinar

During this Covid-19 period, Phoenix has become the number one growth market in the US for appreciated home prices. During this webinar, we learned from Sud Group, leaders in the multifamily investment space, why they see the Arizona market as the current and future growth story of our time.

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Earn Cash Flow & Build Wealth Through Real Estate with District REIT

Passive income real estate is known as one of the best ways to gain an additional source of revenue, attain security in retirement, and ultimately design a roadmap to achieving financial freedom.

However, passive income real estate investing is not necessarily the right fit for every investor. Would you like to take a more active role in real estate investing or a relatively passive role?

Learn all about passive income real estate, and see whether or not it sounds like a good fit for your investing personality type.

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The New Mortgage Syndication Rules For Non Qualified Syndicated Mortgages

The Ontario Securities Commission (OSC) and the Financial Services Regulatory Authority (FSRA) recently released proposed changes to the new rules for mortgages. If you’re an existing mortgage syndicator promoting non-qualified syndicated mortgage (NQSM) investments, you’ll either think it’s very good news or very bad news. We’ll walk you through the proposed changes.

Key Points

  • The regulators have divided the market by class of subscribers. If your class of subscribers generally meet the definition of a Permitted Client then you’re in luck! It will actually be easier for you to carry on your business than it was before the material changes made to the regulations in July 2018 when the Form 3 disclosure was introduced.
  • Fundscraper is able to show syndicators how they can continue profitably in business and give them the comfort that between them and the regulator stands a seasoned platform that will shield them and provide protection for their investors. 

How is the NQSM market changing?

Section 31.1 of Regulation 188/08 has been deleted in its entirety and with it the burdensome disclosure regime that brought to a halt the NQSM market. There are no longer prescribed deliveries or mandated disclosures to Permitted Clients not individuals. Initial disclosure requirements are minimal. In other words: Permitted Clients can be trusted to take care of themselves.

Under this new regime, FSRA has made every effort to facilitate and make efficient capital market investment in the NQSM by Canada’s biggest stakeholders.

Who qualifies as a permitted client?

There are 18 categories of Permitted Client. The obvious ones are charter banks, trust companies, dealers, and the like. The three most commonly used categories in the retail market are:

  1. An individual who beneficially owns financial assets having an aggregate realizable value that, before taxes but net of any related liabilities, exceeds $5 million
  2. A person or company that is entirely owned by an individual(s) referred to in the above paragraph, who holds the beneficial ownership interest in the person or company directly
  3. A person or company, other than an individual or an investment fund, that has net assets of at least $25 million as shown on its most recently prepared financial statements

What are the pros of the NQSM market change?

The regulators have divided the market by class of subscribers. If your class of subscribers generally meet the definition of a Permitted Client then you’re in luck! It will actually be easier for you to carry on your business than it was before the material changes made to the regulations in July 2018 when the Form 3 disclosure was introduced. Additionally, there will be no need for additional registrations with the OSC as contemplated in earlier drafts of the proposed legislation.

What is the private capital market?

If you are not dealing with Permitted Clients or you are dealing with a mix of Permitted Clients and persons who are not, then you fall into the exempt market, aka the private capital market. The OSC will oversee all of your activities in connection with your investors and will require that you provide the same standard of care as it mandates for all dealers. FSRA will continue to oversee all of your activities related to your dealing in mortgages. So, like a dumbbell, the OSC will be at one end of your deal and the FSRA will be at the other!

What are the cons of the NQSM market change?

A big blow for many syndicators is the loss of the $60,000 investment limit. Under this exemption, anyone was permitted to invest up to $60,000 in a NQSM within a 12 month period. To capture those smaller investors, syndicators will now likely have to fall back on the offering memorandum exemption (and its supplement for mortgage syndication) to continue servicing these smaller investors. Under the new guidelines, investment limits are smaller and are subject to eligibility.

The syndicator will also have to be registered with the OSC in some capacity — and will be subject to the same standards of practice as all other security dealers subject to OSC oversight. They’ll likely be required to take the exempt market exam to demonstrate proficiency in exempt market placement, and will have to learn a new investing vocabulary.

Additionally, the syndicator will also now be reporting to the OSC. It is anticipated this may be a major irritant (and cost) for syndicators, though the OSC suggests that syndicators should be treated the same as all other issuers in the exempt market.

For more potential pain points, we outlined more major aggravations the new OSC rules might cause syndicators.

How can I work around the new rules?

Fundscraper is a mortgage syndicator’s solution. We’re registered with FSCO as a mortgage brokerage and with the OSC as an Exempt Market Dealer in the Province of Ontario (as well as British Columbia, Alberta, Quebec, New Brunswick and Prince Edward Island). We have spent the last three and half years perfecting our online compliance procedures with the full expectation of the changes happening today in the mortgage syndication market. We discovered that by creating an interactive online environment we can greatly reduce the costs of compliance while delivering best-in-practice solutions. Once we qualify investors, we apply computer generated algorithms to their investment decisions to assess suitability of investment and flag syndicated mortgage risks.

If you’re not thrilled about the new OSC rules, we can help.

Fundscraper is able to show syndicators how they can continue profitably in business and give them the comfort that between them and the regulator stands a seasoned platform that will shield them and provide protection for their investors. Having Fundscraper as a trusted ally helps put the mortgage syndicator back in business with far less administrative headaches. Contact us to get started today.

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Real Estate and Retirement Webinar

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Fundscraper Property Trust is an investment vehicle that allows Canadians to make equity investments into pooled mortgages. With a target return of 6-11% across our various pools, we harness the stable nature of real estate while providing the type of built-in diversification you would receive from a mutual fund, creating what we hope is an overall safer and simplified way to invest in real estate.

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Mortgage Investment Corporations for Mortgage Brokers and Agents

Mortgage investment corporations (MICs) have been around since 1973. MICs are a terrific vehicle for bringing like-minded investors together to collectively invest in one of Canada’s hottest investment products: mortgages!

Purchasing a mortgage is too expensive for many investors and may overly concentrate their investment portfolio in one asset class. MICs, however, mitigate those risks and add diversification. By bringing together several investors under one roof, the MIC can invest in more than one mortgage, distributing the risk among the members. The MIC can also distribute returns to its investors without making any withholding.

Any broker or agent seeking to create a MIC should seek advice and direction of a qualified lawyer. We put together an overview of the issues to keep in mind as you seek to create a MIC and/or advise your client to invest in one.

Key Points

  • Purchasing a mortgage is too expensive for many investors and may overly concentrate their investment portfolio in one asset class. MICs, however, mitigate those risks and add diversification. 
  • The Tax Act also deems a mortgage investment corporation to be a public company. The benefit of being deemed a public corporation is that the shares of a public corporation are qualified investments for registered plans, including registered retirement savings plans, registered retirement income funds, and tax-free savings accounts.
  • Every prospective investor should receive a suitability assessment, regardless of who they are or how much capital they have to invest.

Promoter (n): the person who organizes the MIC and promotes it to investors.

 

How to establish a MIC

The first step is creating a corporation, which you or your lawyer can do online with an approved service provider. After the company is incorporated, you will have to “organize” it by appointing directors and officers, establishing a registered head office, and putting in place a by-law.

In order to be considered a MIC under the Tax Act, it must have the following attributes:

  1. It must be a Canadian company
  2. It can only invest the funds of the corporation in mortgages that are secured against real property situated in Canada
  3. It cannot manage or develop property
  4. There must be at least 20 shareholders, with no one shareholder owning more than 25% of the issued shares of any class of sharers of the corporation
  5. At least half of the property of the corporation must be in cash, deposits, and mortgages secured on houses or on property included within a housing project
  6. Debt is within the limits set out in the Income Tax Act

What makes a MIC special is the treatment it receives under the Tax Act.

The Tax Act also deems a mortgage investment corporation to be a public company. The benefit of being deemed a public corporation is that the shares of a public corporation are qualified investments for registered plans, including registered retirement savings plans, registered retirement income funds, and tax-free savings accounts.

If the MIC fails to qualify in any one aspect above, it risks losing its tax status as a MIC and its shares will no longer be considered qualified investments. It will have to impose withholding, and shareholders will not be happy.

MICs are not publicly traded companies, so they can only raise money in the private investment markets under rules that govern raising private capital.

Who can invest in a MIC?

In Ontario, there are very strict rules about soliciting people to invest in a venture, including MICs. Raising money in the private markets is much less expensive than in the public markets, as one does not need to prepare and file an offering document (i.e., a prospectus) with the Ontario Securities Commission (the OSC). The most common way that a company organizes and brings in early investors is via the private issuer exemption.

To use the private issuer exemption, the following elements must be in place:

  • There must be a provision in the articles of the corporation (or an agreement among shareholders) that a shareholder cannot trade their shares without consent of the board.
  • There cannot be more than 50 shareholders, not including employees of the corporation.
  • Those 50 shareholders must have a pre-existing relationship with the Corporation, including: an employee of the Corporation, an accredited investor, or a spouse, family member, close personal friend, or business associate of a founder.

Once the corporation passes the 50 shareholder threshold, the corporation is subject to various reporting obligations related to raising capital. It is necessary that the corporation seek appropriate legal advice at this stage.

A mortgage broker or agent cannot invite just anyone to invest in their MIC; investors may only be from a select group and not members of the general public.

What is an accredited investor?

Many promoters of MICs will only allow accredited investors to be investors. An accredited investor is an investor with pre-existing wealth and/or substantial income who has the financial freedom to invest in whatever they please. Because of their financial situation, regulatory authorities don’t think they need the same protections as other investors.

Important considerations for investing in MICs

The Private Issuer Exemption requires the issuer/promoter to assess whether the investment is suitable for the prospective investor regardless of who the investor might be. However, the most common deficiency cited by the OSC when auditing the use of the exemption is the absence of such a suitability assessment. Without it, it’s difficult to determine whether the investment is appropriate for the investor.

It’s not surprising that issues/promoters have been found guilty under securities law for not (i) adequately performing their due diligence obligations and (ii) retaining the services of a registered dealer when selling their security. To avoid conflict (and hefty fines), the issuer/promoter should retain the services of a registered independent securities dealer to facilitate subscriptions in the MIC.

Every prospective investor should receive a suitability assessment, regardless of who they are or how much capital they have to invest.

Lending and the Mortgages Act

In the Province of Ontario, everyone who wishes to be a lender must be registered under the Mortgages Act unless they are otherwise exempt or have employed the services of a registrant under the Mortgages Act to perform those services for them.

MICs are not required to be registered under the Mortgages Act. MICs generally take advantage of a provision under the regulation to the Mortgage Act that provides a person or entity is exempted from having to have a brokerage license if the person or entity carries on business as a mortgage lender solely through a mortgage brokerage or a person or entity that is exempt from the requirement to have a brokerage license.

Working with MICs can be very good for everyone involved: the broker, the investor, the lender, and the borrower. For the mortgage broker or agent, it is imperative that the rules be followed carefully.

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Ensure your compliance is current and up-to-date with the latest regulations. Our experts help companies ensure compliance, improve performance and more.

Mortgage Syndication – What’s Going On?

Ontario has seen a lot of mortgage regulation changes in recent years. In 2018, the Canadian Securities Administrators (CSA) released a series of proposed changes that would see the OSC assume responsibility for the oversight of mortgage syndication in the Province of Ontario. Mortgage syndicators are waiting with bated breath to see what finally comes from the recent interventions of two competing regulatory bodies into their market. We’ll walk you through the latest developments.

Key Points

  • Previously, the regulatory environment was relatively light. Now, the first major proposed change is that mortgage syndications are no longer exempt from the Securities Act (Ontario). The mortgage syndicator will now only be able to choose between distributing the syndicated product in the (i) public markets pursuant to a prospectus filed and reviewed by the regulatory authorities (highly unlikely given costs) or (ii) private markets under the rules governing private placements.
  • The new rules are thought not to come into force until late in the Spring of 2019, if not early summer. It is further anticipated that the mortgage brokerage community will be given an extra year to comply.

Who are the mortgage syndicators and what do they do?

Mortgage syndicators are syndicated mortgage brokers who are regulated by FSCO. In Ontario, only syndicated mortgage brokers (and their agents) are allowed to deal in or advise upon mortgages. Given the proximity to the market, syndicated mortgage brokers are the natural syndicators. The job of the mortgage syndicator is to initiate, promote and organise the syndicate.

A syndicate, by definition, is a self-organised group of people. A syndicated mortgage is a mortgage where there are two or more persons acting as lenders. The lenders have a direct beneficial interest in the underlying mortgage.

It’s attractive to be part of a syndicate as the investor (who now becomes a lender) is sharing the risk of being repaid by the borrower with other investors/lenders of like mind.

What are the new mortgage syndication rules?

Previously, the regulatory environment was relatively light. Now, the first major proposed change is that mortgage syndications are no longer exempt from the Securities Act (Ontario). The mortgage syndicator will now only be able to choose between distributing the syndicated product in the (i) public markets pursuant to a prospectus filed and reviewed by the regulatory authorities (highly unlikely given costs) or (ii) private markets under the rules governing private placements.

Mortgage syndicators will likely do the latter, yet it won’t be without its challenges. It is expected that the OSC will impose a registration requirement that will require mortgage brokers to successfully complete some series of courses that will eventually evidence their competence to solicit and sell in the exempt market.

Mortgage Syndication

Why did the mortgage syndication rules change?

First, it was to harmonize the rules of mortgage syndication across the country. In Ontario mortgages are currently exempt from securities law and the oversight of the OSC. Once the changes are adopted, there will no longer be exemptions from securities law anywhere across Canada and the placement of mortgage security would have to comply with the rules governing the private and public investment markets.

Second, at the time the amendments were announced, the mortgage syndication market was in turmoil, leaving many inexperienced investors exposed to questionable deal offerings made into the market by overly aggressive promoters.

The new rules are thought not to come into force until late in the Spring of 2019, if not early summer. It is further anticipated that the mortgage brokerage community will be given an extra year to comply.

CSA changes vs FSCO changes

Within a month of the CSA announcing its changes, FSCO released its intent to overhaul the rules governing mortgage syndication. Rather haphazardly, FSCO unleashed a web of policies and procedures. Where the OSC thinks it may take a year or two to bring the mortgage brokerage community into line, FSCO thought a few months adequate.

Instead of adopting the seasoned approach of the CSA, FSCO created a one-size-fits-all solution from which no market participant is exempt. The ensuing confusion and the abrupt cessation of market activity was not surprising. The new rules were described at the time of their introduction as transitional, yet as at the date mentioned above, no one knows how long transition is going to be or to what degree the regulators are cooperating.

The new mortgage syndication rules became effective July 1, 2018 — the same day many syndicators governed by FSCO gave up business.

Mortgage syndicators have a choice: embrace the changes imposed by FSCO now, or wait and see what the OSC will require?

Mortgage syndicators are stuck between a rock and a hard place. Embracing the FSCO regulatory regime today will involve significant cost and client interruption. (Further, there’s no guarantee that once the OSC publishes its rules, the syndicator will not have to go back and revisit all of the work they just put in place.) However, if the syndicator chooses to wait it out, he or she will likely lose business. What’s the answer?

What should mortgage syndicators do now?

There’s a way to circumvent FSCO’S transitional rules: Retain a private market intermediary to carry out mortgage participation transactions that comply with the Securities Act (Ontario) instead of the Mortgages, Brokerages, Lenders and Administrators Act (Ontario).

In Ontario, private market intermediaries are referred to as exempt market dealers (EMDs). EMDs are fully registered securities dealers who engage in the business of trading in prospectus exempt securities (which soon will include syndicated mortgages), or any securities to qualified exempt market clients.

Whereas a syndicate is a self-organized group, an EMD will represent a group organized by a third party. In the area of mortgages, it is common to organize groups under mortgage investment corporations (MICs), mortgage trusts (Trusts), or limited partnerships (LPs) whose sole business is investing in mortgages. In any of these examples, the EMD is not selling syndicated interests of mortgages, but rather shares in a MIC, units in a trust or limited partnership interests in a limited partnership.

The mortgage syndicator can continue advising on mortgages, but the EMD is responsible for qualifying the investors and providing the independent investment advice that marks best practice for the OSC.

How Fundscraper can help

Fundscraper is registered with FSCO as a mortgage brokerage and with the OSC as an EMD in the Province of Ontario as well as British Columbia, Alberta, Quebec and Prince Edward Island. We have spent the last two and a half years perfecting our online compliance procedures with the full expectation of the changes happening today in the mortgage syndication market. We discovered that by creating an interactive online environment we can greatly reduce the costs of compliance while delivering best-in-practice solutions. Once we qualify investors, we apply computer-generated algorithms to their investment decisions to assess suitability of investment and flag common investment risks. A qualified investor can begin our process and complete a subscription within twenty minutes from the comfort of their own home.

At Fundscraper, we also enhance distribution by making available, if a client so chooses, a product offering to a much larger educated audience than the client would have access to alone. Fundscraper is able to show syndicators how they can continue profitably in business and give them the comfort that between them and the regulator stands a seasoned platform that will shield them and provide protection for their investors. Having Fundscraper as a trusted partner puts the mortgage syndicator back in business.

Eliminate Compliance Issues

Ensure your compliance is current and up-to-date with the latest regulations. Our experts help companies ensure compliance, improve performance and more.

How Real Estate Investments Earn Money

Investing in real estate is one of the smartest moves you can make, no matter what age or stage of life you are in.

Real estate investments can add diversification to your portfolio – and getting into the market can be as easy as buying a mutual fund.

If you’ve ever had a landlord, you probably don’t dream of being one: Fielding calls about oversize bugs and overflowing toilets doesn’t seem like the most glamorous job.
But done right, real estate investing can be lucrative, if not flashy. It can help diversify your existing investment portfolio and be an additional income stream. And many of the best real estate investments don’t require showing up at a tenant’s every beck and call.

In this article, we take a look at how real estate investments on our marketplace earn money.

Key Points

  • Real estate investments break down into two broad categories: debt and equity.
  • The main ways to make money are from asset appreciation and dividends from rents/interest payments.
  • There are several ways to invest in real estate equity investments, including direct investment, mutual funds, REITs, and investment platforms.

Debt vs. Equity

Real estate investments break down into two broad categories: debt and equity. Let’s first look at the differences between these two types of investments to begin to understand how returns are structured in the form of income or appreciation.

DebtEquity

Under a real estate loan, an investor lends money to a borrower (typically a buyer or real estate developer). 

The investor earns income for the duration of the loan usually at a fixed rate following a schedule of regular interest payments on the loan principal. 

A debt investment is typically less risky than an equity investment, but there are several factors that impact how risky each individual investment can be, as discussed below.

See Example Debt Opportunity Listing

An equity investment gives an investor ownership of a physical property. An equity investment entitles the investor to a claim on money earned from any appreciation earned by the asset when it’s sold. 

Appreciation returns are usually realized in a one-time payment, in the form of capital gains. An equity investment also gives an investor the ability to earn regular income from rental payments for the lifetime of the investment typically on a monthly basis. While equity investments enable investors to earn both income and appreciation, they’re often riskier than debt investments as we discuss below.

The main ways to make money are from asset appreciation and dividends from rents/interest payments.

How Real Estate Investments Earn Income

Is your primary investment objective Current Income? Both debt and equity investments can earn you consistent income. Let’s take a look at how.

Loan Interest Payments

A real estate loan investment is an arrangement in which an investor lends money to a buyer or developer who then pays interest on the principal lent. An investor earns a return in the form of income from the interest payment while the loan is repaid. Payments are often made on a monthly basis making them an appealing investment option for those seeking “passive” or “residual” income.

Debt investments can only earn income, but they offer the advantage of lower risk than equity investments do thanks to their senior position within the capital stack. This means debt investors receive their principal plus interest before an equity investor can realize any returns (apart from rental income potential).

Within the debt tranche of the capital stack, there’s a further division of seniority among the types of debt which determines loan repayment priority. Senior debt is unsurprisingly the most senior and therefore has the highest repayment priority. It’s followed by junior debt and mezzanine debt, and then the equity portion of the capital stack.

In addition to seniority, debt real estate investments can be secured or unsecured. An investor with a secured debt investment has the right to foreclose on a property in the event of loan default to recoup the value of their loan. Senior debt investments are typically secured positions, and other debt investments may be secured, but the terms can vary by investment.

Rental Payments

Equity investments can also generate their own income stream using rental payments. Traditional, or common, equity ownership gives investors the right to lease the property to tenants to earn income through rental payments.

Unlike a debt investment, which generally has a fixed rate of return over a defined lifetime, an equity investment generates rental income that can change over time, growing or shrinking in relation to market demand. Income potential is also based on occupancy rates, which can also vary for any given property. This means that equity investors may incur more risk to earn income, but they also have the potential to earn a higher rate of return.

Also, common equity investments don’t usually have pre-defined periods of ownership and can last indefinitely, giving an investor the ability to earn income until the property is sold. Real estate is a long-term investment, especially for equity investments, which gives investors the ability to earn significant income over time on a monthly basis.

Common equity ownership offers rental income potential, while preferred equity investments offer cash flow in a way that’s more similar to debt investments. Like a loan interest payment, preferred equity investments offer a fixed rate of return commonly referred to as “preferred return.” Due to its middle position in the capital stack, preferred equity investments receive payments until they’ve reached the agreed rate of preferred return after all debt investments have been repaid and before common equity investors receive their return.

How Real Estate Investments Earn Appreciation

There are several ways to invest in real estate equity investments, including direct investment, mutual funds, REITs, and investment platforms. The investment vehicle used to invest in an equity investment impacts how an investor receives their return as well as how and when it is taxed.

For example, an investor with a direct investment can collect their capital gains directly from the sale of an investment. On the other hand, an investor with an investment through a fund may realize appreciation from the sale of a property through a fund distribution or through an increase in the value of the shares that they own. Each option brings its own advantages and disadvantages, which can make each option more or less preferable for an investor, depending on their financial goals and resources.

Regardless of how you invest in real estate, at some point, a rigorous underwriting process, which evaluates the aspects of a potential investment property, is key. If you’re investing independently, the onus for that underwriting process will fall on your shoulders, whereas, if you’re investing through a fund or platform like Fundscraper, a team of experienced real estate professionals will handle the evaluation on your behalf.

No matter who performs the underwriting, this due diligence process plays a vital role in determining whether an investment opportunity is financially sound.

Evaluating Your Options

Common equity investments are easier to access than debt investments. Individual investors can buy an investment property and manage it on their own. However, due to the high sums of money, knowledge, and time commitment required for direct investment, individual investors are often limited in the number and types of properties that they can buy — and manage — on their own.

As with debt investments, pooled-fund investment options, such as mutual funds, REITs, and investment platforms, offer a way to invest small sums of money across several assets and asset types. Private equity funds are also available to accredited investors. While it’s more feasible for an individual investor to invest in a single-family home or duplex, a fund can give an investor access to investments across a wide range of commercial real estate in multiple locations at a fraction of the dollar investment size.

For instance, with Fundscraper, you can invest in opportunities with a target diversification level that matches your goals containing a mixture of assets across different geographies.

Fundscraper allows investors with small amounts of capital to get in on private real estate deals. Whether you are looking for cash flow now or let your money sit and grow over the long term, Fundscraper offers a wide range of opportunities including Real Estate Investment Trusts, Private Equity, Mortgage Investment Corporations and Mutual Fund Trusts with shorter and longer term horizons.

We welcome you to create a free profile and browse our marketplace. If you’d like to discuss your financial goals and your options with one of our licensed dealing representatives, fill out this short questionnaire and book your call today.

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Should I Register as a Dealer To Talk About My Product?

Asset managers of private mortgage investment entities often pose the following question: “Do I need to be registered with the securities regulatory authorities to openly discuss my product offering?” It depends: Are you advertising, or are you advising? An issuer can certainly tell the world what it has to offer; advertising by itself is okay. But it’s important to exercise caution.

Key Points

  • The regulator’s primary concern is advertising or promotion that is (i) unbalanced and misleading, (ii) selective and/or (iii) misuses of future oriented information. Any advertising that misrepresents and manipulates information
  • An “adviser” is defined by the Securities Act (Ontario) to mean a person or company engaging in or holding himself, herself or itself out as engaging in the business of advising others as to the investing in or the buying or selling of securities.
  • The issuer who elects to be a dealer, either through registration or by way of an ICDR, increases its regulatory liability. Retaining an independent securities dealer will always be the better practice and, in many instances, likely cheaper.

Advertising and advising are not the same thing.

Why are regulators concerned about advertising?

The regulator’s primary concern is advertising or promotion that is (i) unbalanced and misleading, (ii) selective and/or (iii) misuses of future oriented information. Any advertising that misrepresents and manipulates information — such as exaggerated and unsubstantiated performance claims or unrealistic hypothetical performance scenarios — raises red flags.

Regulators are also concerned if the issuer is acting in the capacity of an “advisor” to persons to whom they are advertising their wares. Depending on what exemptions are relied upon, only certain people can participate in certain transactions. For this reason, private issuers have to be very careful to whom they sell their security. Complicating the matter more, simply because someone is able to purchase the exempt security, does not mean it is suitable for that person. Thus, advisors must first determine if a proposed purchaser is qualified, then whether the investment is suitable for them.

What is advising?

An “adviser” is defined by the Securities Act (Ontario) to mean a person or company engaging in or holding himself, herself or itself out as engaging in the business of advising others as to the investing in or the buying or selling of securities.

Whether or not a firm or individual ought to register, the regulator will look for certain “triggers” for registration. The list is non-exhaustive, but includes the following:

  1. The firm or individual holding itself out as being in the business of buying and selling or advising on the buy and sell of securities
  2. The firm or individual acting as an intermediary – a broker – between the issuer and the buyer/seller
  3. The firm or individual regularly trading or advising in any way that produces profits to be for a business purpose
  4. The firm or individual receiving any form of compensation for carrying on the activity
  5. The firm or individual contacting anyone to solicit securities transactions or to offer advice may reflect a business purpose

Anyone found to be in the business of advising must be registered with the regulatory authorities. In Ontario, that’s the Ontario Securities Commission.

What is solicitation?

The word “solicitation” is used in two ways. In the most general usage, “solicitation” means making potential purchasers aware of a given product. There is no law prohibiting an asset manager from boasting about their product (provided the boast is truthful) or contrasting their investment product to others in the marketplace (provided it’s not misleading).

Solicitation becomes a trigger when it evolves from product promotion to subscriber conversion. When the promoter engages a person with the goal of having that person subscribe for units, then the promoter is dealing in securities.

There is a clear distinction between advertising and advising or product promotion and subscriber conversion.

How can I ethically convert subscribers?

These considerations aren’t meant to deter you from converting subscribers! We want to make sure you understand how to go about it ethically. When it comes to subscriber conversion, asset managers have three options: (i) hire a registered dealer, (ii) apply to become a registered dealer themselves, and (iii) have a “connected” dealing representative (generally an employee of the asset manager who is qualified to be a dealing representative) sit on the desk of a securities dealer and process only those trades of the asset manager.

Hiring a registered dealer vs becoming a registered dealer

The purpose of hiring a registered dealer is to offload the regulatory burden (and the concurrent liability) that attaches to solicitation for trading. The scope of the retainer will be determined by the services required . Many managers simply require a dealer to process subscribers. The retainer may be broader, including soliciting new clients, providing services, and curing prior deficiencies.

The dealer has two jobs: confirm the proposed subscriber is actually qualified to participate in the exempt market and assess whether the investment is suitable for the proposed subscriber. It is with respect to suitability assessment that most issuers fail in the eyes of the regulator. As conflict is so apparent, the presumption is that it cannot be done in a properly disinterested fashion.

Issuers may also seek to become registered with the regulatory authority to advise on security. It requires a terrific amount of work, time, and money. There are a lot of hoops to jump through, and once everything is in hand and the requisite documents are filed, it may take anywhere from four to eight months to be issued a license.

Advertising crosses the line into advising when the focus shifts from general product promotion to individual subscriber conversion.

Working with a connected dealer representative

In the last couple of years, the regulatory authorities have begun to permit issuer-connected dealer representatives (ICDRs). An ICDR is a dealing representative who is connected with one issuer only and registered with a registrant. Generally, an ICDR is an employee of the issuer who has taken and passed the courses necessary to be a dealing representative.

At the end of day, the issuer ends up with the worst of both worlds: it is now paying a dealer a “desk fee” (in the place of commissions, etc.) and still risks the possibility of being shut down if their own ICDR makes a mistake.

The issuer who elects to be a dealer, either through registration or by way of an ICDR, increases its regulatory liability. Retaining an independent securities dealer will always be the better practice and, in many instances, likely cheaper.

It’s perfectly legal for a private issuer to advertise its wares. The ordinary rules governing advertising also apply in the securities industry: be truthful, do not mislead. There’s a fine line between product promotion and subscriber conversion, and there’s nothing wrong with seeking advice from the pros. An independent exempt market securities dealer like Fundscraper can help you develop and deploy effective marketing campaigns to attract qualified subscribers.

How Much Money Do I Need to Retire? Learn How Real Estate Can Help You Achieve Your Goals

Planning for retirement is a life-long process. Whether you’re 30 and just starting to climb the corporate ladder or you’re 80 looking to ensure you have the monthly income you require, you should be thinking about and planning for retirement. It’s never too early — or too late! — to save for retirement. Talking about money can be daunting, but we’re here to help.

Most people understand the importance of saving early, but many struggle with this question: How much money do I need to retire? Many factors determine how much money to save for retirement, which is why we recommend you speak to a licensed financial advisor to discuss your options. To get you started, here are a few things to keep in mind.

Key Points

  • The 25x rule shouldn’t be the only tool in your financial toolkit, but it might give someone who has yet to start saving a ballpark figure to aim for if they intend to retire around age 65.
  • There’s another major benefit to holding your retirement savings in a registered account that more investors should know about: You can use your registered funds to invest in real estate.
  • Having asset-backed investments like real estate provides greater security and lower risk to your portfolio.

How much you should be saving goes directly to how much you think you will need to live on each year that you are not earning an income.

How much should I be saving now?

There’s no cut-and-dried answer to this question, but you can make an educated estimate. The 25x rule invites you to calculate how much you think you’ll need in a given year in retirement, then multiply that number by 25. The 25x rule shouldn’t be the only tool in your financial toolkit, but it might give someone who has yet to start saving a ballpark figure to aim for if they intend to retire around age 65.

(Expected Annual Retirement Expenditures) x 25 = Required Savings Amount

How much should I withdraw from my retirement funds when I retire?

Financial advisor Bill Bengen created the 4% rule in 1994. It recommends an individual withdraw 4% in year one of retirement and adjust the fraction in subsequent annual withdrawals to reflect the rate of inflation. Due to lower inflation, he recently revised his recommendation to the 5% rule. Lower inflation means investors can “safely” pull out more than the 4% rule. That’s good news for investors seeking passive income. (Source: The Creator of the 4% Rule for Passive Income Just Changed it!)

The Modern Day Playbook For Super Successful Investing

How can a smart, modern investor get in on the real estate investing action, especially since going on your own may require prohibitive amounts of capital? Most people do not have the requisite knowledge or expertise to invest in real estate on their own.

How can I save early and wisely?

The vast majority of Canadians use their RRSPs (Registered Retirement Savings Plans) to make contributions to their retirement savings, whether in an individual or spousal plan. RRSPs have many advantageous qualities for individuals planning their retirement, including:

  1. Contributions are tax-deductible – “RRSP Season” as we like to call it runs for the first 60 days of the year, just before “Tax Season.” During this time, you can make RRSP contributions with pre-tax dollars, allowing you to deduct RRSP contributions from your income each year. This provides immediate tax relief in any given year.
  2. Earnings are taxed sheltered – If you use your RRSP to invest, any earnings made are sheltered from taxation as long as they remain in the plan.
  3. Tax deferral – RRSP contributions and earnings will be taxed when you withdraw them. However, it is likely that upon withdrawal, your marginal tax rate will be lower than when you initially made the contributions.

There’s another major benefit to holding your retirement savings in a registered account that more investors should know about: You can use your registered funds to invest in real estate.

It’s important not to pigeonhole yourself into only investing in a handful of assets such as publicly-traded equities and bonds. This is where real estate can come into play! Many Canadians tend to focus their attention (and RRSP contributions) on a small handful of asset classes and are unaware that RRSPs can also be used to invest in:

  • Canadian mortgages
  • Mortgage-backed securities
  • Income trusts

Having asset-backed investments like real estate provides greater security and lower risk to your portfolio.

Fundscraper has numerous real estate backed offerings that are eligible for investment with your registered capital (RRSP, RRIF, TFSA, etc.), helping you contribute to your retirement savings.

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