How to Generate Passive Income in Canada

Novice investors often tell us that real estate investing sounds too intimidating. When we explain how Fundscraper lets you invest as little as $5,000, they tell us it sounds too good to be true. It’s not—we promise! The truth is, real estate investing is a realistic, achievable way to expand your income sources and make passive income. We put together an overview of seven ways to get started. Which one sounds right for you?

Key Points

  • One of the most common methods of earning passive income is through the ownership of financial investments like real estate.
  • Mortgages are the most common and significant type of debt held by Canadians. Approximately 40% of Canadians have a mortgage.
  • Unlike REITs, where your investment is placed in physical properties, with a MIC, your investment is placed in property mortgages.

What is Passive Income (Canada)? 

Income can be divided into two main categories: Active and Passive. Active income is earned by exchanging services — including wages, taips, salaries, and business income — for money. Passive income is divided into two subcategories: real estate and portfolio income. Unlike active income, passive income requires little to no involvement in the generation of income and is typically earned on an ongoing basis.

What is Passive Investment Income (Canada)?

Passive investing is one of the most common strategies for increasing your income, growing your investment portfolio, and building a healthy nest egg for the future. We’ve compiled a list of ways real estate can help you generate passive income to achieve your investment goals.

One of the most common methods of earning passive income is through the ownership of financial investments like real estate.

How to Make Passive Income in Canada

Here are even some real estate passive income ideas (Canada) to get you started.

  1. Real Estate Investment Trusts (REITs)

REITs are one of the most popular real estate investment vehicles amongst Canadians. They’re trusts that passively hold interests in real property, with at least 75% of the trust’s revenue coming from rent or mortgage interest from Canadian properties, as well as capital gains from the sale of such properties. Modelled after mutual funds, REITs are the next closest thing to owning real estate and finance a wide variety of buildings, including many shopping malls, office buildings, and apartment complexes.

Unlike traditional mortgages, REITs offer broad diversification with both equity and debt investment opportunities. A downside to this investment opportunity is lack of transparency and control on your investment because investors cannot choose which real estate assets their investment goes into.

  1. Unit Trusts

By investing into a unit trust, your investments are handled by a fund manager who uses their expertise to invest your money into a portfolio of assets. At Fundscraper, this is our bread and butter, with the Fundscraper Property Trust (FPT) offering Canadians the opportunity to invest in pooled mortgages.

Pooled Mortgages consist of one or more mortgages that offer a similar return and loan-to-value ratio, meaning that you can invest in numerous mortgages that align with your risk appetite through one transaction.

 

  1. Mortgage Investment Corporations (MICs)

MICs offer investors an opportunity to pool their money and buy shares in their MICs. Since they invest directly in mortgages rather than property, MICs are less susceptible to the same unforeseen issues that may arise in physical properties. Additionally, a MIC may invest up to 25% of its assets directly in real estate, but may not develop land or engage in construction, and must have at least 20 shareholders. 

MICs offer investors an opportunity to pool their money and buy shares in their MICs. Since they invest directly in mortgages rather than property, MICs are less susceptible to the same unforeseen issues that may arise in physical properties. Additionally, a MIC may invest up to 25% of its assets directly in real estate, but may not develop land or engage in construction, and must have at least 20 shareholders. 

Unlike REITs, where your investment is placed in physical properties, with a MIC, your investment is placed in property mortgages.

  1. Mortgages

Homeownership allows you to build equity. And, depending on the local market conditions, real estate may appreciate. Investing in a mortgage, especially someone else’s, means you’re taking on the role of a lender and the borrower must repay the loan with interest, usually monthly. If chosen properly, these monthly principal and interest payments can offer a steady, predictable stream of passive investment income.

Mortgages are the most common and significant type of debt held by Canadians. Approximately 40% of Canadians have a mortgage.

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  1. Real Estate Syndications

When you invest your money into a syndicate mortgage, you become a secured lender and are recognized as a part-owner of the mortgage. You’re not investing in a fund; instead, two or more investors are investing in one specific mortgage, pooling their resources together to own a “piece of the pie.” Investors hold in proportion to what they contributed. In real estate syndications, passive investors don’t have to be actively involved in property management, accounting, or tenant-related issues.

One of the benefits to real estate syndications is the potentially high returns, including annual passive income and a profit on the sale of the property. A downside to real estate syndications is the barriers to entry, as the minimum investment for most offerings is $25,000. Syndicate members are expected to be sophisticated mortgage investors as they are not relying on the efforts of anyone else for a return on their investment.

One of the oldest real estate “plays” is buying an additional property to earn money and extra income.

  1. Real Estate Crowdfunding

Similar to syndications, real estate crowdfunding is when a group of individuals pool their capital together to purchase real estate. Real estate crowdfunding uses the internet and social media platforms to reach potential investors.

The main reason that many people opt for real estate crowdfunding is that it doesn’t require a large amount of money to start. You can invest as little as $1,000. Unlike REITs, with crowdfunding, you’re investing in properties directly and can choose which properties you would like to invest in. Moreover, real estate crowdfunding helps investors to expand the risk in their portfolios by not having their entire funds in the equity market.

  1. Buying Income Producing Properties

Whether it’s buying a student house in a university town or renting out a duplex in a residential area, owning a property can be lucrative, but typically requires lots of planning, management, and a large down payment. Standard bank financing will typically top out at 75% loan-to-value. While property management isn’t for everyone, for the few willing to do the homework, owning and managing an income property can complement an investment portfolio geared to generate income.

How to Maximize Generating Passive Income in Canada

Real estate investment is an excellent way to build passive income streams, grow your investment portfolio, and build a healthy nest egg for the future. Done right, it doesn’t have to take a lot of time and energy. There is, however, an added risk. As a result, this strategy isn’t for every investor. Understanding that everyone has different preferences, needs, and risk tolerances, we recommend consulting with a financial advisor before you decide whether or not to invest in passive income assets. It’s time to expand your income sources and make real estate investing your new side hustle!

How to Analyze REITs

The following article will walk you through why investing in real estate investment trusts are advantageous, the different types of REITs, pros and cons of this investment vehicle and finally how to analyze each trust to ensure it’s a good fit for you and your investment goals. 

Key Points

  • Real Estate Investment Trusts are the lowest-maintenance way to dip your toe into real estate investing. Modelled after mutual funds, REITs are trusts that allow you to passively hold interest in real estate. 
  • REITs allow investors, such as yourself, to participate in owning income-producing properties that otherwise may have been inaccessible to the average Joe.
  • To get into the nitty-gritty, at least 75% of the trust’s revenue must come from rent or mortgage interest from Canadian properties, as well as capital gains from the sale of such properties. 

Not too long ago, I opened a new so-called High-Interest Savings Account that’s earning me 0.010% on my hard-earned cash. 

Now don’t get me wrong, the name has a very poetic ring to it, but sheesh – you know it’s not great when you have to go down to four decimal places to learn how the bank plans to grow your money!

Like so many Canadians, I knew that while this account would bring me 100% security, it wouldn’t get me very far in terms of financial growth and my long-term plans. And so, my personal financial horizons had to expand to include stocks, bonds, mutual funds, real estate, GICs, EFTs and whatever other combinations of the alphabet the financial sector could throw at me.

At Fundscraper, we firmly believe that as an intelligent investor (which we know you are because you’re doing your homework right now), diversification is key. And part of a well-diversified portfolio includes investing in real estate.

While there are an amplitude of ways to invest in the real estate market (you can read an overview here), one of the most popular among Canadian investors are Real Estate Investment Trusts, also known as REITs (another acronym for you to file away in your memory). 

Here’s Why You Should be Investing in Real Estate Investment Trusts

Real Estate Investment Trusts are the lowest-maintenance way to dip your toe into real estate investing. Modelled after mutual funds, REITs are trusts that allow you to passively hold interest in real estate. They allow investors, such as yourself, to participate in owning income-producing properties that otherwise may have been inaccessible to the average Joe.

REITs come in many shapes and sizes and often hold interest in specific forms of property, whether it be apartment complexes, office buildings, shopping malls or industrial spaces – spreading your investment over multiple properties and across many regions. Simply put, they aggregate capital from investors, which they then use to acquire, build, operate and/or update these properties. 

To get into the nitty-gritty, at least 75% of the trust’s revenue must come from rent or mortgage interest from Canadian properties, as well as capital gains from the sale of such properties. 

When you invest in a REIT, the Trustees of the REIT hold the legal title to manage the trust on behalf of the unitholders (you), so no decision making is required on your part. These Trustees have a fiduciary duty and the income that is earned by the trust is passed onto the unitholders. 

REITs pay out almost all of their taxable income to shareholders, which makes their dividends attractive. The average Canadian return on a REIT is around 4% – that’s 400x higher than that “high interest savings account” we talked about earlier.

Bottom Line: REITs work in a similar fashion to how an investment property (such as owning and renting out a single-family home) earns rental income. However, unlike owning a rental property, REITs help you avoid the headache of property management, and best of all they trade on the stock exchange, making them more liquid than traditional real estate.

Types of REITs

Now that you know how REITs work, let’s explore the different types of REITs that you can invest in. 

Equity REITs

When most people talk about REITs, they’re talking about equity REITs.

Equity REITs derive most of their revenue from rent collection and from the sale of the properties they own. These REITs tend to specialize in owning certain types of buildings such as apartments, malls and/or resorts. Because a majority of their revenue is generated through rent collection, it’s fairly straightforward to calculate their payouts, providing relatively stable income to their unitholders.

Equity REITs, however, tend to be more sensitive to recessions and booms, often following the cyclical nature of the stock market. Like most markets, they are susceptible to swings in supply and demand, where too much supply can lead to lower rental income, in turn lower payouts for investors. 

Mortgage REITs

Just to make things confusing, mortgage REITs are also sometimes called mREITs or debt REITs. However, regardless of the naming convention, they offer their own set of benefits.

Unlike equity REITs, mortgage REITs make loans secured by real estate, but do not own or operate the properties themselves. By providing financing for these income-producing properties, mortgage REITs earn interest off these investments, which they then pay out to their unitholders. 

Like equity REITs, individuals can buy shares in these REITs via the stock exchange, just like would for any other stock. 

Of interesting note, mortgage REITs tend to perform better than equity REITs when interest rates are rising. However, changes in interest rates may also affect the probability that some borrowers will refinance or repay their mortgages – there’s two sides to every coin. 

Pros and Cons: What You Need to Know

Pros

  • No Property Management – We often consider real estate a passive form of investing. However if you buy a property and rent it out to a negligent tenant, it can be a huge time suck. REITs help you avoid being a property manager altogether.
  • Liquidity – Many REITs are traded on the public stock exchange. That means that unlike owning traditional real estate, you can sell your share with a quick phone call. 
  • Portfolio Diversification – REITs invest your money in multiple properties, in multiple different areas. This helps to diversify your portfolio and ensure that all your eggs aren’t in one basket.
  • Access to Commercial Properties – REITs open up investors to a whole host of properties that most real estate investors wouldn’t typically have access to. It’s not everyday that the average investor could go out and buy a multi-million dollar apartment complex.
  • Avoid Double Taxation – Unlike many investment vehicles, REITs pay out their distributions before they pay tax. This means that you avoid double taxation – helping you build wealth.

Cons

  • Lack of Control – Unlike when you buy a home and rent it out, as a unitholder you have no say in what properties you want to invest in or where they are located. While you don’t get to scope out the property first, you have to trust that the Trustees have done their due diligence – rest assured, they earned the name “TRUSTee” for a reason.
  • Property Specific Risks – As mentioned, REITs tend to specialize in a specific type of property, such as an office building REIT. It’s important to note that each type of property has risks associated with it and are susceptible to different economic conditions. This can be seen in the transition to work from home, in the case of office buildings. 
  • Investment Time – Like most real estate, REITs are best suited for longer term investments. It is recommended for investors looking to invest their money for 5+ years.
  • Slow Growth – In Canada, a REIT is required to distribute 90% of its profits to investors. Unlike penny stocks which don’t typically offer dividends and instead re-invest those earnings, REITs only have the remaining 10% of profits to grow the company by investing in additional properties. This means that you most likely won’t see your investment take off within a year or two.

How to Analyze REITs

Since REITs are dividend-paying stocks, they can be analyzed in a similar way that you would analyze other stocks, with a few minor differences. Before crunching the numbers, it’s important that you first look at the following factors:

  • The REITs’ Tenants – Are any of the tenants having major financial issues? This will likely affect their ability to repay their loan or pay their rent.
  • Acquisitions and Dispositions – Is the REIT growing their portfolio? Are they shrinking? Neither one of these is inherently good or bad, but it’s important to make note of and understand why they took those actions.

…now to crunching the numbers. Once a REIT looks like a solid investment opportunity, you need to make sure you’re paying a fair price for the stock.

Funds from Operations (FFO)

Following the General Accepted Accounting Principles (GAAP) , REITs must charge depreciation against their assets. However, as you likely know, many real estate properties generally appreciate in value over time, not depreciate. The depreciation expense can have a substantial impact on their reported net income and make a dividend payout ratio appear higher than it truly is. 

Additionally, we must account for the capital gains or losses from the sale of property. While these gains and losses are real, they’re not indicative of how much cash flow you can expect the REIT to generate in the future, so it’s important that we exclude these values to get a better understanding of the REITs performance. 

That’s where Funds From Operation (FFO) comes in. This quick calculation gives investors a clearer picture of the REITs true earnings. It is calculated using the following equation:

FFO = Net income + depreciation expense – gains on asset sales + losses on asset sales

Adjusted Funds from Operations (AFFO)

It’s important to note that each company calculates AFFO slightly differently. However, AFFO provides further adjustments to the REITs FFO to provides and even more accurate measure of the REITs performance. In the standard FFO calculation, we do not account for capital expenditures (CAPEX). Using AFFO, we deduct any capital expenditures to give a more accurate valuation. 

But utilizing these calculations, you’ll be able to get a better understanding of the REITs performance and if the REIT is undervalued or overvalued in comparison to other REITs.

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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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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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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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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.

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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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The Modern Playbook for Super Successful Real Estate Investing

Every winning team has two things: a great coach and a great playbook. At Fundscraper, our coach is Luan Ha, MBA, our founder and CEO. And he recently published “The Modern Playbook for Super Successful Real Estate Investing.”

What is the Modern Playbook for Super Successful Real Estate Investing?

Luan is one of North America’s leading real estate experts. His playbook — which you can download for free — is filled with valuable insights about putting your money to work. He writes in a conversational, easy-to-understand style, drawing comparisons to the sport of professional football: scouting, leading, game-planning, and play-calling. But you don’t have to be a sports fan to get a lot out of it. If you’re interested in learning more about real estate investment, this free resource is an excellent place to start.

A good playbook is the secret of success, whether in sports or business.

Luan methodically describes the background homework behind his playbook. In the “Tips and Quotes” section, he explores advice from industry icons that helped him find success. Very informative is the “Profiles of Best Investors” section, a look at the big players, banks, institutions, wealthy families, and pensions. Have you ever heard of the famous 20% rule of investing, practiced by the Yale University Endowment Fund? Luan will tell you all about it!

Luan’s 9 best go-to plays for successful real estate investing

At the heart of Luan’s playbook is his actual list of go-to plays. These are the real, tried-and-true methods that got him to where he is today:

  1. Do your Due Diligence – from creating a checklist, to relying on experts to make sure the “story” makes common sense
  2. Determine the Location Works – all the factors to bear in mind
  3. Assess the Fundamentals of Supply and Demand – key things to remember
  4. Understand the Zoning – useful rules of thumb
  5. Consider Debt as an Investment Vehicle – important considerations
  6. Carefully Analyze the Debt Leverage of the Project – a double edged sword
  7. Figure Out Your Real Estate Investment Style – match your risk appetite, liquidity, expectations and return objectives to the deal
  8. Maximize Your Exit Options – more are better
  9. Avoid Mistakes – automatic if you follow the first 8 Go To Plays

Luan is convinced his playbook will give you a leg up in making real estate decisions. At the same time, he recognizes that not everyone has the time or skills to make these types of decisions on their own. That’s where Fundscraper comes into play!

How to get started

Who are we? We’re a team of experts who can do the heavy lifting for you, but at the same time, leave it to you to decide which real estate investments are right for you. We’ll be your coach, or your cheerleader, or both. We’re here as much or as little as you need.

Fundscraper is on the cutting edge of technology and government compliance. We’re registered with and regulated by the Ontario Securities Commission and also falls within the jurisdiction of Financial Services Regulatory Authority of Ontario.

To quote Luan, “Go for the touchdown and pass the ball to Fundscraper.”

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Why Real Estate Is an Essential Part of Every Investment Portfolio

Think you can’t afford a real estate investment? Think again. Worried now isn’t the right time to add another property to your portfolio? It is possible, and we’ve got you. Even if the extent of your financial experience is a high-yield savings account, you can—and should!—diversify your portfolio with real estate. We’ll teach you how the 1% invests.

Key Points

  • Think you can’t afford a real estate investment? Think again. Worried now isn’t the right time to add another property to your portfolio? It is possible.
  • Too often, the traditional portfolio mix fails to achieve optimum performance because of the under-representation of direct real estate investing. 
  • Every investor’s goal should be to build a more perfect portfolio designed for maximum rewards and minimum risk.

The case for diversifying your investment portfolio

Too often, the traditional portfolio mix fails to achieve optimum performance because of the under-representation of direct real estate investing. Our thesis is simple: You’ll likely be more successful if you put more emphasis on solid direct real estate investing, while at the same time maintaining a high degree of safety.

Being risk averse is a good thing. We’re risk averse, too! Most people are naturally risk averse. We’re drawn to what we know and hesitant of what we don’t know. The average person knows more about traditional investments like stocks and bonds, so that’s where they put most of their money. But the investment environment, especially in the stock and bond markets, can be volatile. If you’re risk-averse, you should know that limiting your investments to only the public markets is one of the biggest investing risks of all.

Investing limited only to public markets risks the chance of devastation if the “bubble” precipitously bursts based on factors beyond our control, such as environmental disasters, inflation, or fluctuating interest rates. Common sense tells us to spread our money out into a diversity of pots, hoping the ups and downs will balance out and we will enjoy a somewhat stable, if unspectacular, return on our investments. As such, it’s a good idea to put a bigger emphasis on real estate investing.

Every investor’s goal should be to build a more perfect portfolio designed for maximum rewards and minimum risk.

Why is real estate an essential part of an investment portfolio?

Direct real estate investing fluctuates quite distinctly from other conventional asset groups like stocks and bonds. For instance, real estate is tangible and is what lawyers call an “immovable.” It’s not a substitute that should take the place of other assets in your portfolio, but rather an asset group all its own.

Unlike stocks and bonds, real estate trades privately based on local factors such as location, supply, demand, and investment lifespan. It is often scarce, particularly in growing areas, which translates to a history of appreciating value. In your portfolio, real estate investing is a channel to investments backed by real hard assets providing a regular income stream and long term growth coupled with the benefits of diversification.

You can enjoy superior performance and diversity at the same time. This is especially true if you’re maintaining and growing the value of your retirement portfolio. Smart real estate investing can only enhance the prospect of enjoying the benefits of things like reasonable leverage (typically as much as 4 or 5 times) and the miracle of compound interest over an extended period of time.

You can add real estate to your portfolio without actually buying property.

What are the benefits of real estate investment?

Meaningful real estate investing is essential for a well-rounded and successful investment package, and the benefits go well beyond diversification. The most obvious benefit of real estate investment is the financial one. Real estate earns attractive monthly returns and can provide a regular fixed income stream over a set time frame. Speaking of tangibility, that’s another benefit: Real estate is a hard permanent asset that can be easily securitized. It has value, and you can calculate that value at any given moment.

Take advantage of having solid real estate investing as a meaningful part of your portfolio. It’s a self-evident way to enjoy reasonable returns and balance out the vagaries and unpredictable fluctuations in public securities markets, both domestic and international. It’ll pay off in the long term while maintaining a high degree of safety.

Other benefits of real estate investment to note include:

  • The ability to take advantage of leverage
  • Tax deductions
  • A chance to create added value
  • An increased voice in the management of the asset

What is the 20% rule of investing?

Most of us never get a chance to participate directly in a major real estate project — usually grabbed up by big players, like private equity firms, banks, insurance companies, pension funds, and government institutions. We are mostly left to public mutual funds, real estate investment trusts (REITs), exchange traded funds (ETFs), and the like.

Consider the experience of and the lessons to be learned from the Yale University Endowment, which is one of the best performing investment portfolios in North America, having a current value in the range of $30 billion. The fund is known for its “20% rule” which recommends at least 20% be invested directly in private markets, such as real estate.

This invariably translates into significantly higher returns over time for a real estate investor over one who employs a more traditional allocation based in public markets. One can only conclude that it makes sense to piggyback onto a tried and true paradigm of real estate investing established by the major players.

Your investment portfolio can enjoy superior performance and diversity at the same time.

How do I get started?

If you’re new to real estate investing, the idea of adding such a large asset to your portfolio may seem intimidating. But it’s easier and more attainable than you might think.

Start Investing in Real Estate 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.