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

Posted on August 10, 2021October 11, 2022 by Gregory M. Colford, B.A., J.D., C.I.M.®

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:

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
The firm or individual acting as an intermediary – a broker – between the issuer and the buyer/seller
The firm or individual regularly trading or advising in any way that produces profits to be for a business purpose
The firm or individual receiving any form of compensation for carrying on the activity
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

Posted on August 10, 2021October 11, 2022 by Gregory M. Colford, B.A., J.D., C.I.M.®

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:

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.
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.
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.

Start Investing in Real Estate Backed Investments Today

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Why the Alt A Residential Market Exists — and Why Investors Should Care

Posted on August 10, 2021October 11, 2022 by Gregory M. Colford, B.A., J.D., C.I.M.®

Experienced investors consider Alt A residential mortgages a great secured product, offering a higher return than Canada Mortgage Bonds and traditional first residential mortgages. Yet to the uninitiated, the Alt A residential mortgage market is just another real estate investment offering. We’ll explain what it’s all about.

Key Points

The risk in the residential non-conforming mortgage market is tradeable with the risk in the conforming market. The real difference between the two is that borrowers in the non-conforming market come with stories — they are “storied mortgages.”
Canada’s residential mortgage market can be divided into two segments: “conforming” residential mortgages and “non-conforming” residential mortgages.
Conforming mortgages have the benefit of mortgage insurance, but most non-conforming mortgages do not qualify for insurance.
Changes in the regulatory environment have resulted in a much stronger borrower entering the private mortgage market.

Canada’s residential mortgage market can be divided into two segments: “conforming” residential mortgages and “non-conforming” residential mortgages.

An overview of Canada’s residential mortgage markets

Canada’s residential mortgage market can be divided into two segments: “conforming” residential mortgages and “non-conforming” residential mortgages.

A conforming mortgage is either fully insured by one of the mortgage insurance companies, or which is a non-insured conventional mortgage with loan-to-value of 80% or less. Borrowers with these mortgages have strong credit histories and files that are fully documented in terms of income verification and other important aspects of the loan applications. Conforming mortgages often receive the best interest rates from mortgage lenders. Our Schedule A banks dominate the conforming mortgage market.

Conforming mortgages that have the benefit of mortgage insurance make up the backbone of what are Canada Mortgage Bonds. Our big banks don’t just sit on their mortgages. To generate further income for themselves, lenders originate mortgages, pool them, then sell the pool as mortgage backed securities (MBS) to the government. To pay for the MBS, the government sells Canada Mortgage Bonds (CMBs) to investors (think pension funds, insurance companies and the banks themselves).

If the borrower is using mortgage financing for the purchase of a recreational property or housing for a family member, or the borrower is purchasing a residence for investment purposes, then the mortgage issued the borrower would be described as “non-conforming.” If the borrower has not yet established a credit history generated in Canada, that borrower will generally only qualify for “non-conforming” mortgage financing, i.e., the Alt A mortgage market.

Conforming mortgages have the benefit of mortgage insurance, but most non-conforming mortgages do not qualify for insurance.

What is the Alt A mortgage market?

Historically, there was a divide in the residential mortgage market. The mortgage was either “A” or it wasn’t. To be an “A” residential mortgage, the borrower had to meet a very rigid criteria set by the Schedule A banks which at minimum required a three-year employment history with the same employer, income verification, three years of clear Income Tax Notices of Assessments, and a credit score 700+.

The principal reason for the rigidity was to ensure the residential mortgage would qualify for mortgage insurance. The borrower had to fit within the “box.” Any borrower that did not fit within the box would have to seek out “alternative” mortgage financing. As time passed, folks who did not fit within the box, yet had good credit, came to make up what we call today the alternative or “Alt A” mortgage market.

The risk in the residential non-conforming mortgage market is tradeable with the risk in the conforming market. The real difference between the two is that borrowers in the non-conforming market come with stories — they are “storied mortgages.”

Who invests in the Alt A mortgage market?

The Alt A market, which caters to non-conforming mortgages, has proven to be an appealing mortgage investment opportunity for a variety of people, including:

Contractors, entrepreneurs, and small business owners who have volatile income and have a difficult time retaining traditional bank financing
Borrowers with challenging credit history
Asset accumulators who invest heavily in rental properties and have ‘too much debt’ on paper, making them riskier to schedule A banks
Investors purchasing income properties or second properties for family/recreational use
Those acquiring certain rural and agricultural properties that have residential components
“New to Canada” immigrants who are likely to find jobs, form households, and buy homes, but do not have credit history in Canada yet

The Modern Day Playbook For Super Successful Investing

Who borrows in the Alt A mortgage market?

The people most likely to use Alt A mortgages are what we call “New to Canada.” They’re immigrants who are sought after under Federal and Provincial immigration programs designed specifically to attract those persons who possess a specific skill or trade. They are the immigrants most likely to find jobs, form households and, ultimately, buy homes. But they do not have credit history in Canada, thus the name “New to Canada.”

Other borrowers in the the non-conforming residential first mortgage market are generally persons with a challenging credit history, investors purchasing income properties, and persons purchasing second properties for family or recreational properties. The acquisition of certain rural and agricultural properties that have residential components also fit in this category.

What are the risks of investing in the Alt A mortgage market?

Most non-conforming mortgages in the Alt A mortgage market do not qualify for insurance. Therefore, pools of nonconforming mortgages cannot be collaterialized for the purposes of issuing MBSs. Because non-conforming mortgages are typically riskier and more difficult to handle, the lender will charge the borrower more. Further, as the non-conforming mortgage does not have to comply with any restrictive guidelines, the lender may allow a higher loan-to-value than if it was a conforming mortgage. The lender may also entertain borrowers with less than ideal credit history and loosen any income verification practices it employs, especially with respect to borrowers that may be self-employed or have alternative sources of income rather than traditional employment income.

Yet, apart from these differences, the underlying real property security for non-conforming mortgages may be at least the same as for conforming mortgages in that they may be located in desirable marketable areas and well maintained at the date of underwriting. Non-conforming mortgages may also carry many of the same characteristics as conforming mortgages in that the security may be the same; they may have the same payment frequency; and the loans may be amortized resulting in a recapture of capital for the lender throughout the mortgage term.

Changes in the regulatory environment have resulted in a much stronger borrower entering the private mortgage market.

Changes in Alt A mortgage regulation through the years

15 years ago, a borrower’s mortgage could qualify for mortgage insurance at a 95% Loan-to-Value (“LTV”) and an amortization period of 40 years. Employment income used to qualify for a Mortgage did not always have to be fully confirmed and/or documented and credit scores could be as low as 580. That’s no longer the case.

Regulation has evolved. LTVs are lowered and amortization periods have been shortened. In July of 2020, CMHC increased the credit score requirements of borrowers with less than 20% down payment from 600 to 680. That knocked out a huge fraction of the borrowing populace. With a sub 680 score and no insurance, that band of borrowers will have extraordinarily difficult time retaining traditional bank financing. Now, that group looks to the alternative mortgage market.

Private lending can be quite lucrative for both lenders and their investors. And in the Alt A or “non-conforming” residential first mortgage market, it can be reasonably safe as well.

The future of the Alt A mortgage market

As the rules have become much more stringent (and the types of properties insurers are willing to cover have narrowed), borrowers are looking for alternatives. Alternative lenders are desperately trying to fill this void created by regulation. Today, they can offer their investors secure long term returns of 6% to 8% (and sometimes more) simply because there are so few options for persons forced out of the traditional mortgage markets by regulation.

Canada enjoys one of the strongest real estate markets in the world. Whether the borrower is “new to Canada” or is simply the square peg that doesn’t fit Big Bank’s round hole, the Alt A mortgage market has proven to be an appealing mortgage investment opportunity for adventuresome investors who like good stories.

Start Investing in Real Estate Backed Investments Today

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An Inside Look: How Financing a Real Estate Project Works

Posted on August 10, 2021October 11, 2022 by Luan Ha

Real estate investors often wonder why a developer might choose to pay what seems to be an unusually high rate of mortgage interest when compared to prevailing rates. Well, the truth is, sometimes it’s in their long term interest to do so, instead of raising equity capital. This article explains the whys and why not’s from an insider’s perspective.

Key Points

There are three ways to fund a real estate project: debt, equity, or a combination.
The costs associated with the money or capital required for a project from the various sources of capital is called the “cost of capital” and is vital to determining a developer’s “optimal capital structure.” It all hinges on the concept of ROE (Return on Equity), which very much takes into account leverage.
The choice of debt, equity, or combination financing is exceedingly complex and will depend on the circumstances and metrics of each project. At the very least, you may now have a better understanding of why sometimes a real estate developer will take on a high-interest first or second mortgage, bearing say 10% or 12% where going rates for standard mortgages or lines of credit are a lot less.

How does a developer fund a real estate project?

A developer needs capital to fund land acquisition, construction, and all soft and hard costs associated with a real estate project. In the absence of an unlimited bank account, they have three options: debt financing, equity financing, or a combination.

Debt financing is accomplished through borrowing. Usually, this: (i) means a higher ratio of investment via debt capital as opposed to equity capital; (ii) allows for tax-deductible interest (i.e., the interest paid on debt is a business expense and is deductible); and (iii) utilizes leverage to increase the return to equity owners.

Leverage is using borrowed money (debt) to amplify or increase potential returns from a project. It allows a developer to multiply buying power in the marketplace. So, for example, if the project costs $100, the developer could get 10 investors to chip in $10 each. They each own one tenth of the project. When finished, let’s presume the project will be worth 133.00. Now, each investor’s share is worth 13.30! Well the developer knows banks are in the business of lending money so the developer (and his investors!) know the bank will come in for $60 of the cost of the project! Whoo – woo! The investors only have to put in $40! So, for $40 the equity investors have $100 of brick and mortar. But once the building is finished those $40 investors will have building worth $133.00! That’s not bad. If we were to increase the amount of indebtedness by another $20, the investors would only have to put up $20! Now for $20 you get a building worth $133. That’s how leverage works! The more debt you “lever” into a project, the less equity you need; the smaller the equity requirement, the greater the return on that equity!

Equity financing refers to selling part of the project to investors who then become equity owners in the project. Equity holders generally get paid last, after any debt holders, so it is natural to expect a higher rate of return given this higher risk. Given more risk to an equity investor, the cost of equity, or in other words the return expected from an equity investment, is generally highest — except in the case where the developer is able to keep equity for itself and benefit from owning more rather than less. The only time a developer has to share ownership of a project is when the developer needs more equity.

There are three ways to fund a real estate project: debt, equity, or a combination.

Choosing between debt financing and equity financing

The “cost of capital” is generally the return expected by the suppliers of capital for their contribution of such capital. It is vital to determining a developer’s “optimal capital structure” – where you have an optimal balance from various capital sources (such as debt and equity) to reduce the overall weighted average cost of capital (more on this later). It all hinges on the concept of ROE (Return on Equity) which very much takes into account leverage. The actual calculation of ROE is “net income” of the business (i.e., income after expenses (including debt repayment!) and taxes) divided by the shareholder equity. As debt is subtracted from the calculation, the ROE increases. In fact, if the ROE appears too high, it may be a warning sign that there is too much debt in the enterprise. Generally, an ROE equal or less than 10% would be considered poor.

Learn More About Investing

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Typically, equity financing returns deliver a higher IRR (Internal Rate of Return) over the life of the project than debt financing which is reasonable when you think about. Debt financing is generally secured. If something goes wrong, the secured lender can step in, seize the assets and repay themselves. Equity is full “at risk”; it’s not secured. If something goes wrong, the equity investor is out of luck! They potentially lose everything. Therefore an equity investor will demand more in return than a debt investor. In real estate it is not unusual at all that an equity investor will look for a return of 20% or more on its investment. And because they are an owner, they expect that forever! If the need for additional equity could be satisfied with high interest rate debt, then that becomes a credible alternative for the developer. If high rate debt is 14%, but the developer anticipates being able to pay it all back in 3 years, debt makes a lot of sense. A developer with an eye on maximizing ultimate profit will be understandably jealous of keeping as much equity as feasible and therefore may prefer to pay a risk premium for mortgage financing.

There’s also “bridge financing” (which really has nothing to do with bridges), which is a type of mortgage financing that is a premium when compared to the risk free rate of return, but a discount if you compare it to the cost of equity. It’s often used by developers to temporarily finance the cash flow for a short period of time (ergo, the “bridge”). Instead of injecting additional equity, they will need to fund the financing gap and bridge the project until it reaches the next stage of development or a subsequent financing stage. Generally, bridge loans are short term (12-36 months), pay interest only so it is non-amortizing, and have a well-defined exit strategy.

Here’s what a typical project lifestyle looks like and what kind of financing is utilized during different project development stages.

A developer may also choose a combination of debt financing and equity financing, coming up with an “optimal capital structure” that balances both and keeps in mind the cash requirements of the project at its various stages.

What are cost of debt and cost of equity?

If you need financial capital to construct an asset and then sell the asset, the interest expense for borrowing the capital is the cost of debt. Equity also has a cost, in the form of profit-sharing, and this is the cost of equity or the expected rate of return a fellow owner would expect for a similar risk profile investment. The weighted average of a project’s cost of debt and cost of equity is generally the cost of capital. The lower your overall average cost of capital, the more profit you can keep for yourself as the owner.

Consider a small project where the developer is planning to do a build and flip, with the below Pro-forma budget. This model below assumes a duration of 12-18 months:In the above No Leverage scenario, the developer maximizes the cash profit. However, they have to inject 2.146M of their own equity. For every dollar the developer invests, i.e. their equity injection, they will earn a 19% return or 19 cents for every dollar of equity. When a party invests for an ownership interest, then they have an equitable interest, or equity, and have a beneficial interest in the profits from the project. Put another way, an equity investor will likely expect or require a 19% return on their invested equity capital (the “expected return” or equity’s “cost of capital”).

Whereas if someone were to invest and own the debt or mortgage of a property, then they become a debtholder entitled to a return defined by a predetermined interest rate. As a debtholder, you will get paid first, but that’s why your return is fixed. As an equity holder, you may get paid last, but you keep the rest of the upside.

What is leverage?

As stated above, leverage is using borrowed money (debt) to amplify or increase potential returns from a project. In some scenarios, for every dollar a developer invests, they can earn more per dollar by investing less equity. Consider this example:

By taking on additional debt and actually reducing the nominal dollar profitability, the developer achieves a few strategic objectives. It frees up over $550K of the developer’s capital, which they can deploy to another site, thereby diversifying their portfolio and helping them line up additional sites (a pipeline) for future work. It adds additional liquidity into the project. And financially, it increases the rate of return or ROE for every dollar the developer invests. Instead of earning $0.19 for every dollar invested, the equity owner earns a projected $0.238!

Borrowing from a private lender vs bringing on additional equity partners

We’re going on a math tangent now — stay with us! Even if you don’t speak equations, seeing real-life examples is a helpful way to better understand investing concepts.

The weighted average cost of capital (WACC) is calculated by the formula:

(Proportion of Equity Capital %) * (Cost of Equity) + (Proportion of Debt Capital %) * (Cost of Debt) = [100% * 19% + 0% * 12% ] = 19%

Your debt holders only demand 12%, but equity partners will want their 19% return. From a project point of view, the cost of that capital is going to be 19%! It’s the expected return your equity holders expect to receive by investing in the project. If you took on debt even at 12%, the math would work out to be 13.8%. So, overall, you can pay $0.138, or pay $0.19 for every dollar invested.

Ask yourself: Which project has a lower cost of capital? As the principal owner of the project, you want to drive down your cost of capital as much as possible. That way, you can take on projects of varying profitability and be competitive with how much you can pay for the residual value of the land at the time of acquisition.

The choice of debt financing, equity financing, or combination financing depends on the circumstances and metrics of each project.

How to get started

Funding a real estate project is a complex subject. We hope you now have a better understanding of why sometimes a real estate developer will take on a high-interest first or second mortgage when going rates for standard mortgages or lines of credit are a lot less.

Still have questions? Fundscraper is here to help its community wade through these kinds of considerations which are key to analyzing the underpinnings of its project offerings. We aim to provide our clients with the ability to make informed decisions and deliver a transparent investing process. Contact us today to learn more about your real estate investment options.

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How to Evaluate MICs

Posted on August 10, 2021October 11, 2022 by Gregory M. Colford, B.A., J.D., C.I.M.®

Historically low-interest rates in recent years have become the driving force for many savvy investors to build wealth through one of Canada’s hottest private real estate investment products: mortgages. This is all possible through Mortgage Investment Corporations (MICs), which are designed to bring like-minded investors together to passively invest in real estate mortgages. Instead of owning “brick and mortar” and playing property manager, you’re a banker! But how well do they work? What considerations should investors note? Here, we show you how to analyze a MIC before investing in one.

Key Points

Historically low-interest rates in recent years have become the driving force for many savvy investors to build wealth through one of Canada’s hottest private real estate investment products: mortgages.
There’s more than one way to buy a property or buy a home. MICs are an accessible investment vehicle for many — especially those seeking diversification from traditional investments like mutual funds and the stock market.

The Modern Day Playbook For Super Successful Investing

Here’s Why You Should be Investing in Mortgage Investment Corporations

A MIC is a company that pools shareholder capital, lends that capital out as mortgages, earns income via interest and fees, and pays 100% of its net income (after management fees) back to the shareholders.

Dividends paid by the MIC are taxed as interest. Many MIC investors prefer to hold their shares in a registered account like an RRSP, RESP, RRIF, or TFSA.

An investment in shares of a well-managed MIC provides investors with:

Capital preservation
Regular dividend income
Potential for growth via reinvestment
Constant deployment of capital
Full-service origination and administration

Still have questions about how to invest in mortgage investment corporations? Schedule a call with us and we’ll walk you through it.

Types of MICs

MICs usually hold the majority of their assets in high-yield, uninsured residential mortgages. Unlike banks, these pools of capital are generally lending for much shorter terms, with 6 to 24 months being standard.

MICs lend money to people who would or have been turned down by more traditional outlets like banks, credit unions or large alternative lenders. As such, they are able to charge significantly higher interest rates on their mortgages (in some cases in excess of 10%). In a hot real estate market such as the GTA and Vancouver, many borrowers have sought money from MICs to purchase homes or bridge gaps in funding.

To understand the allure of MICs, compare them to other fixed income investments. It’s rare to find a GIC that pays even 2% for a one-year term these days. Government bonds offer similarly low yields, even for 10-year terms. Investment-grade corporate debt does pay more, but even with those bonds, 4.0% to 4.5% is pretty much the limit these days in Canada. Bottom line, if you’re slightly more adventuresome, MICs can offer a better return.

There’s more than one way to buy a property or buy a home. MICs are an accessible investment vehicle for many — especially those seeking diversification from traditional investments like mutual funds and the stock market.

Pros and Cons: What You Need To Know

Pros

Investing in a MIC spreads the investment across a large pool of mortgages, mitigating the risk from investing in single specific mortgages.
Fund managers actively manage the investments and mortgages, providing an investor with a hands-free investment experience.
MICs are required to comply with Federal regulations and the provisions of the Canadian Income Tax Act.
A MIC generates its return from monthly mortgage payments made by the borrowers. This provides investors a stream of income while their investment is secured against real property. An investor is relying on debt repayment; not rental income!
Under the Income Tax Act, taxable dividends paid to shareholders are taxed as interest income. A MIC does not pay any income taxes, provided that we distribute all of our taxable income each year.

Cons

The people receiving the mortgage may have low credit. With rates on prime mortgages so low, for someone to be paying on the order of 10% annually indicates that they’re a subprime borrower.
With housing prices so lofty, the underlying collateral behind these private mortgages may not be so sound. Should prices start to fall and a borrower defaults, the MIC may not recoup all of its money when it seizes and sells the asset.
There’s potential for a so-called liquidity mismatch: Most MICs are “private” meaning they do not publicly trade their shares. An investment in a MIC is not “liquid”. Investors who need easy access to cash should avoid investing in private MICs.

How to Analyze Mortgage Investment Corporations

Check track record and team expertise.
When planning to invest in a MIC, check out the track record and team expertise of those sponsoring/promoting the MIC. Anyone can set up a MIC (and there are hundreds!), but it takes skill to lend carefully and profitably. Get help – a licensed advisor can help you sift through the noise an help you find the folks that can deliver you the investment return you’re targeting.
Make sure the investment is suitable for your risk tolerance and investment goals.
Risk-averse investors should look for a mortgage pool that is lower in risk. The riskiness of a fund or pool can be judged by the pool’s underwriting criteria – is the pool made up mostly of first mortgages (suggesting it’s relatively conserbative), mostly seconds (oh, might be a tad risky) or is it some balance of the two? Sometimes it’s easy to find this information. A reputable issuer will have good disclosure documents like an offering memorandum (What’s an offering memorandum?) that will provide lots of detail. Again, a licensed advisor will help you find this information. If income and preservation of capital are your goals, you’ll likely lean toward a pool that has conservative underwriting criteria and consistently delivers modest but good returns and supports your personal finance. Learn more about our underwriting criteria here. Advisors like Fundscraper will help you find something suitable.
Understand the mortgage portfolio composition and concentration.
- Types of Mortgages
  There are a variety of types of mortgages – first, second, third and so on. A mortgage (also called a “charge”) is simply a registered notice to the world that in the event the owner of the property fails to pay back a debt owed, then the person that has the benefit of the mortgage/charge may force a sale of the property to satisfy the debt owed. Mortgages are ranked according to time of registration – first on title gets the first “kick at the can”! Only after the first is satisfied, can the next party step up! So, as you can imagine, the further down the line a lender might be,, the higher the risk is that the lender will not be able to be repaid by forcing a sale of assets as there simply may be no assets left to sell when that lender’s turn comes up! And that is how mortgages are generally priced: the higher likelihood of repayment the lower the rate of interest; the lower likelihood of payment, the higher the rate of interest!
  An asset manager like Fundscraper will create a mortgage pool to reflect risk of repayment. Our first mortgage pool only invests in first mortgages, which means Fundscraper has a greater likelihood of being made whole on its investments in the event a borrower fails to repay its debt owed.
- Terms of Mortgages
  The term of a mortgage is the length of time a borrower may use the funds advanced by a lender. A term may be any period of time. The private mortgage world a mortgage loan will typically be anywhere from six months to three years. The reason for the shorter term is that these mortgages are risky than traditional mortgages and lenders like to review terms more often then in a traditional setting. These shorter term mortgages will often renew. Mortgage pools that are populated with these shorter term mortgages benefit by the frequent renewals as changes in rates can be made and fees earned in the renewal process. For example, in Fundscraper’s Diversified First Mortgage Pool the terms of the first mortgages contained in that pool vary between 6-18 months.
- Geographical Location
  You should be wary of mortgage pools that have a high concentration of mortgages in one geographical location, because it is more sensitive to adverse local economic and real estate conditions. Our Diversified First Mortgage Pool is selective about real estate development, investing in single-family and multi-family residential assets in established neighbourhoods in southern Ontario.
Know the loan-to-value of the mortgage portfolio.
For most mortgage pool funds, a loan-to-value ratio of 75% is considered conservative (banks typically lend at a max. loan-to-value ratio of 75%). This means that the amount of the loan cannot exceed 70% of the property’s value. The difference between the loan and property value creates a safety cushion that protects investors from losses in the event of a borrower default that triggers a foreclosure and sale. Get a crash course on loan-to-value here.
Understand all fees.
Investors in mortgage pools sometimes pay higher fees that can reduce the payout amounts to you. Fees can be high and can include management fees, performance fees, and mortgage origination fees. The operating expenses of the mortgage pool are also funded from investor money. This means that a manager can earn a higher return than investors through the different types of fees. Our First Mortgage Pool has a 1% management or mortgage servicing fee and the fee details are disclosed in our offering memorandum.
Check for compliance.
Fundscraper Property Trust must comply with the rules of government agencies, which are described in its disclosure documents. The principal document is the offering memorandum, which contains information regarding the Trust’s structure and objectives and management team experience. Fundscraper Capital Inc., the promoter of the Trust, is strictly regulated as an Exempt Market Dealer.

Still not sure how to analyze mortgage investment corporations in Canada? Whether you want to buy a single-family home or rental property, invest in office buildings, are considering buying an investment property, or have questions about real estate investment trusts (REITs), our team can help you understand your options. Schedule a call with us and we’ll answer all of your questions.

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How Do I Invest My RRSPs into Private Real Estate?

Posted on August 10, 2021October 11, 2022 by Gregory M. Colford, B.A., J.D., C.I.M.®

Private real estate investment is too often overlooked in an investment world dominated by hedge funds, ETFs, Principal Protected Products, publicly traded shares, and bonds. If you think private real estate investing is only for the wealthy or experienced, think again. Private real estate investing is for everyone, especially because you can use your RRSPs to invest. It’s an affordable, approachable way to get started. Not sure how to do that or what that means? We’ll explain.

Key Points

Most people don’t realize that they can invest in private mortgage investment entities like mortgage investment corporations and mortgage trusts, as well as mortgages directly, with their RRSPs.
What is evolving today is that the less risk-averse investor should actually be the one weighing their portfolio more favourably toward real estate than otherwise. This is because real estate is such a strong non-correlated asset class to the hoped for “high flyers” to which so many less risk-averse investors are attracted.

What is an RRSP?

RRSP stands for “registered retirement savings plan.” A “registered” plan means the plan, and the account associated with it, is registered (or held) by a service provided by the Canada Revenue Authority to manage accounts that benefit from the special treatment our federal and provincial government’s grant to these unique retirement savings plans. Other examples of “registered” plans are “Registered Retirement Income Funds” and “Tax Free Savings Accounts”. What is discussed below is applicable to RRIFs and TFSAs as well!

The majority of Canadians hold their retirement savings in registered accounts. Most often people invest their RRSPs in stocks, bonds, mutual funds, exchange traded funds and other public securities. Many people believe that is all they can invest in through their RRSPs, but that only scratches the surface of what’s possible.

Most people don’t realize that they can invest in private mortgage investment entities like mortgage investment corporations and mortgage trusts, as well as mortgages directly, with their RRSPs. If you’re interested in doing this, we can help.

What are the benefits? Considerations?

Investing in private real estate is an excellent way to diversify your portfolio. Savvy investors know not to put all of their eggs in one basket, and private real estate helps minimize risk of loss. It also helps generate return and preserve capital.

Investment advisors commonly recommend that a person’s portfolio have between 10% and 20% in real estate. It is generally thought that investors who are risk-averse would tend to hold a mix with more real estate and less risk-averse investors would tend to weigh stocks more heavily in their portfolio. What is evolving today is that the less risk-averse investor should actually be the one weighing their portfolio more favourably toward real estate than otherwise. This is because real estate is such a strong non-correlated asset class to the hoped for “high flyers” to which so many less risk-averse investors are attracted.

Most people don’t realize that they can invest in private mortgage investment entities like mortgage investment corporations and mortgage trusts as well as mortgages directly through their registered accounts.

How to determine which real estate investments are right for you

If you’re interested in investing your RRSPs in private mortgages, whether directly or through a mortgage investment entity like a MIC or mortgage trust, then the first thing you should do is seek expert advice if you have little experience in the private mortgage markets. The process is not difficult, but if you’ve never done it before, you’ll need an expert to walk you through it. That’s what we’re here for!

Your advisor should be a registered mortgage broker or an exempt market dealer focused on mortgages. At Fundscraper, we’re both. We begin by asking about your investing experience, investment portfolio to date, risk appetite, expectations, current needs, and future needs. This is called a suitability assessment, and it helps us determine whether private real estate is an appropriate investment for you at this juncture of your life. If yes, the next step is identifying a mortgage investment product that would be suitable for you.

How to invest RRSPs into private real estate

Once we have found something that is suitable for you, the next steps are setting up how you can acquire the private mortgage investment security with your current RRSP funds that are held by your bank or financial advisor. Those RRSP funds are likely tied up in mutual funds, exchange traded funds, and other RRSP eligible securities. We’ll help you with this process as much or as little as you need.

Fund your investment. Liquidate a fraction of your RRSP holdings to the cash amount you need to make your new investment.
Open a self-directed RRSP. Ask your financial institution (any Canadian chartered bank or trust company) to do this.
Transfer your liquidated funds to your new account. You’ll complete a “transfer instruction” whereby your new financial institution will request that your current RRSP institution transfers the liquidated funds to your new self-directed RRSP account. Once all the forms are completed, they are filed with the originating institution instructing it to transfer your cash portion to your newly created self-directed RRSP account with the new financial institution.

Learn More About Investing
Guide to Real Estate Investing

6 (Achievable) Ways to Earn Passive Income

How Do I Invest My RRSPs into Private Real Estate?
Wait for the funds to transfer. The transfer can take up to four weeks. In order to maintain RRSP eligibility, funds must move directly from one RRSP account to another. You cannot withdraw the funds yourself, take them to your financial institution, and deposit them.
Invest your RRSPs into private real estate. Once the funds arrive in your self-directed RRSP account, tell the self-directed RRSP account to fund your investment in the private mortgage investment entity. You do that by way of delivering to the financial institution a “payment direction” — the financial institution has a standard form of payment direction that it will provide to you. The payment direction tells the financial institution to invest in the private mortgage investment entity for you through the newly created self-directed RRSP account for the amount set out in the direction.

Investing your RRSPs in private mortgages is easy! Nevertheless, it’s important to have your advisor orchestrate the process on your behalf, as there are moving pieces that have to be coordinated.

How do I get started?

Your registered account savings are your nest egg. Be careful with how you employ and invest these funds. Work closely with reputable dealers to first determine whether investing in private mortgage securities is suitable for you and, if so, what the best private mortgage investment products are for you at the time you want to make the investment.

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How to Invest in Real Estate

Posted on August 4, 2021January 12, 2022 by Gregory M. Colford, B.A., J.D., C.I.M.®

The wealthiest investors all have one thing in common: They invest in real estate. You can do it, too, even if you can’t afford a down payment. Read our latest article to learn how to invest like the 1%.

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. Fundscraper will teach you how to invest in real estate like the 1% does. If you’re wondering how to invest in real estate, Canada is an excellent real estate market for both seasoned investors and newbies alike.

Here’s Why You Should be Investing in Real Estate

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. Most people don’t think they have the means or personal finance to buy an investment property, a rental property, an office building, or a single-family home as an investment, but they very well might.

The bottom line isn’t necessarily where you think it is.

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

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 real estate investors over those who employ 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.

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.

Is Investing in Real Estate a Good Decision?

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 market and bond market, 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.

The Modern Day Playbook For Super Successful Investing

Why Investing in Real Estate isn’t just for the Wealthy Anymore

An investment property probably conjures images of the wealthy 1%, but we help make that dream accessible to many. 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, to grow and build wealth, it’s a good idea to put a bigger emphasis on real estate investing.

You can add real estate to your portfolio without actually needing to buy a home, or even buy a property.

How to Invest in Real Estate Like a Pro: What You Need to Know

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.

Your investment portfolio can enjoy superior performance and diversity at the same time. You don’t even need to be a landlord or property manager!

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

Now that you know more about how to invest in real estate in Ontario, Fundscraper is here to answer any further questions you have about how to invest in commercial real estate, real estate development, and more. It’s time you start earning passive rental income. Contact us today to get started.

Start Investing in Real Estate Backed Investments Today

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Guide to Buying Investment Property Mortgages

Posted on August 4, 2021October 4, 2021 by Gregory M. Colford, B.A., J.D., C.I.M.®

Key Points

You can expect the interest rate on your mortgage for investment property, Canada specifically, to be at least 0.50% to 0.75% higher than the rate on your primary mortgage.
If you don’t want to manage real estate, or don’t have the money for the down payment and financing to buy the real estate, consider an alternative to a conventional mortgage.

Buying rental property can be a great way to invest for the long term and generate monthly income. Like any investment, research the pros and cons before making any decisions and be clear on your goals and risk appetite for owning rental property.

Investment Property Mortgages: What You Need to Know

Advantages

Disadvantages

You pay fewer taxes.

You can deduct certain expenses from your income, including mortgage interest, property taxes, insurance, maintenance, upgrades, property management, and more.

You take on the responsibilities and challenges of a landlord.

Rental units need repairs and dealing with tenants can be challenging.

You may be able to deduct losses for tax purposes.

If your expenses exceed your rental income, you may be able to deduct that loss from any other sources of income.

It may be difficult and costly to sell the property later.

Real estate is not a liquid investment. It can be time-consuming and pricey to sell, depending on market conditions.

You receive regular monthly income.

Other kinds of investments may pay out less often or income may be less predictable.

It may be difficult to finance the purchase.

You must have a down payment of at least 20% when you buy a second property.

What to Consider Before Buying an Investment Property Mortgage in Canada

What kind of property do you want?

Most first-time investment property buyers tend to start with condos and single-family homes.
With property, bigger is not always better. It likely means more taxes and more space to maintain.

What’s an ideal location?

Look for property close to schools, hospitals, public transportation, businesses, and retail.
Focus on neighbourhoods where demand for rental properties is strong and expected to remain so.

How is the local rental/job market?

A healthy job market will likely spur demand for housing and may result in rising rental income.
A growing area with major improvement projects planned could make the location more attractive to potential renters.

Does purchasing a property make financial sense?

Investing in rental property (or a rental property mortgage) should be considered a long-term investment that helps build capital.
Consider whether your real estate investment has the potential to provide a better return when compared with other investments.

Get the advice of experts

Assemble a team of professionals to advise you on real estate, legal, tax, and financial decisions.
Consider including an investment advisor on your team, as any property you buy will impact your asset mix and overall portfolio. That’s where Fundscraper comes in!

You can expect the interest rate on your mortgage for investment property, Canada specifically, to be at least 0.50% to 0.75% higher than the rate on your primary mortgage.

Getting to Know More About Investment Property Mortgage Rates on Loans

Mortgage interest rates will always be higher on investment properties than on your primary residence. Lenders add this upcharge because they consider a rental or investment property mortgage — Canada markets included — to be a riskier loan product.

To protect themselves against the extra risk that comes with investment property financing, lenders charge a higher interest rate and have stricter qualification rules for borrowers. That makes it extra important to shop around and make sure you’re getting a fair mortgage rate on your investment property before you buy.

Learn More About Investing

Guide to Real Estate Investing

6 (Achievable) Ways to Earn Passive Income

How Do I Invest My RRSPs into Private Real Estate?

Achieving Your Long-Term Goals with a Mortgage on an Investment Property

Everyone has their own reasons for getting into property investment. What are your long-term goals? Do you have an investment target – a certain amount of money you’re hoping to make? This adds purpose and structure to your plans.

If you know your financial goals but aren’t sure how to structure your plans to meet them, that’s okay. We all start somewhere! Consider looking at past historical data and making reasonable expectations for the future. If you have information on how much properties like yours have appreciated in value over the years, you can make educated guesses about your financial future and estimated mortgage payment.

Are You Ready for an Investment Property Mortgage?

Assess your current financial situation to see if buying investment property makes sense for you now. Consider these questions:

Can you afford the sizable purchase price of real estate and still cover your existing financial obligations?
Is your credit in good standing?
Do you have the minimum 20% down payment you’ll need to secure financing?
Have you factored closing costs into your expenses?
If any repairs are needed to a property before it’s rentable, do you have the money to pay for them and the mortgage until you’re able to rent it?
If you have a primary residence, could it, or a line of credit secured against it, be used as a potential financing source?
Don’t forget that lenders will employ either a “Rental Add-Back” or “Rental Offset” to assess your ability to repay their indebtedness. Learn about each, but know that rental offset will always leave you in a better position than rental add-back.
Know that mortgage insurers will not provide mortgage default insurance on investment properties. Generally, it’s only available on residential homes worth under $1 million.

If you don’t want to manage real estate, or don’t have the money for the down payment and financing to buy the real estate, consider an alternative to a conventional mortgage.

Passive real estate investing in a mortgage pool may be a better option for you. You can even use your RRSP to fund your mortgage, which we call a self-directed RRSP mortgage investment property.
Contact Fundscraper today to discuss your options for investment property mortgage, Canada and beyond.

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How to Read Loan-to-Value Like a Pro

Posted on July 31, 2021August 13, 2021 by Gregory M. Colford, B.A., J.D., C.I.M.®

Loan-to-value (LTV) is likely the most discussed ratio in real estate lending and mortgage investment circles. Conceptually, it’s a fairly simple concept: the ratio of a loan to the value of an asset purchased with the proceeds of the loan. The ratio is the value of a debt that has been secured against a present value of an asset that has been offered by a borrower as collateral. If in the event the debt has not been repaid, the lender can seize the asset and sell it to satisfy the debt owed.

LTV correlates with the security an investment provides. The general rule of thumb is the higher the interest rate, the higher is the perceived risk of the mortgage investment. Thus, studying the LTV is a common way to assess risk. Let’s walk through how to read LTV like a pro.

Key Points

Borrowers often insist that their property is worth much more than a lender is willing to accept.
A lender always approaches a transaction with the conservative view that the potential borrower will default. It’s not a statement about the borrower; it’s simply how lenders assess debt transactions.
Values are always changing, and the underlying LTV calculations change with them. As the LTV ratio changes, so too does the risk profile of the mortgage investment. Lenders constantly monitor their original LTV calculations against actual LTV values as markets undulate forwards and backwards.

When Is Loan-to-Value Determined?

The LTV ratio is determined at the time the loan is advanced, meaning it’s fixed for the purpose of the loan. As time passes, the actual value of the securitized asset can go up or down. Once the loan is out the door, the value of the lender’s security is subject to the whims of the market. Regardless of which way the value goes, the lender is owed the same amount.

Borrowers often insist that their property is worth much more than a lender is willing to accept.

How Is the Loan-to-Value Determined?

The LTV ratio is the loan amount against the value of the asset. What the “value” of the asset is can sometimes be a difficult matter to determine and have parties agree upon. The borrower will want the asset to have the highest value possible, while the lender will want a conservative value—one that can be easily realizable in the event the lender is forced to sell the asset to pay off the loan.

Borrowers often insist that their property is worth much more than a lender is willing to accept. Lenders complain that borrowers are too greedy and fail to appreciate that the value of their property might not be worth as much as they think if a sale of the property is forced to repay the debt. This problem is most often satisfied by hiring an independent third party appraiser to assess the value of the asset being offered as collateral.

Realization (n): The amount received, in excess or loss, of the adjusted basis of the property.

What Is the Cost of Realization?

All lenders price with a mind to realization. A lender always approaches a transaction with the conservative view that the potential borrower will default. It’s not a statement about the borrower; it’s simply how lenders assess debt transactions.

How easy it is to sell the underlying asset goes directly to the cost of borrowing and will be reflected in the LTV. It may be wonderful to have a debt security on a property that is 40% LTV, but if you can’t sell the property, then it’s kind of meaningless.

The general rule of thumb is the higher the interest rate, the higher the risk of the mortgage investment.

How Is Loan-to-Value Related to Interest Rate?

A high interest rate can mean anything. Interest rates do not rise proportionally to the percentage LTV. The rate is generally determined by the market based on liquidity, the actual LTV as discussed, and the desperation of the borrower. A high rate of interest usually signals a high LTV ratio. However, LTV is a strictly relative value particular to a given market. What’s considered a very good LTV in one market may be horrible in the next.

Can Loan-to-Value Change?

The LTV calculation is generally done only once, at the outset of the transaction. It’s a thorough process that requires time, expense, and expertise. Yet, nothing stands still – markets rise, fall, and are subject to unexpected events. What one may have thought a very conservative investment may suddenly become a very risky investment given events beyond the lender’s/investor’s control.

Values are always changing, and the underlying LTV calculations change with them. As the LTV ratio changes, so too does the risk profile of the mortgage investment. Lenders constantly monitor their original LTV calculations against actual LTV values as markets undulate forwards and backwards.

We invite everyone to share in the opportunities that we create with our borrower clients.

How Do I Get Started?

Loan-to-value might seem like a simple concept to grasp, yet many investors have lost very large sums of money by investing in highly leveraged properties. Don’t let that happen to you! Before you invest in real estate, speak to a qualified advisor who’s an expert in mortgages.

At Fundscraper we review residential and commercial real estate transactions all the time — it’s our “day” job! We work closely with our borrower clients to make sense of the value propositions they advance and do the homework necessary to insure the LTV we determine based on the evidence in front of us is an accurate and safe assessment against which we are willing to risk our money. We can help you invest smarter. Contact us today to learn how mortgages and private real estate can be great investments.

Start Investing in Real Estate Backed Investments Today

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The Role of the Credit Committee of an Exempt Market Dealer

Posted on July 31, 2021November 15, 2021 by John J. Pizale, BSc, JD

The Credit Committee, sometimes called the Investment Committee, is a panel of individuals ubiquitously found in financial institutions, pension and endowment funds, credit unions, banks, insurance companies, and the like. Here, we’ll focus on the role and inner workings of the Credit Committee of an Exempt Market Dealer offering real estate products to the public.

Key Points

An EMD is a firm that has been licensed to distribute investment securities that are exempt from the rigours of a prospectus normally required by the Canadian Provinces in which it is registered to carry on business
The Board of Directors of an EMD normally establishes the Credit Committee comprised of senior management individuals with authority and relevant skill and experience. They meet regularly to consider new investments and approve, amend or turn away investment opportunities being brought forward under the auspices of the EMD
The credit committee serves as a natural buffer or safeguard against an overly enthusiastic promoter. An essential part of its mission is to protect the ultimate consumer of products offered to the public under the umbrella of an EMD

What is an exempt market dealer (EMD)?

An EMD is a firm that has been licensed to distribute investment securities that are exempt from the rigours of a prospectus normally required by the Canadian Provinces in which it is registered to carry on business.

EMDs may act as dealers for prospectus exempt securities sold to qualified clients. Typically, an EMD offers products covered by an Offering Memorandum (OM) which need not be pre-cleared by a Securities Commission. An OM is an issuer-prepared document purporting to describe its business. OMs assist prospective purchasers in their decisions of whether to invest in the securities being offered by the Issuer.

The Credit Committee does much of the “heavy lifting” for investors in evaluating the underlying merit of any investment opportunity.

What is a credit committee and what does it do?

The Board of Directors of an EMD normally establishes the Credit Committee comprised of senior management individuals with authority and relevant skill and experience. They meet regularly to consider new investments and approve, amend or turn away investment opportunities being brought forward under the auspices of the EMD.

The Credit Committee has a broad range of duties and responsibilities, including the obligations to:

Ensure regulatory compliance for each investment
Review regularly investment policies and recommend to the Board of Directors changes in policies, procedures, internal controls and underwriting guidelines
Promote wise investment and credit management
Rule on investment opportunities, taking into account credit, market, operational and legal risks
Ensure any investment is consonant with the EMD’s published investment criteria and policies

What is a loan officer?

The Loan Officer assigned to any proposed transaction is an experienced underwriter charged with presenting the investment opportunity to the Credit Committee, including all the supporting research. An underwriter’s main task is to assess the quality of an investment, its sponsors, and its inherent risks. Oftentimes, the Loan Officer’s presentation to the Credit Committee will have been previously vetted and endorsed by the Loan Officer’s supervising manager.

Why is it called underwriting? The term comes from the historical practice of Lloyd’s of London Insurance of requiring each risk taker (often for a sea voyage with risks of shipwreck) to put their “written” signature “under” the total monetary risk they were willing to assume in return for a fee. Hence the term “underwriting.”

It’s the credit committee’s job to approve, amend, or disapprove of an investment application.

How does a credit committee evaluate an investment opportunity?

Over and above its general obligations, on a daily basis, the Credit Committee is charged with evaluating potential investment opportunities falling within the EMD’s jurisdictional orbit. The review begins with the Loan Officer’s discussion paper, which includes a profile of the people behind the deal, its proposed terms, detailed analyses, and recommendations.

After deliberating over the Loan Officer’s underwriting report and completing any follow up interviews, the Credit Committee can approve, amend, or disapprove of the investment application at hand.

If the application is turned down absolutely or with amendments, the Loan Officer will advise the applicant accordingly. If it’s approved, a letter of intent will be sent. Upon acceptance by the applicant, a term sheet and commitment letter prepared by the Loan Officer and approved by the Credit Committee is forwarded to the applicant for signature and acceptance. The Loan Officer then will confirm that all due diligence and funding requirements are in order and that arrangements are put in place to fund the transaction. The EMD’s Legal Counsel will be retained to prepare and register the mortgage and/or any other security documents and ensure all conditions have been satisfied before funds are released. Barring the need for an extension down the line, the work of the Credit Committee is now done.

At this juncture, the EMD moves on to fulfill its regulatory obligations and attends to matters related to qualification of investors, suitability, conflicts of interest, disclosure, and more. It’s a complex process; the full treatment of these tasks is beyond the scope of this paper!

The credit committee serves as a natural buffer or safeguard against an overly enthusiastic promoter. An essential part of its mission is to protect the ultimate consumer of products offered to the public under the umbrella of an EMD.

What is due diligence?

Due Diligence, as applicable, covers many things, including:

The credentials of an Issuer or Sponsor
The financial details of the proposed deal, including principal amount, yield, duration, and other salient features and conditions
Creditworthiness of the borrowers and/or guarantors, including credit checks, financial statements, personal references, and net worth statements
Third party reports such as valuation appraisals, architectural certificates, environmental reports, building condition assessments, geotechnical appraisals, and quantity surveyor reports
Leases, rent rolls, and estoppel certificates
Development budgets and construction schedules
Ability of the originator to fund budget shortfalls and need for a Deficiency and Cost Over Run Agreement
Zoning and building permits
Details of prior and subsequent encumbrances and availability of lender consents, if necessary
Assessment of loan to value ratios and other compliance with the EMD’s investment criteria
Evaluation of current competing market conditions for similar deals, including prevalent offerings by competitors
Timing of advances to the borrowers
Availability of collateral security
Builder’s risk and liability insurance
Validity of repayment schedules, as well as feasibility of exit route through refinancing or sale of underlying property
Evaluation of originator’s track record and project’s progress to ensure continued sustainability in case an extended term is needed
Location of the property, including marketability, condition, and value
Contemporaneous assessment of general economic and societal forces, including state of financial markets, existing and proposed government policies, local issues, and force majeure conditions
Review of commitment administrative and all incidental expenses and fees
Legal structure and supporting documentation

Meet the Fundscraper credit committee

Our team has over 125 years of experience in real estate development, finance, private equity, law, and technology. We’re proud leaders in our fields! Meet the Fundscraper credit committee here.

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