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

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

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.

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.

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How to Invest in Real Estate

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.

How to Invest in Real Estate

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

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.

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.

How to Invest in Real Estate

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.

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Due Diligence Checklist Before You Invest in Private Real Estate

Today, there’s a wealth of options for accessing the market for investors of all kinds. Many investors struggle with the private real estate investment due diligence process. It can be intimidating and stressful to know where to start, what information to review, and how to determine whether or not a property is a smart investment. We’re here to make that process a lot less intimidating by explaining essential due diligence to-dos for investors, whether you choose a fund, service, or platform.

Key Points

  • Many investors struggle with the private real estate investment due diligence process.
  • Past performance does not guarantee future results, but looking at track record is one way to gauge an organization’s expertise.
  • Make sure you understand a service’s fee structure and confirm that it makes sense in light of the value the investment manager is creating for you using your capital.
  • People turn to real estate to improve their portfolio’s overall diversification. Public REITs are terrific products, but if your investment portfolio is generally made up of publicly tradable shares, you may lack diversification.

See If You Qualify

Before spending too much time envisioning your future with a particular service, be sure to check and confirm which kinds of investors it admits. For example, some funds provided by famous private equity real estate companies, like Blackstone, have a history of only admitting investors that meet certain salary thresholds, while newer platforms, like Fundscraper through Fundscraper Property Trust, allow anyone to invest.

Check Past Performance

Past performance does not guarantee future results, but looking at track record is one way to gauge an organization’s expertise. How has the manager fared in prior years? Did they show responsible custodianship over investors’ funds in the past? What does their portfolio say about their investment biases? How is their portfolio weighted? Each of these factors can help you determine what your investment experience might be like with a particular service.

 Due Diligence Checklist Before You Invest in Private Real Estate

Understand the Fee Structure

Every real estate investment has built-in expenses. In order to generate dividends, a property incurs ongoing fees, such as property management and future upkeep. Make sure you understand a service’s fee structure and confirm that it makes sense in light of the value the investment manager is creating for you using your capital.

Make Sure You Can Manage Your Investment

One of the big advantages of investing in real estate directly is that you never have any doubt about what your money is up to or how to track it. On the other hand, when you invest through a third party like a fund, partnership, or corporation, you can only track what they make visible. Now that most investment services are online, make sure you can interact with, manage, and evaluate your investment to your desired level of involvement.

 Due Diligence Checklist Before You Invest in Private Real Estate

Consider Diversification

People turn to real estate to improve their portfolio’s overall diversification. Public REITs are terrific products, but if your investment portfolio is generally made up of publicly tradable shares, you may lack diversification.

Public REITs in Canada correlate very closely with our public markets. When the markets go up, so do the REITs; when the markets go down, the REITs follow. Private real estate investment does not correlate with the public market. It’s one of the important reasons folks look to “anchor” their investment portfolios with private real estate investment. It sits at the bottom of your portfolio and chugs along, regardless of what’s happening in the public markets.

At Fundscraper, part of our due diligence is making sure you understand yours. Download our due diligence checklist template for real estate property investment here.

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Become a master of real estate investing! This playbook has inside industry knowledge that you can use to help generate passive income! Discover tactics used by the savviest investors, how to diversify, maximize your returns and avoid mistakes. It’s everything you need to know to invest like a pro.

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