David St Amour is taking control over his personal investments. His angle? Real estate. Specifically, investing in private mortgages. Over the past five years, the 63-year-old president of Sealyam International Inc., an Ottawa-based firm that facilitates and finances corporate mergers and acquisitions, has invested at least 70% of his personal investment portfolio in lending money to individuals who can’t (or won’t) qualify for traditional bank mortgages. “Absolutely, it’s a good investment,” he says. “I’m much more comfortable in mortgages than I would be in any equity, any future, anything.”
With the U.S. sub-prime mortgage crisis spawning events that threaten to topple global institutional lenders, investing in private mortgages might seem counterintuitive. But if you have surplus capital and financial and real-estate smarts, it’s a relatively low-risk strategy that offers stable, consistent returns, control over your investments and shelter from volatile equity markets.
Private mortgages are an “embryonic” business in Canada and not something that’s talked about a lot. “But in today’s climate, it’s a very good opportunity, contrary to what people think,” says Steven Lee, managing partner at Markham, Ont.-based mortgage brokerage Verico Newbridge Mortgage Inc. With banks pulling back on credit approval over the last year, “it’s opening up more choices in inventory for the private investor, and now they’re able to cherry-pick.”
Private mortgages are usually arranged between a single investor and borrower (pooled investments are possible but less common) and facilitated by a mortgage broker. Borrowers usually use the cash as bridge financing to buy time to get their credit or finances in order to qualify with a traditional bank or to realize capital on another asset.
Unlike bank mortgages, lenders receive monthly payments consisting of interest only until the mortgage term matures, usually in one to two years. On maturity, the agreement is renegotiated or terminated, and the principal is repaid in full.
Investors typically receive interest rates of 9% to 11% on first mortgages, and 12% to 15% on second mortgages. So, if you loaned $100,000 to a borrower at the agreed-upon interest rate of 12% for a one-year term, you would receive 1% a month, or $1,000 per month, for the next year. And because the mortgaged property is used as collateral for the loan, if the borrower defaults, you can recoup your investment by putting the property under power of sale.
Private mortgages are ideal for investors who want “full control over what they’re investing in,” says Anthony Fritz, an Ottawa-based mortgage broker. They offer predictable income that’s less susceptible to equity-market volatility. And with short terms, you can get your money back quickly. In addition, most private mortgages are also RRSP-eligible investments.
Peter Merrick, a certified financial planner and president of Toronto-based MerrickWealth.com, agrees it’s a worthwhile investment to consider. “It’s tangible, and you have the security [of being able to take over the property] in a worst-case scenario.”
Still, it’s a vehicle best suited to investors with significant real estate and financial experience. “There are two levels of risk,” says Fritz. “One is the borrower defaulting, and the other is not realizing all of your value upon liquidation of the property.”
To mitigate the downside and find quality deals, you’ll need to work with experienced mortgage brokers. A good place to start is to ask your real estate lawyer for referrals. But be sure to do your homework before committing to any broker. Find out how long they’ve been in business and what their level of education is. Ask how many private mortgages they place each year and what level of support you can expect after funding.
A good broker will provide meticulous due diligence on both the borrower and the property before presenting you with an investment opportunity to consider. They’ll review property appraisals, structure an effective mortgage agreement and exit strategy. They’ll also weigh current and expected housing values and help build in safeguards, such as an appropriate loan-to-value amount that doesn’t exceed 80% (and is often much lower). Some will provide support and administration if a borrower defaults. “If the homework is done and everything is done properly, in my opinion it’s one of the safest investments out there,” says Fritz. “We’ve funded over 1,000 private mortgage deals, and less than 10 went to power of sale.”
First-mortgage deals range from $100,000 to $300,000, while second mortgages are usually for $20,000 to $25,000. Lee suggests that novice investors start small. “It takes time to understand how the whole process works.”