Bank of Canada announced holding the key interest rate at 0.25% until at least 2023. In a candid press release the newly appointed Governor of Bank of Canada, Tiff Maclem, expressed the bank’s commitment to hold rates low in no uncertain terms: “It’s going to be a long climb out…” The 5 years Canadian bond is now yielding only 0.35%, down from 1.6% earlier in the year. The lower rates of interest have compressed yields in the bond market and stocks are subject to unprecedented volatility. So where do investors find value in these unprecedented times?
One asset class that has been largely overlooked is investing in private mortgages. Not only have they been incredibly reliable investments, but they are also growing in popularity and provide attractive returns. The returns can be on par or better than most dividend-paying stock on a risk-adjusted basis. Private mortgages have inherent benefits as an investment vehicle that makes them particularly suitable in times of uncertainty.
Steady, monthly interest payments are a fantastic way to create passive income. Most private mortgage investments return between 6-9% and payout quarterly to investors, a highly attractive rate of return compared to most other fixed-income investments.
Private mortgages are backed by physical property, allowing holders of the mortgage to foreclose and sell the asset to recover their funds in case of default. This is one of the strongest types of recourse for any investment, provided there is enough value in the underlying property.
Depending on the investors’ risk tolerance and return objectives, private mortgages are secured by way of a mortgage registered on title in the 1st or 2nd position, which means the property can not be sold or transferred without first paying out all the mortgages. A good understanding of valuation and market trends is key to a suitable assessment of security.
Private mortgages typically only lend up to 65-70% of the value of the underlying property, thereby creating a 30-35% cushion against market fluctuation. This margin also covers the cost of foreclosure and commissions in case of a forced sale. The structure will create inherent downside protection for the investment, ensuring the principal is well protected, a feature that is unique to this investment vehicle. A good understanding of valuation and market trends is key in a suitable assessment of security.
There are a variety of ways to invest in mortgages: individuals can source and invest direct opportunities, or they can rely on professional teams who aid investors in finding the right opportunity and suitably assess risks. Whether a direct investment or through mortgage funds or managers, experience in Real Estate finance, is a key factor when considering an investment in this asset class.
Tax Shelter Investment
Mortgage investments can be funneled through a tax-sheltered account such as a TFSA or RRSP for added tax benefits. This will allow individuals to defer or avoid taxation on the earnings which can add up to 40% to the total return.
Embedded inflation protection
Considering the underlying asset is physical real estate, there is inherent protection against inflation. The value of Real Estate typically increases in tandem with inflation and provides investors with effective protection against inflation by preserving the value of the underlying security.
The biggest drawback of investing in private mortgages is the lack of liquidity. However, as they are typically 12-18 month term investments, with proper planning liquidity risk could be mitigated by laddering strategies. Investing in larger mortgage funds also provides more liquidity but comes at the cost of management overhead.