Alternative Lending Sources
Build Your Portfolio Without Banks
This is an excerpt from an article in the March 2011 issue of Canadian Real Estate Magazine called “Optimizing MICs”
Mortgage Investment Corporations-The Best Kept Secret in Financing
Have you ever been looking at a deal which at first glance seems like it will turn out to be really profitable? You know the drill; crunching the numbers, finding a great margin or cash-flow, you start salivating onto your calculator and then inevitably… the “F” word comes up…by that I mean financing of course.
Most successful investors use OPM to leverage their own capital and risk in order to get their deals completed. When an investor has a deal to be financed in hand, the proverbial questions are; where is the best source of funds, what is needed to qualify, what is the cost of the money and how soon can I get the money?
In April 2010, Canadian real estate investors were thrown a couple of curves from the finance minister to “rein in” any undue risk to the Canadian banking system. Individual mortgage qualification got more difficult and down payment increased to a 20% minimum on non-owner occupied properties. This resulted in fewer investor approvals through the traditional lending system. An issue for alot of investors and mortgage brokers alike is, the banking system is the only method of financing they know and as a result, many more investor deals are being declined.
Some investors and mortgage brokers are able to get deals funded by using private sources. This is an excellent way to get deals done however, to make a profit you must make sure the margin is large enough to pay for the upfront fees and much higher rates.
An alternative source of funding which seems to be a “best kept secret” in Canadian lending is the mortgage investment corporation, commonly known as a MIC. These niche market entities although not well advertised, are used by many individuals because they will lend where the banks often won’t.
MICs are organizations that take in funds from investors and turn around and lend those funds out in the form of mortgages. As real estate investors, it is prudent to understand how these MICs work, how they can help us do more deals and how we can perhaps utilize them in more ways than just a great source of funding.
What is a MIC?
A MIC is similar to a bank, but there is a major difference. Banks lend out money on deposit from its account holders for loans, lines of credit and credit cards, make a huge profit and in turn, reward the account holders with a measly return for the use of their money.
MICs pool money together, lend it in the form of first or second mortgages and share 100% of the net profits to its shareholders. Projected returns are typically around 6-11% per year. These returns are often paid out quarterly in the form of a dividend and taxed to the individual as interest income which can be received in cash or reinvested back into the MIC.
Mortgage investing used to be a more “exclusive” vehicle reserved only for the sophisticated. Today MICs offer both the sophisticated and non-sophisticated investor a “hands off” way to balance a portfolio as an alternative to the bond/fixed income market. With a typical minimum investment of $5,000, most investors appreciate the stability and security coupled with a nice return.
Specifics and operation of a MIC
Because investing in a MIC is a security, MICs are carefully monitored and controlled by the CRA, the Securities Commission and FICOM, which is the Financial Institution Commission of Canada. In order to issue shares or securities, companies need to go through an arduous and expensive prospectus. Fortunately, MICs rely on an exemption from this by providing an Offering Memorandum (OM) and a warning statement to all of their prospective shareholders. The OM describes the vehicle you are investing in, the names and backgrounds of the management team, some tax information and the warning statement explains the risks to investing to the prospective shareholder.
MICs must follow the guidelines set by the Canadian Income Tax Act, Section 130.1: Salient Rules. The following are a few pertinent highlights:
a) There must be a minimum of 20 shareholders
b) No individual shareholder can hold more than 25% of a MIC’s total capital
c) Shareholders can invest from RRSPs, RRIFs, RESPs and TFSAs
d) A MIC must invest a minimum of 50% of its capital in residential mortgages and/or cash and insured deposits at Canada Deposit Insurance Corporation member financial institutions
e) All MIC investments must be within Canada but can accept investment capital from outside Canada
f) A MIC itself is tax exempt corporation
g) A MIC is considered a “flow through” investment vehicle and as such must distribute 100% of its net income to the shareholders
h) Dividends received with respect to directly held shares, not held within RRSPs or RRIFs, are taxed as interest income in the shareholder’s hands. Dividends may be received in the form of cash or additional shares
i) A MIC may invest up to 25% of its assets directly in real estate but may not develop land or engage in construction. This ceiling on real estate holdings does not include real estate acquired as a result of mortgage default.
j) A MIC may distribute income dividends derived from mortgage interest, revenue from property holdings, and capital gain dividends from the disposition of its real estate investments.
k) A MIC may employ financial leverage by using debt to partially fund assets.
l) A MIC is subject to an annual audit of its financial statements
Read Alternative Lending Sources – Part 2
Alternative Lending Sources