The opening up of the private credit and lending market by new more entrepreneurial and tech-enabled players brings a wealth of new and enhanced alternative income investment options for investors. Even traditional real estate mortgage investments have become subject to substantial overhaul as entrepreneurs rethink underwriting, structure, and processes. This has led to increased access and a surge in interest in “alternative investments” from retail investors.
Historically, alternative investments were mainly available to institutional investors (ex: pension funds) or ultra-high-net-worth investors. However, these new entrepreneurs have brought this asset class into the mainstream. According to a Morgan Stanley insight piece, private credit has grown from $875B in 2020 to $1.4T in 2023. It is expected to grow to $2.3T by 2027, which is amongst the fastest growing asset classes.
A subset of private credit is a Mortgage Investment Corporation (MIC), which most investors are unfamiliar with. To shed some light on this asset class, we were introduced to Alex Leduc, CEO of Perch Capital – a Canadian Mortgage Investment Corporation that feels MICs have not been living up to their full potential and bill themselves as the nexus to “modern mortgage investing”. We asked him questions to better understand the dynamics of a MIC and how it fits into the alternative investments space.
Hortz: Can you explain what a Mortgage Investment Corporation (MIC) is and give us an overview of what the North American MIC landscape looks like?
Leduc: A Mortgage Investment Corporation is a fund that raises money from investors and then takes those funds to originate mortgages to borrowers. Each month, the borrower makes their mortgage payments and those mortgage payments in turn are used to pay dividends to the investors on a monthly or quarterly basis, depending on the MIC. A private MIC (like Perch Capital), is strictly for dividend returns as the shares are bought and sold at the same value, meaning there is no asset price volatility. There are also publicly traded MICs available, which have both a dividend and capital gains component.
MICs will typically lend out short-term mortgages (4-24 months) that do not fit the box at traditional lenders. Since they are not subject to the same regulations that restrict larger lenders, they mainly compete on speed and loan parameter flexibility. However, as a smaller lender with less regulation, they have a much higher cost of capital and as a result charge much higher rates. In Canada, a MIC’s mortgage rate for the borrower will typically be 5-6% higher than a traditional lender.
Statistics Canada estimates the entire Canadian mortgage market to be $2.1 Trillion and Lending Tree estimates the US mortgage market to be $12.1 Trillion. Within the Canadian mortgage market, Perch Capital estimates that the Canadian residential private mortgage book (excluding traditional lenders) is roughly $30B or 1.4% of the total market in size and will only continue to grow as borrowers face higher interest rates and tighter qualifying criteria due to increasing regulatory pressure on traditional lenders.
It is worth noting that the MIC is one type of the many mortgage fund entities available to Canadians. By investing in our MIC, you will be exposed to the real estate market, but not necessarily investing in real estate directly. Our MIC loans money to borrowers as debt in the form of short-term, first and second position mortgages on residential properties across Canada. In other words, Perch Capital has a security interest in the property, however, we are not co-owners of the home or entitled to property price gains or losses in any way. In the US, there are also a variety of different MIC fund types that will depend on the purpose of the fund and the type of investors they seek to attract.
Hortz: What are the key opportunities and benefits of investing in MICs? Any other things they should know about these investments and the MIC marketplace and how they compare with other real estate income investments?
Leduc: A MIC offers multiple benefits including being a registered investment, meaning you can invest in them with your RRSP (Canadian equivalent of a 401k) or TFSA which can further enhance your after-tax returns. Also privately held MICs like ours are bought/redeemed at the same purchase price, so there is no asset price volatility. The returns are purely dividends paid and these typically are not subject to massive fluctuations. The argument here is not that a MIC delivers the highest returns, it is that they deliver consistently strong returns even in periods of downturn.
Other key benefits include:
Cash flow in the form of high monthly or quarterly dividends for income investors is reassuring for those who may have seen real estate investors face negative cash flow in recent years due to factors such as rising mortgage payments and tenant arrears/vacancies. Many of them look at the opportunity to earn positive income a lot differently today.
Liquidity is addressed as some private investments require extremely long lockups (ex: 5-7 years), whereas a MIC typically only locks up funds for 1 year. While liquidity is not guaranteed, the underlying mortgages in the fund typically mature within 12 months and those maturities can be used to fund redemptions directly. The friction in selling is also pretty minimal, whereas selling a rental property can take substantially longer and cost more.
Professional management handles having to maintain a property as a landlord which can be extremely time-consuming and if outsourced can take a large chunk out of those excess returns. Similarly, sourcing deals as an individual investor can result in your capital being underutilized and you may get inferior quality deals. Most importantly, when things go wrong (ex: tenant/borrower stops making payments), you need to move quickly and involve the right parties to mitigate losses. This is something that is best left to experts, as the average person will not be equipped to navigate this properly.
Diversification is critical as directly funding a mortgage or buying a property concentrates your risk into a single property, which exposes you to idiosyncratic risks (ex: that housing market, that borrower, etc.) versus being an investor in a mortgage fund means you are taking a small piece of every mortgage in the portfolio.
Hortz: How are your mortgage underwriting processes and technology different from mainstream banks and other financing firms? Why do you characterize your offering as “modern mortgage investing”?
Leduc: We apply a more holistic risk management approach to protect capital where strategic conditioning and proactive portfolio management help keep loan losses to a minimum. Most lenders lend mainly on property value and react to defaults instead of anticipating them. We fully underwrite the deal to ensure both the property and borrowers can service the deal. By monitoring deals through to maturity, we identify and manage potential risks before a default can occur.
For example, we place a heavy emphasis on the exit strategy of the borrower and how viable it is. Since we operate a mortgage brokerage, we can look at a deal’s exit more objectively than other lenders. Using our in-house auto-adjudication and optimization algorithms to model expected losses and the exit, we are able to properly capture the entire deal’s true risk profile. A private mortgage is always meant to be a temporary solution to a bad situation and we want to ensure the transaction is beneficial to both us and the borrower by ensuring there is a clear way out.
By leveraging our technology, we can also streamline the entire back office which cuts down on costs and allows us to service a large portfolio of residential mortgage loans with minimal overhead. In turn, that lets us pass back those savings through higher returns we can pay our investors.
The combination of our more expansive portfolio and risk management mindset along with our technology applications comprise our view of a more modern mortgage investing offering.
Hortz: How can U.S. and Canadian investors access your alternative income vehicles?
Leduc: For privately held MICs (like Perch Capital), these are typically off-market financial investments. To invest in these vehicles, Canadian investors have to go through an exempt market dealer or eligible wealth advisors, which are independent third parties that will assess the suitability of the investment for them and then establish how much they are eligible to invest.
US investors are restricted to institutional, family office, and Upper High Net Worth US investors with a $1million+ minimum. Access is through our site (perchcapital.ca) by filling out form “How to invest” or by emailing investors@perchcapital.ca.
Hortz: What thoughts can you share with advisors and asset allocators on how to position MICs in their client portfolios?
Leduc: Alternative investments are generally being recommended to make up 10-30% of someone’s portfolio, so naturally asset allocators are busy trying to find the right investments that they can recommend to fill that bucket. As with any investment, it will differ based on the client’s needs, but generally, a MIC will make a strong use case under scenarios such as:
-
Stable returns and capital preservation are important to your client.
-
The client needs monthly income from their portfolio to pay for their lifestyle.
-
The funds are not required to potentially be liquidated within the next year.
-
A client wants to migrate out of active management in real estate (ex: they manage many properties) but does not want to exit real estate as an asset class or income source.
The Institute for Innovation Development is an educational and business development catalyst for growth-oriented financial advisors and financial services firms determined to lead their businesses in an operating environment of accelerating business and cultural change. We operate as a business innovation platform and educational resource with FinTech and financial services firm members to openly share their unique perspectives and activities. The goal is to build awareness and stimulate open thought leadership discussions on new or evolving industry approaches and thinking to facilitate next-generation growth, differentiation, and unique client/community engagement strategies. The institute was launched with the support and foresight of our founding sponsors — Ultimus Fund Solutions, NASDAQ, FLX Networks, TIFIN, Advisorpedia, Pershing, Fidelity, Voya Financial, and Charter Financial Publishing (publisher of Financial Advisor and Private Wealth magazines).