Whether you are new to mortgage investing or a seasoned professional, it is crucial to apply certain key principles to maximize your investment returns while managing risk. After all, achieving high returns today means very little if you wind up with a significant loss down the road. At Morrison Financial, we believe that consistent application of these fundamentals is the cornerstone of long-term private lending success.
1. Prioritize First Mortgages
A first mortgage loan refers to a loan that has priority claim against certain real estate. Financial institutions, like banks, typically only do first mortgage loans as they offer significant protection against capital should a borrower default. Through legal proceedings, a first mortgage lender can sell the property and recoup their investment before any leftover proceeds are paid to subsequent lenders (e.g. a second mortgage lender) and the property owner.
Second or other subsequent mortgage loans typically offer a higher yield, but this means little if your principal is constantly at risk. For most investors, it is wiser to choose the more secure, reliable returns that first mortgages provide.
2. Focus on Shorter-Term Loans:
Mortgage loans with terms between 12 and 24 months strike the ideal balance between return and market exposure. Short-term loans allow the lender to focus on the credit or execution ability of the borrower rather than macroeconomic factors. Remember the impact of the COVID pandemic on office buildings, and how the rising interest rate led to a prolonged correction in Canadian real estate values. Shorter duration investments also provide greater flexibility by allowing the lender/investor to reassess their investment more often and reinvest their capital in opportunities that may be better suited for the market conditions or their individual situation.
Certain investments in real estate can last between 5 to 10 years, posing significant uncertainty given that the sociopolitical environment can substantially change over such a period. Longer duration investments can also pose liquidity issues for some investors, as their capital would be locked in the investment for a greater period of time.
At Morrison Financial, we focus on short-term loans with clearly defined exit strategies rather than speculation on future macroeconomic factors. Our loans continue to perform whether real estate values decrease, increase, or stay flat.
3. Reinvest Promptly to Avoid Idle Capital
A great investment can still lead to mediocre returns if your capital sits idle between investment opportunities. As an example, a 6-month investment yielding a 12% return will only result in a 6% annualized return if the capital sits idle for the following six months. Such an investment could lose out to another investment (presumably lower risk) that offers a 7-9% annualized return.
Investment continuity is a key aspect to maximizing your returns long term. However, investment continuity can be challenging to achieve for one-off investments in real estate because finding the right opportunities can take a lot of time and effort. Pooled mortgage investment structures, such as mortgage mutual funds and mortgage investment corporations (MIC) have investment managers who ensure that investor capital is continuously deployed to maintain yield.
4. Capitalize on the Distribution Reinvestment Plan (DRIP)
On the topic of reinvesting money, most private mortgage funds offer the option to reinvest your monthly distribution through a Distribution Reinvestment Plan (DRIP). Most investors have a limited understanding of DRIP and its impact on investment returns. From our perspective, DRIP may be the most effective way to maximize your investment return over the long run. See the example below illustrating the difference in total return on a $25,000 investment with an 8% annualized return mortgage investment with monthly DRIP vs with no monthly DRIP.
The effect of DRIP is less pronounced in the short term but the difference in performance becomes much more significant with time from the compounding effect. For reference, after ten years, the total investment growth is 121.96% with DRIP versus 80.00% without DRIP. After twenty years, the total investment growth is 392.68% with DRIP versus 160.00% without DRIP, a significant outperformance in the long run.
This example assumes that the annualized distribution is constant and does not account for individual tax considerations.
5. Diversify your investment
Diversification remains one of the most effective tools for managing risk in any form of investment, so its importance cannot be overstated. Investing all your capital in a single loan can materially impact your return should the loan not perform. A more effective method to diversify is to invest in a pool of mortgage loans through private mortgage funds or mortgage investment corporations. These entities would typically spread your capital across tens or hundreds of loans; thereby reducing the impact of any single loan underperforming.
6. Invest with an Experienced Manager
Mortgage investing is a powerful way to grow your investment portfolio and/or earn passive income. The main caveat is that it must be done correctly. Investing in mortgages requires expertise in deal sourcing and structuring, credit analysis, legal implementation, and loan management. Such activities are highly specialized and can be challenging for everyday investors to complete on their own.
We always recommend individuals invest their capital with an experienced manager or lender with decades of experience to position themselves for long-term investing success.
Morrison Financial is one of Canada’s longest-standing private real estate finance firms. During its 38 years in business, Morrison Financial has advanced over $1.6 billion in loans. Morrison Financial operates two mortgage income funds which invest in a diversified portfolio of short-term residential development projects across Ontario, and its trust units are eligible to be held in registered accounts. Morrison Financial has retained Belco Private Capital (“Belco”) as its exempt market dealer. Contact us to schedule a time with one of the dealing representatives to determine whether this investment is suitable for you.
Written by:
Chawin Vajanopath, MBA, Senior Director of Operations
Ryan Tan, Business Development Intern
