Canada’s mortgage investment industry has grown significantly in recent years, with Mortgage Investment Corporations (MICs) emerging as one of the most popular investment vehicles. According to Statistics Canada, the MIC sector has grown from less than $10 billion in 2007 to more than $36 billion as of 2021. This article seeks to provide investors with an in-depth understanding of MICs, focusing on the potential rewards and risks associated with this type of financial instrument.
An Introduction to MICs
Mortgage Investment Corporations are a type of alternative investment that allows Canadians to easily invest in a diversified portfolio of residential mortgages. As income-producing investments, MICs pool capital from several investors for the purpose of investing primarily in first and second mortgages. MIC investors are considered preferred shareholders and are entitled to dividend payments generated by the fund in the form of interest and fees collected from borrowers.
Although MICs may sound like a novel asset class, they were first introduced under the Mortgage Financing Act in 1973 to encourage private lending and investments in the residential mortgage sector. Because MICs are not required to conform to the strict lending standards of the major banks, they have more flexibility in approving loans. As a result, more borrowers have turned to MICs for their mortgage financing needs.
Recognizing this potential, investors have increasingly viewed MICs as an attractive fixed-income opportunity, especially during the decade that followed the 2008 financial crisis when interest rates on government bonds and Guaranteed Investment Certificates were low. Because MICs invest in a relatively stable market — Canadian mortgages — they provide non-correlated returns and have outperformed public markets during periods of volatility.
MICs are also popular because they receive special tax treatment under Canada’s Income Tax Act. Because they are “pass-through” investment vehicles, MICs can avoid paying taxes, so long as they distribute 100% of their net income to shareholders.
How MICs Work
A Mortgage Investment Corporation operates both as an investment fund and a registered corporation that oversees the entire mortgage selection, adjudication, administration and management process. Funds deposited into a MIC are invested primarily in first and second residential mortgages, usually over a period of one to two years, in major urban markets across Canada. Each MIC employs its own adjudication and risk management practices and targets an annual yield range based on the characteristics of the mortgage portfolio, including property type and location, borrower profile, loan-to-value, and security position. In this way, MIC investment risks can be aligned with an investor’s risk tolerance. MICs can be structured from ultra-defensive to high-yield, so they appeal to investors with various risk profiles.
MICs generate revenue by charging borrowers interest and fees on their loans. Because MICs are alternative lenders, they normally charge above market rates, providing a potentially higher source of income for shareholders. All fees and interest collected by the corporation are passed on to shareholders, providing a truly passive, defensive investment opportunity.
Benefits of Investing in MICs
MIC investing provides diversification benefits in an investment portfolio, the potential for higher returns compared to traditional fixed-income investments, and regular income through dividend payouts.
A MIC diversifies by investing in assets with low correlation to public markets. MIC investing provides exposure to Canada’s residential real estate market but without the risks and hassles associated with property ownership, including title transfer, tenant management, liquidity constraints, and potential negative cash flow. MIC securities are also diversified across several criteria, including geography, borrower type, and loan-to-value (LTV) ratio..
MICs have historically provided much higher rates of return than traditional government bonds and GICs. Leading funds, like CMI MIC Funds, target returns of 6% to 11% annually, with a proven track record of achieving those targets.
Investing in a MIC also creates monthly cash flow that can be withdrawn as income or reinvested in perpetuity. MICs can be held in registered accounts including a Tax-Free Savings Account (TFSA), Registered Retirement Savings Plan (RRSP), and a Registered Retirement Income Fund (RRIF), allowing investors to grow their portfolios in a tax-free or tax-deferred way.
As recent history has demonstrated, MICs are a proven hedge against market volatility by providing non-correlated returns and competitive yields. MICs continue to benefit from strong demand, as more borrowers seek out alternative lending arrangements and access to second mortgages.
MIC Investment Risks
Like any asset class, MICs are not immune to risks. Before investing, investors should carefully assess how each MIC fund mitigates against real estate market fluctuations, credit risk, liquidity risk, and the potential impact of interest rates on the fund’s operations. Investors should be extra cautious of investing in MIC funds with excessive exposure to farmland, raw land, or new developments, as these properties are typically harder to foreclose on should the borrower miss payments.
Although MICs benefit from regulatory clarity under the Income Tax Act, investors should work with funds that consistently monitor any changes in the regulatory environment. Until now, rules to tighten mortgage lending have primarily impacted traditional banks, which has driven more borrowers to alternative lenders that are not subject to traditional banking rules.
Analyzing MIC Performance
In choosing a provider, investors should carefully evaluate key MIC investment risk metrics, such as the fund’s loan-to-value ratios, borrower types, and the geographic distribution of mortgages. Funds that are overly exposed to major urban markets often have suppressed yields due to growing competition among wholesale lenders. While major cities are essential for a well-balanced fund, exposure to smaller cities and towns is equally important.
One of the best ways to analyze a MIC’s performance is to look at its fact sheet, which should provide details on the fund’s investment objective, assets under management, portfolio composition, average loan size, and weighted average LTV. The fact sheet should also provide details on the average maturity for each security position, as well as a geographic breakdown of the mortgages within the portfolio.
The document should also provide information on the fund’s yield targets and historical performance. Analyzing a MIC’s 12-month trailing return and average return since inception provides a good assessment of its performance. Naturally, funds that have a proven track record of meeting their yield targets offer the best investment opportunity.
To maximize due diligence and risk mitigation, investors should only work with funds that have a team of professional mortgage underwriters who review each mortgage loan and manage risks on behalf of investors. The mortgage selection and adjudication process are critical for the fund’s success, so there should be strict due diligence processes embedded within the fund. This team of mortgage professionals should also advise investors on which MIC fund is most suitable for their goals and risk tolerance.
Conclusion
Like any investment strategy, MIC investing requires a balanced approach for long-term success. MICs should be viewed as an important pillar of a well-balanced portfolio, but not the only pillar. Investors should work with a reputable fund provider to determine optimal capital allocation, comfort level, and risk profile.
CMI Financial Group is Canada’s leading private mortgage lender, having facilitated more than $2.5 billion in successful mortgage placements. Our CMI MIC Funds provide barrier-free entry into Canada’s residential mortgage market, based entirely on each investor’s risk tolerance. You can learn more about CMI MIC Funds by exploring our fund offerings.
If you still have questions about CMI MIC Funds or want to schedule a free consultation, contact CMI to learn more.
