Syndicated mortgages are growing in popularity but they come with investor cautions for mortgage brokers putting them out there.
A syndicated mortgage is formed when a number of investors or individuals pool their funds to make a loan to the developer. Each investor in the syndicate is registered on the title of the property in accordance with the amount contributed to the syndicate.
The growth is fuelled by developers looking for another source of cash after traditional lenders tightened loan conditions following the 2007-2008 economic collapse. Investors today are becoming disillusioned with the rate of return on traditional investments.
“Three years ago, we had 20 to 24 projects (that were financed with syndicate funds) and now we have 72,” says Asad Saeed, sales manager for FDS Broker Services, an Ontario-headquartered mortgage broker that deals in syndicated mortgages across Canada. It also has a branch office in Nova Scotia. Saeed said that of those 72 projects the firm is handling, 10 have exited or moved to a completion phase and investors have seen the return of their principal investment. The remaining 62 are in the planning or construction phase.
“Typically, the interest paid out on the investment is eight per cent (per annum) paid out in quarterly instalments,” says Saeed, adding there can be a bonus component at the completion of the project. If the developer makes a profit over what is expected, then a bonus can be shared by investors. The project’s life is set as part of the syndicated mortgage terms. It could be two to five years.
During the intervening years, before the project is completed, it’s common practice for developers to set aside enough funds to pay the quarterly dividends, which is a fixed annual rate during the project life. (The funds are usually parked with a fund administrator who has to file annual reports with provincial regulators.) At the exit point, the investor’s capital is returned and, if feasible, the bonus is paid.
Mortgage brokers, who are not exclusive to the syndicated mortgage market, say that syndicate mortgages are just another tool in the toolbox to get projects off and running. The mortgage structure can vary and mortgage brokers may either put together their own syndicates from a regular pool of investors, develop their own syndicated mortgage product that brokers can bring clients to, or deal with a company that underwrites a project after putting it together and then rely on one or more mortgage companies to raise the funds.
FDS uses Fortress Real Developments of Richmond Hill, Ont., a Canadian real estate development company that seeks out and analyses investment opportunities in major Canadian markets. Saeed calls Fortress the “underwriter” of projects that FDS can put out to investors, who then choose which project syndicate to join depending on that building’s time line and location. FDS takes cash investments to a minimum of $30,000 and investments can take the form of RSPs, a Tax Free Savings Account or even a Registered Retirement Income Fund.
The question that might be asked is why developers might want to go to private investor syndicates and pay a higher interest than the banks. And how do such vehicles ensure protection for the investor?
Saeed says that while banks will often lend funds that are a portion of the land value to cover “hard” costs such as construction, the developer may have to cover some soft costs such as planning, zoning and architectural design costs. The developer would need a higher amount than a bank might be willing to loan.
A B.C. mortgage broker interviewed by REM says that a syndicate might also step in because the pre-sales have not reached the level the bank feels comfortable with. Some syndicated mortgage funding can keep the project moving until the pre-sales reach the desired level and the syndicate members can be bought out by a more traditional lender.
The protection offered the investor is being registered on the land title.
Paolo Abate, CEO of Real Wealth Mortgages (which is being rebranded later in 2015 to Union Capital Management Co.) says his brokerage firm matches capital to needs and does a variety of mortgage deals including syndicated mortgages. But, he only puts investors into a mortgage when he has determined their risk tolerance, he says.
“We try to do a suitable assessment of whether they should be in a first mortgage, a second mortgage or a syndicate mortgage,” he says, adding the minimum investment is $25,000 but the average investment is $75,000 to $100,000.
Abate has authored a consumer’s e-guide to Real Wealth’s syndicated product called Syndic8, with the 8 denoting the interest rate of return. The online document is a primer on the mechanics of how syndicated mortgages work, the positive returns they can generate, and also the pitfalls that can occur.
Abate says he published the guide because “I thought there was a lot of misinformation out there in the marketplace and average Canadians often didn’t know what they were investing in,” he says. “There is also a lack of information.”
Abate’s approach to syndicate mortgages is slightly different; the company only operates in the Toronto market. “We only fund projects and developers that we know,” he says, adding that one of the mistakes made on syndicate mortgages is not carefully monitoring the project and how the funds are spent. “There is a huge infrastructure boom going on in Ontario today and the projects we are focusing on are those that are 500 metres from public transit,” he says.
Mortgage brokers interviewed in B.C. and in Ontario pointed out the risks of real estate development. The major one is that the appraisal for the property’s value, upon which borrowed funds are based, may not be accurate or reflect current market values. Another is an improper site investigation. Site conditions that may impact site use include zoning problems or added construction costs as geological issues are encountered.
Saeed says that because syndicated mortgages come with risk, his firm requires that investors seek legal advice to understand what they are contracting to. “For every project we provide the investor with free independent legal advice (paid for by the developer),” he says.
The growing popularity of syndicated mortgages has prompted unlicensed companies to jump into the fray. In Ontario, the industry regulator is the Financial Services Commission of Ontario (FSCO), which late last year issued a consumer warning regarding syndicated mortgage websites operated by non-licensed entities. Only investors who participate with mortgage brokers that are registered with FSCO are protected, as FSCO holds those companies to a set standard. “These websites may refer to the investments as ‘pooled mortgage investments’ or ‘principal secured investments’,” FSCO cautioned.
As of July 1, FSCO has also issued new disclosure forms that mortgage brokers must fill out and give to clients or lenders involved in syndicated and other mortgages.
Jean Sorensen is a contributing writer for REM.
