The global economy faces numerous challenges in 2024, including slowing economic growth, inflation and financial risks, geopolitical tensions, and evolving central bank priorities. For investors, these challenges demand a more cautious and strategic approach to portfolio construction than those promoted by traditional investment managers. To navigate these uncertainties, investors are increasingly turning to alternative investments to boost returns and reduce overall risk in their portfolios. In this context, private mortgages emerge as a strategic investment option, particularly during periods of economic uncertainty and interest rate fluctuations.
Understanding Private Mortgages
In Canada, private mortgages are loans provided by private lenders rather than traditional financial institutions like banks or credit unions. Private mortgage lenders are typically individual investors or private lending corporations that specialize in mortgage services. Private mortgage investors are often high-net-worth individuals, family offices, institutional investors, and private corporations. They are drawn to private mortgage investments for their potential to provide returns that are uncorrelated with public markets and predictable cash flow.
Because private mortgage lenders aren’t bound by the same rules and regulations as traditional banks, they offer more flexible lending arrangements. This flexibility allows them to focus more on the value and equity of the underlying property rather than solely on the borrower’s income and credit history. Because of these flexible lending terms, private mortgage lenders typically charge higher interest rates and fees than traditional banks.
Since the 2008 financial crisis, millions of Canadian borrowers have turned to alternative lenders to secure their first and second mortgages. Although private mortgage borrowers typically pay higher interest rates, they’re not subject to stringent stress tests, debt servicing ratios, limited refinance activities, and rigid income verification processes that characterize traditional bank loans.
In Canada, private mortgage lenders are regulated provincially rather than federally. The regulatory framework varies by province, and each province has its own set of rules and requirements. Common elements of provincial regulation for private lenders include licensing and registration, consumer protection, interest rate limits, compliance and disclosure requirements. Private mortgage lenders are also subject to national oversight through the Financial Transactions and Reports Analysis Center of Canada (FINTRAC). Provinces may have specific requirements related to anti-money laundering (AML) and compliance that align with federal regulations enforced by FINTRAC but are tailored to provincial contexts.
Understanding Traditional Investments
Traditional investments are well known options, such as stocks, bonds and mutual funds, that investors use to build a diversified portfolio, manage risk, and achieve financial goals. They are distinguished by their long-standing history, liquidity, and widespread use in investment strategies.
For decades, traditional investments have formed the foundation of most investment portfolios, with the “60/40” allocation of stocks and bonds being the most popular strategy. These investments offer diversification, liquidity, and a strong historical track record of performance.
Despite these benefits, traditional portfolios are exposed to various risks, including market risk, economic risk, and interest rate risk. These risks are often magnified during shifts in monetary policy, as changes in interest rates can impact bond prices and other interest-sensitive assets. When interest rates rise, bond prices typically fall, and vice versa.
The Impact of Economic Uncertainty on Traditional Investments
Despite their established track record, traditional investments like stocks and bonds are highly sensitive to economic trends and monetary policy. As recently as August 2024, stock markets experienced unprecedented volatility after the Bank of Japan raised interest rates to multi-decade highs and the United States Federal Reserve kept its policies unchanged.
Economic uncertainty has a long track record of driving stock market volatility, especially when shifts in economic trends are sudden or unexpected. The threat of a recession or an inadequate central bank response to a changing economy affects investor risk sentiment and behaviour, often triggering risk aversion, panic selling, or asset reallocation. Changes in the business cycle also impact corporate earnings and valuations, which also influence market returns.
Economic downturns can also affect real estate investments, leading to lower demand and falling property values. Downturns that are accompanied by rising unemployment can also trigger foreclosures and distressed sales. For investors, economic instability can lead to higher vacancy rates and a loss of rental income as tenants struggle financially.
Benefits of Investing in Private Mortgages During Economic Uncertainty
Private mortgage investments are not affected by the same factors as traditional investments, providing non-correlated returns that make them suitable during periods of economic uncertainty.
Because private mortgages are non-correlated with public markets, they have historically provided higher returns than traditional fixed-income investments, such as bonds. These higher yields can be particularly appealing when returns on traditional assets decline during economic downturns. Private mortgages also provide predictable income, paying investors interest collected from mortgage borrowers, typically monthly
Private mortgages can also add diversification to an investor’s portfolio, reducing their overall portfolio risks. By investing outside of traditional asset classes and industries, portfolios can mitigate against economic uncertainty. Private mortgages have historically been less susceptible to stock market and bond market fluctuations, changes in monetary policy, or shifts in the business cycle.
Private mortgages are backed by residential property. In the event of borrower default, the investor has a tangible asset to fall back on, which can potentially be sold to recoup the investment. This security can provide a layer of protection not available with unsecured investments.
Navigating Interest Rate Fluctuations with Private Mortgages
The global economy is entering a delicate interest rate environment, as central banks seek a more balanced approach to monetary policy. Central banks in Canada, Sweden, Switzerland, Japan, and the eurozone have already lowered interest rates this year. The US Federal Reserve is widely expected to begin lowering interest rates in September, while the Bank of Canada has cut rates twice this year, with additional cuts anticipated in the fourth quarter.
Private mortgages can adapt to interest rate changes because they typically have shorter terms. While terms can extend up to three years, the average private mortgage has a term of 12 months. If inflation leads to higher interest rates, the rate on these mortgages can reset and increase at renewal, providing higher income to investors. In a lower-rate environment, private mortgages still provide higher yields than other fixed-income assets, as mentioned above.
Considerations and Risks
Private mortgage investing offers broad diversification benefits, the potential for higher returns, and an asset-backed investment opportunity that’s non-correlated with public markets. Before investing in private mortgages, investors must conduct thorough due diligence, including comparing private mortgage investment opportunities and providers. Investors should also consult with a financial advisor to ensure that private mortgages align with their investment goals, investment horizon, and risk tolerance.
Case Studies and Historical Performance
Private mortgages have historically shown resilience and adaptability during periods of economic uncertainty. Following the COVID-19 pandemic in 2022, global stocks and bonds declined sharply, marking one of the worst years for financial markets in decades. Private mortgage investments outperformed during this period, providing investors with predictable returns that were non-correlated with public stock and bond markets.
The pandemic caused widespread disruptions in employment and income stability, increasing the need and demand for private mortgages, especially among borrowers struggling to secure traditional financing to refinance their homes. Private mortgage investors saw an opportunity to provide these borrowers short-term, higher-interest loans, (reflecting the risk associated with their financial situation). While these mortgages offer higher yields, strategic diversification and predictable income, they also play a crucial role in helping borrowers navigate challenging times and stabilizing their financial situations.
How to Get Started with Private Mortgage Investing
Before investing in private mortgages, it’s important to research and compare reputable private mortgage providers. Leading Canadian private mortgage lenders have an established track record in the mortgage market, employ rigorous due diligence processes, and have an in-house team of mortgage experts, adjudicators, and investment professionals.
A reputable private mortgage company can facilitate your entire private mortgage investment, including presenting you with customized opportunities based on your investment goals and risk tolerance. They will present you with the most suitable investment opportunities based on factors such as mortgage type, security position, property type and location, interest rate, loan-to-value ratio, and borrower profile. They will also monitor and manage your mortgage investment throughout its term to help safeguard your investment. This allows you to invest with confidence and enjoy a hands-free experience..
Conclusion
From attractive interest rates to portfolio diversification and real estate collateral, private mortgage investing offers numerous benefits during periods of economic uncertainty.
CMI Financial Group is one of Canada’s largest and fastest-growing private mortgage lenders. With nearly $3 billion in lifetime mortgage fundings and more than $1 billion in mortgage assets under management, CMI has navigated investors through complex market cycles and economic shifts. To explore how to make private mortgages a part of your investment strategy, contact one of our investment professionals today for a free consultation.
