For decades, real estate investing has been a preferred method of portfolio diversification and inflation hedging. Having a higher net worth made it easier to invest in multiple properties for cash flow and passive income. As property values soared in the 2000s and 2010s, real estate holdings provided capital appreciation in addition to passive income. However, recent shifts in monetary policy and market dynamics have made it more difficult and less lucrative to successfully manage investment properties.
Real estate investing has historically proven to be advantageous for high-net-worth investors. Over the past 50 years, investing in real estate has delivered very similar inflation-adjusted returns to the stock market—only with much less volatility and higher levels of income. Real estate is its own asset class and has different attributes than equities and fixed income, making it a good portfolio diversifier.
Whereas smaller investors usually invest in real estate for the purpose of renting out the units, high-net-worth investors often engage in “land banking,” or buying vacant land on the expectation that it will one day be converted into residential or commercial property. Wealthier investors also have more capital to invest in multi-family units with higher recurring revenue potential. With median home values doubling over the past decade, real estate investors have enjoyed strong capital appreciation, especially in major metropolitan centres such as Toronto and Vancouver.
Despite boasting attractive historical returns, real estate investments aren’t without risks. Compared to stocks, real estate is illiquid, making it harder to sell quickly. The challenge of finding a suitable buyer grows when an investor is trying to sell a large investment property, such as an apartment complex or other multi-family units. Real estate transactions are often costly, with commissions, legal fees, and other expenses costing upwards of 5% of the property’s total value.
Owning real estate also carries high overhead expenses—insurance, mortgage payments and utilities, to name a few—which magnifies the investor’s risks when the units are vacant. Even when units are occupied, managing relationships with tenants is often time-consuming and challenging.
As real estate investors are finding out now, one of the biggest risks with holding investment properties is entirely out of their control: interest rates.
A Shifting Landscape
Investors and homeowners have grown accustomed to ultra-low mortgage rates, so when the Bank of Canada (BoC) raised interest rates to 22-year highs, there were major ramifications for new investors and mortgage holders with upcoming renewals. The BoC influences mortgage rates indirectly through monetary policy that impacts the price of credit, especially for banks. These banks then pass on the higher costs to consumers, usually in the form of higher interest rates on a variety of products. With the BoC committed to tackling inflation, interest rates are expected to remain higher for longer—and this means no mortgage relief anytime soon.
At the same time, home values are down from their peaks. According to the Canadian Real Estate Association (CREA), benchmark home prices are down 13.1%, or $124,900, from their March 2022 highs.
Against this backdrop, owning income properties is no longer economical, according to BMO economist Robert Kavcic. “Investors are almost completely absent from the Canadian housing market, especially in Toronto (maybe not so in Calgary),” Kavcic told The Globe and Mail. “No surprise there, because the economics just don’t make any sense right now.”
According to Kavcic, income investors are “deeply cash-flow negative with 20% down at current prices and mortgage rates.” While this was a problem before the BoC’s current tightening cycle, it was mitigated by ultra-low interest rates and rising property values. “Now, investors are largely cash-flow negative even on the interest portion of their payments,” he said.
Existing investors who are still locked into lower mortgage rates are also seeing less capital appreciation, but they’re benefiting from higher rents. The average asking rent in Canada has risen to $2,078, a new all-time high, according to Rentals.ca and Urbanation. Rent prices are up 21% over two years.
Benefits of Mortgage Investing
High-net-worth investors who still want the benefits of real estate without the risks are increasingly turning to private mortgages. Mortgage investors act as private lenders to a growing segment of the residential mortgage market; they lend to borrowers needing short-term financing – such as to fund their next home purchase, finance a renovation project or consolidate high-interest debt – but unable to qualify with a traditional lender
Mortgage investing provides direct exposure to the residential real estate market but without the risk of homeownership or title transfer. Unlike investment property, mortgage investing doesn’t carry significant overhead costs or potential liquidity constraints, negative cash flow, tenant management and vacancies. As a result, investing in the mortgage market is potentially less volatile than owning physical property Mortgage investing is suitable for cash-flow-focused investors who want to earn regular income instead of relying on potential capital appreciation. Historically, top-performing mortgage investment portfolios have generated returns of between 6% and 16% annually.
Investing in private mortgages allows wealthy investors to put their capital toward one of the fastest-growing segments of the alternative investmentg space. Whole mortgage investment programs offered by reputable non-bank lenders can provide a more attractive risk/return profile that is specifically tailored to the needs of the investor. To access whole mortgage programs, investors generally need to have at least $500,000 in liquid capital. If you live in Ontario or British Columbia, a minimum net worth of $1 million and a net income before taxes of at least $200,000 are required. In all other provinces, a minimum net worth of $500,000 is preferred.
Not all private lenders are created equal. CMI Financial Group is one of Canada’s fastest-growing non-bank financial services providers, with more than $2 billion in lifetime mortgage placements. What sets CMI apart from other mortgage lenders is our commitment to our clients, partners and investors. Our mortgage portfolio has an exemplary track record, backed by a national footprint emphasizing geographic diversification and industry-leading underwriting and due diligence practices.
To learn more about how private mortgage investments can fit into your portfolio as a defensive, cash-flow investment, contact CMI today to schedule a free consultation.