There is a common misconception that only the Kevin O’Leary and David Thomsons of the world can get into the private lending business. With much of the category serving the commercial mortgage market, which is notoriously capital intensive, it is no surprise that many Canadians are under the assumption that they need to be tycoons to become private lenders.
This could not be further from the truth, however. Especially in more recent years, private credit has become not only institutionalized but also more mainstream among borrowers. According to a new CHMC report, MICs and private lenders held an estimated $10 billion in 2016, a number that rose to $13-$14 billion in 2018. Despite fewer mortgage originations, private credit also increased its market share to 1%; while that’s still a small figure in the context of the entire marketplace, private money is a fast-growing segment that is currently offering investors a great opportunity to participate early (and by “early” we mean before the category becomes oversaturated).
The investment vehicle has also become more straightforward and accessible with professional advisory, capital placement, and other assistive services now made available to investors who want to put their money to work. A firm like CLI, for example, delivers to various types of investors all the components (capital, access to borrowers, and a risk management strategy) needed to put mortgage lending in their portfolio.
Capital
The first and most obvious requirement is having access to capital for the purpose of lending out. Prudent investors choose to diversify their investments and in doing so diversify their risk.
Advice on how much of one’s liquid funds should be allocated to private lending varies. Some say as much as 20%, and yet others stick to a 10% ceiling. The amount of capital one invests in private credit depends on numerous factors like one’s risk tolerance, cash flow, and fiscal objectives.
Thanks to a favourable lending environment and a more mature mortgage industry, investors now have several options for a spectrum of capital sizes. Those who want to divide their liquid capital across several allocations, for example, can park some of their money in MICs (Mortgage Investment Corporations), which pool funds from multiple investors. Others who have sufficient capital can also work with entities that serve as consulting intermediaries and underwriters.
Access to borrowers
Establishing a good reputation and building a network in the financial and real estate industries take time. Those getting into the business of private lending will find that one of the greatest challenges is finding non-subprime borrowers (i.e. borrowers with lower risk).
There is always a reason that traditional lenders, who usually offer lower interest rates, are off the table for some people. While this does not necessarily mean that these types of borrowers will be unable to meet their financial obligations, it does indicate the presence of additional risks, and an alternative creditor should still set borrowing criteria.
Gaining access to a pool of filtered and vetted loans is like being handed the key to instant risk mitigation and better yield. Both MICs and firms that offer end-to-end solutions to private lenders can be expected to have a good selection of high-quality mortgages—ones whose borrowers are adequately and thoroughly scrutinized.
Accordingly, investors who want to work with these institutions must study the latter’s underwriting practices and criteria for borrowers. The firms’ policies and strategies should align with one’s investment profile to make sure that objectives on both ends are met.
Risk management strategy
How does the capital infusion improve the borrower’s cash flow? How much value will the asset have on the date of maturation? What are the real estate forecasts telling the market?
Answers to these types of questions not only convey a borrower’s ability to pay but also indicate the magnitude of the risks being taken. Not everything can be compensated with higher interest rates, and a private creditor must know where to look and which questions to ask in each unique deal.
Diversification is also an issue with which one must contend. In an effort to spread out the risks, some investors end up with a portfolio filled with non-complementary, low-quality ventures. Avoiding “diworsification” by assessing every opportunity can be time-consuming, defeating the purpose of passive investments.
An exit strategy is essential in every undertaking. For example, because longer loan durations mean higher risks, private loans are often short-term, with some maturing only after a month or so. Aside from excellent underwriting practices, private lenders should be able to examine every opportunity, weigh the costs and benefits, and derive an exit.
Hard-earned money goes down the drain when risks are not appropriately managed, and investors must utilize their resources efficiently so that risk mitigation and due diligence don’t take over their lives and other businesses. Employing a team of experts who can focus on the nuances of every mortgage scenario puts to better use one’s time, energy, and available capital.
Because there are several factors that impact even the most passive of ventures, people are intimidated by the concept of allowing money to grow outside the realms of more traditional income sources like business and employment. However, with institutionalized resources now made available, investing no longer has to be complicated. In the realm of private mortgages, CLI is one such institution that simplifies the lending process through a streamlined and hassle-free approach, whereby the investor is presented with a basket of already-filtered-and-vetted investment options.
A study commissioned by the British Columbia Securities Commission (BCSC) revealed that around 70% of Canadians don’t see themselves as investors. Even among those who did have investments, only 40% thought that the word “investor” described them accurately. Perhaps an introduction to mortgage-focused firms will improve these statistics and demonstrate the accessibility of passive investing.
