The difference between mortgage investment corporations and private lenders comes down to bulk loan investments versus single loan investments. When choosing a corporation, the result is a diversified investment with guaranteed dividends. In this article, we'll cover why there's opportunity in numbers with mortgage lending for those seeking innovation during uncertain financial times.
What is a Mortgage Investment Corporation?
A Mortgage Investment Corporation (MIC) is a funding vehicle for investing in Canadian mortgages. Using a MIC, lenders pool their capital together to buy "mortgage shares" as a way to invest in an alternative investment. MICs eliminate the time and risk needed for the investors when investing in individual mortgages.
A MIC isn't just an investing "concept." MICs are actually labeled as special companies by the federal government under Section 130.1 of the Income Tax Act. In Canada, MICs account for the bulk of private mortgage issuance.
MICs are granted the power to borrow from banks, mortgage companies, and other lenders to fund investments. This borrowed capital is used in conjunction with investor capital to fund a mortgage portfolio. All MIC activity is regulated by the Office of Financial Sanctions Implementation (OFSI).
What MICs do in a nutshell
MICs are managed similarly to investment funds. Participants typically pay management fees that represent a percentage of the assets being managed. Business operations managed by MIC administrators include:
- Sourcing investment opportunities.
- Analyzing mortgage applications.
- Negotiating interest rates.
- Analyzing mortgage applications.
- Settling on terms and conditions.
- Dealing with legal representation.
- Fund administration.
Some of the legal requirements of mortgage investment corporations
MICs also have some special requirements. First, each MIC must have a minimum of 20 shareholders. However, no shareholder may hold more than 25% of a MIC's capital at any given time. This is what's referred to as being a "widely held" asset.
Restrictions also exist for how investments are spread across a MIC's portfolio. First, 50% of a MIC's assets must be made up of residential mortgages. While MICs are allowed to own real estate, they are restricted from engaging in "developer" activities. The restriction applies for both developing land and engaging in construction activities. To avoid any crossed wires, most MIC administrators stick to mortgage loans.
How are MICs different from private lenders?
The answer is volume. While private lending is focused on lending funds for a single mortgage, MICs are focused on investing in mortgage pools.
Think of MICs as REITs for lenders
For those who have been working in the real estate market, MICs probably sound very familiar. They are often confused for real estate investment trusts (REITs) because the two investment vehicles have many commonalities. In terms of analogies, MICs can be considered REITs for lenders.
Like REITs, MICs are alternative investments that utilize pooled funds for enhanced capital-raising potential. This makes REIT and MIC "entities" more competitive than single investors. This investment style is ideal for real estate because it allows investors to own portions of investments that would be financially inaccessible on an individual investment basis.
MICs and REITs also share the trait of allowing flow-through status for taxation of income, capital gains, and interest income. MICs are actually given preferential tax treatment that allows income and capital gains to flow directly to shareholders prior to being taxed. This translates to not being taxed twice for investors.
Other perks of MICs
Mortgage investment corporations are treated as a public company. The benefit of having that status is that the shares of the MIC are qualified investments for registered plans, including registered retirement savings plans (RRSPs), registered retirement income funds, and tax-free savings accounts (TFSAs).
Types of mortgages a MIC can offer
MICs traditionally offer short-term mortgages. Legally, they are permitted to invest in new mortgages. They may also invest in second, third, and fourth mortgages. MICs can provide options for borrowers having trouble obtaining conventional mortgages. This often includes self-employed borrowers, real estate developers, and newly established businesses. The perk of a mortgage investment corporation is that vetting for mortgage fraud, underwriting, and management of broker-client relationships are handled by the corporation administrators.
Generally, a mortgage investment corporation will can approve and loan mortgages and financial services that financial institutions wouldn’t. This means lending to borrowers with slightly off loan-to-value ratios. Although these investments may be ‘riskier’ (the MIC shareholders usually have some knowledge of the borrower beforehand), that added risk translates to high yields for the investors. Remember that MICs don’t compete head-to-head with large institutions on the mortgage market.
Establishing a MIC: inception, MIC shares, and governance
The process of setting up a MIC is similar to the process of setting up any type of Canadian corporation. The initial administration work includes:
- Electing directors/officers.
- Creating a faculty for appointing committees, hiring employees, and issuing shares.
- Creating voting methods for different share classes.
A MIC's first investment action occurs when an investor deposits funds into the MIC. This triggers the MIC's allotment of company shares in exchange for the capital. Under a MIC setup, each investor is entitled to a certain number of what are called "preferred shares." Preferred shares are important because they entitle each shareholder to a prorated share of the mortgage income generated by the MIC.
A MIC is continuously receiving funds from investors who purchase shares at fixed dollar amounts. These funds are then pooled to lend money for mortgages that will be paid back with interest by borrowers. MICs generate revenue from mortgage interest, fees, penalties, capital-gain dividends, and any property holdings owned by the entity.
How are MIC shareholders paid?
The income generated from loans is paid to MIC shareholders in the form of dividends. While interest income is the main source of MIC revenue, net income is calculated as the MIC's total revenues from all sources after operating expenses are subtracted. Under the Income Tax Act, MICs are required to distribute 100% of before-tax net annual income to shareholders as dividends. The Income Tax Act also stipulates that a MIC's annual financial statements must be audited.
Conclusion: MICs are great for diversification in lending
MICs offer consistent dividends with the Canadian flow-through tax benefit. Of course, the most important benefit MICs offer is access. Shareholders gain access to income through earned interest on a scale that would be impossible to reach as an individual investor. The transparency and regulation dictated by Canadian law also make this a preferred choice.
Frequently Asked Questions
Can a MIC invest outside Canada?
By law, all MIC investments must be made within Canada. However, MICs are free to accept investment capital from outside of Canada.
What are the benefits of investing in a mortgage investment corporation?
Like REITs, MICs allow individual investors to get "in on" a larger pool of mortgages that they would be excluded from when using their own capital exclusively. A MIC can be a strong tool for portfolio diversification because it provides steady dividends with a flow-through tax advantage. Lastly, MICs provide access to investing that is carefully managed by industry professionals in exchange for a small fee.
Where can you find more information about MICs?
The best way to start learning about the structure of Canadian MICs is by reading the official text of the Income Tax Act's section on Mortgage Investment Corporations.