The question then becomes, How do you avoid syndicated mortgage investments with disproportionate risk/return profiles?
Below are a few things to consider before investing in a syndicated mortgage:
1. What are the funds being used for?
- For development projects, syndicated mortgage are typically used to refinance existing debt and/or to cover “soft” costs (eg. legal, planning, permitting, admin, etc.)
- For income producing properties, the borrower is likely looking to take equity off the table to deploy elsewhere
- Fees paid to mortgage brokers and others should only represent a small fraction of the use of funds
2. What is the loan-to-value ratio (LTV)?
- LTV determines how much debt is on a property relative to the value of it. Generally speaking, a lower LTV means a more secure investment
- All syndicated mortgage investment opportunities should disclose the LTV
- Finally, the property value should be determined by a reputable independent appraiser
3. Where does the syndicated mortgage rank in the event of default?
- Syndicated mortgages are often a second mortgage. Second mortgages rank behind first mortgages (senior debt)
- If a syndicated mortgage ranks behind a first and second mortgage or if the LTV is high prior to considering the syndicated mortgage, you should proceed with extreme caution as the risk profile of the syndicated mortgage may be mimicking that of an equity investment which carries much greater risk
- As an investor, you should consider where you rank in the event of a default and if there is enough security to cover your investment
4. Is there collateral security?
- To reduce the risk profile of a syndicate mortgage, the borrower may provide collateral security which may include a blanket mortgage or general security agreement on other assets and/or personal guarantees
- Collateral provide investors greater comfort in the event of default. Even if the subject property cannot recover all the capital, investors will have security on other assets that may make up the difference
5. Risk Disclosure
- Are the companies that are selling you the investment providing you with adequate disclosure of the risks? No investment is risk-free or guaranteed so be aware of companies that claim this.
- Generally speaking, investments that are earlier stage will have a higher risk profile (eg. An office building that is being developed is riskier than an office building that is complete and has tenants paying rent). Higher risk investments should provide higher returns.
6. Is the company offering the investment licensed?
- The companies selling the syndicated mortgages should be licensed by either securities or mortgage investment regulators
7. Who are you investing alongside?
- Investing alongside sophisticated investors who manage a syndicated mortgage provides you with the piece-of-mind that in the event of a default, you will have a professional group working with you to recover your funds
- Investing alongside novice investors may leave you poorly represented in the event of default making your investment a nightmare
Syndicated mortgages are a great way for investors to gain exposure to private real estate investment opportunities and for developers to raise capital at lower costs but the returns must align with the risk profile. If not, you may be exposing yourself to equity risk for debt returns.