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Primer on Mortgage Investment Corporations (MICs)

A regular reader emailed me about how his financial advisor recommended that he invest in Mortgage Investment Corporation (MIC) and was wondering if they were a good idea or not.  Seeing that I’ve never heard of a mortgage investment corporation before, I had to do a little digging to get the details.

What is a Mortgage Investment Corporation (MIC)?

These companies provide “private” mortgages to mostly residential properties at higher than posted rates.  These private mortgages are funded by investors (and banks) and in return, they get a portion of the mortgage return.

A MIC is structured very similarly to an income trust where they “flow through” all of their income to investors.  With this type of business structure, the MIC will face very little or not tax which gives it the ability to pay higher distributions.  On the flip side, it means that it’s the investors who foot the tax bill.  More on taxation below.

One thing to note though that MICs lend money to borrowers who can’t qualify for traditional mortgages offered by the big lenders (big banks etc).  This would lead me to believe that these borrowers have sub par credit or other blemishes to their financial record.  This is something to keep in mind when evaluating the risk in these investment vehicles.

Where can they be held?

MICs are eligible to be held in taxable and tax sheltered accounts like RRSPs and RRIFs (maybe even TFSA?).

Taxation

MIC distributions are treated like interest income if the MIC is held outside of an retirement account.  What does this mean?  If you receive $100 in distributions from a MIC, then you’ll basically add $100 to your earned income for the year.  So if you’re marginal tax rate is 40%, then you’ll owe $40 in tax.

What are the Returns?

Like any investment, the returns can vary.  From my research however it seems that most return around 8-10% in distributions (after their fees).  However, these numbers are based on the past and do not indicate future returns.  Who knows what the returns would be like with increased defaults during a recession.

What are the Fees?

From my reading of various MIC’s available, they typically charge a 1.75% – 4% MER range.

What I like

If you are interested in investing directly in private mortgages without all the administrative headaches, then a mortgage investment corporation may be the answer.

What I don’t like

To me, there seems like a lot of risk investing in a mortgage investment corporation.  Most MICs require a substantial investment ($25k+) and a long minimum investment period (3 years +).  To top it all off, the invested capital or distributions aren’t guaranteed like a longer term GIC.  Even though most investments do not guarantee capital, the lack of liquidity is a real turn off.

As well, like I mentioned above, default rates on mortgages funded by MICs may be higher due to who they are lending to.  Poor credit in conjunction with higher mortgage payments sounds like a mistake waiting to happen.

Conclusions

While MIC returns sound ok on paper, my question is, why not simply invest in a REIT?  While a REIT typically distributes rent collected to investors instead of interest from mortgages,  their distributions are similar along with the benefit of high liquidity.

Overall, I give MICs a thumbs down, mostly due to higher risk and lack of liquidity (ease of selling).  In my eyes, a REIT would be a much better choice.

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40 Comments

  1. mojo30 on April 14, 2009 at 11:19 am

    I would not lend my money to people unless they have good credit and so I would not invest in this type of biz…I think that the chances of someone paying you back is maybe 50%..too much risk IMO..

  2. FrugalTrader on April 14, 2009 at 11:27 am

    I’m willing to bet that there’s a good kickback to the financial advisor who recommends these products.

  3. Dividend Growth Investor on April 14, 2009 at 12:10 pm

    When you mentioned that MIC could invest in subprime mortgages that really turned me off of this vehicle. Invest in REITs instead.

  4. Taz on April 14, 2009 at 3:17 pm

    I would certainly agree with the liquidity issue of an MIC. What about for someone who is able to maintain liquidity through other means? My limited searching would indicate that your initially invested prinicpal has more protection in a MIC than in a REIT.

    To me (limited research) it would appear that an REIT would be a better wealth building tool with an MIC being a better income generation tool.

    Opinions?

  5. FrugalTrader on April 14, 2009 at 3:31 pm

    Taz, MIC’s do not protect your principal (from the research that i’ve done), they’re not liquid, and their distributions are not guaranteed. Those are the reasons why I would choose a REIT over a MIC.

  6. InvestAssetWealth on April 14, 2009 at 5:05 pm

    Great primer on Mortgage Investment Corporations FrugalTrader. Much agreed, the cons you have outlined are indeed the major turnoffs. Large initial investment, long minimum time horizon, and lack of liquidity. There are better vehicles available to receive 8%-10% returns out in the market.

    InvestAssetWealth

  7. Ryan C on April 14, 2009 at 8:42 pm

    FrugalTrader – actually most MIC’s do not pay a good “kickback” to financial advisors which is why most investors (even those that are quite experienced) have not heard of them. Most MIC’s only pay a 1-3% commission – often without a trailer – so advisors go after greater commissions available through other securities. It’s unfortunate because MIC’s are EXCELLENT investment vehicles. A well structured MIC offers excellent security (mostly 1st mortgage position) with relatively low loan-to-value ratio’s and they yield in the 8-12% range. They are FAR more secure than REIT’s which are subject to the (ir)rationality of the market (at the least the public ones are). REIT’s issue units which are back by the Trust which, in turn, is backed by the underlying assets (real estate). MIC’s issue shares which are backed directly by the asset (real estate) via a loan – this gives a MIC investor much better security – assuming good MIC structuring.

  8. Jordan on April 14, 2009 at 8:52 pm

    I’d also suggest linking to and readers checking out a similar article on the Canadian Financial DIY blog: the “Ins and Outs of Mortgage Investment Corporations” I found it to be a good complimentary article, and also has links to many different MICs, including ones with only a $5k minimum purchase.

    http://canadianfinancialdiy.blogspot.com/2008/05/ins-and-outs-of-mortgage-investment.html

    I’d consider expanding my REIT realestate holdings to include an MIC especially since I’m not currently a home owner. At the moment I would completely avoid investing in any that are completely in BC, Alberta or Ontario. I feel these real estate markets will continue to face steep property declines. Vancouver is falling faster then any US housing market did when they started their declines 2 years ago and owners are extended more then anywhere else. This will eventually result in a high rate of foreclosures as speculators and then families are quickly pushed underwater and beyond their means. Since it’s my understanding that many MIC loans are in the secondary position on the mortgage they’d be hit first.

  9. Houska on April 15, 2009 at 12:19 pm

    Guys – agree with what has been said, but I think you have to be careful with the REIT vs MIC tradeoff. REITs are an exposure to the real estate asset class, pure and simple. It sounds like MICs are a packaged income product “guaranteed” by real estate assets – so more like high-yield (and higher risk?) fixed income exposure with an additional exposure to broad-based real estate market downturn. If you want real estate exposure in your portfolio, it doesn’t sound like MICs will give it. If you want high-yield income products, REITs will give that only indirectly and not directly.

    I share the concern that I would dig a lot deeper and suspect MICs are likely a niche product, but I’d be worried about treating REITs and MICs as substitutes.

  10. LuLu on April 15, 2009 at 1:54 pm

    How about private mortgage (aka 2nd mortgage or arm’s length)? You can lend out your money to a borrower charging 13% interest, and the loan is backed by the borrower’s real estate. The risk can be mitigated if the loan to value of the house is low (ie 80% or so). Isn’t this a better vehicle than MIC or REIT?

  11. FrugalTrader on April 15, 2009 at 1:57 pm

    LuLu, the advantage of a MIC over holding a 2nd mortgage privately is diversification. A MIC can hold hundreds or thousands of mortgages which helps curb the risk of default.

  12. Rory Campbell on April 21, 2009 at 2:57 pm

    Hi,
    REITS are equity investments and MICS are debt investments. Debt takes priority to equity when there is a default.
    I am the president of 3 MICs and we have a minimum investment of $5,000 and there is no minimum term of investment. We have never missed a dividend in 15 years and the yeilds of our funds have been between 8 and 13.79%. We have never paid a commision to financial planners and our portfolios are under 75% advance against value.
    Do your homework and seek transparency and complete disclosure and you will find an investment that has dramatically outperformed the market.

  13. FrugalTrader on April 21, 2009 at 3:02 pm

    Hi Rory, thanks for the feedback. Is there a site in Canada that compares MIC’s? There seem to be many with fairly significant differences between them in terms of minimum investment, minimum term etc.

  14. LuLu on April 21, 2009 at 3:11 pm

    Hi Rory, the only MIC I found so far with $5000 investment is ACIC Investment. However, this is not applicable to Ontario, as the requirement of “accredited investor” (net worth $5M or annual income 200K or liquid asset 1M) kicks in. Do you know if there’s any MIC that accepts TFSA?

  15. Rory Campbell on April 21, 2009 at 3:16 pm

    I am unaware of anyone that does a comparative analysis of the various mics in Canada. There are significant differences and investors should do their research. Don’t be afraid to ask questions and if you don’t get the right response don’t invest.

  16. Rory Campbell on April 21, 2009 at 4:38 pm

    Hi Lulu,
    We accept TFSA and have done so for several clients. There are severalother MICs that also accept TFSA. Some of the trustees that offer self administered RRSPs also do TFSA. We have dealt with Olympia Trust, National Bank Financial and Canadian Western Trust for these products. You can call 1-800-667-0440 and our admin staff can probably answer your questions. They know more than me about TFSA.

  17. Daniel Wintschel on April 27, 2009 at 4:35 pm

    I think that maybe there’s a few things I’d like to add. Probably like a lot of investments, there are great ones and bad ones, but a couple things.

    1) A MIC is not limited to lending for the purposes of residential mortgages. They can lend to developers, as well as do construction loans and land-servicing loans (but can not do construction or development themselves). The quality of the debt can be extremely high.

    2) Minimums. There are several MICs that have $5K – $10K buy-ins for minimum investments, which is not an unreasonable amount, especially when using something like a Manulife One / Smith Manoeuvre combo.

    3) Liquidity. There is risk here, but for example, one MIC I know of has a 3-year term, but it is liquid. The way the penalty works is that if you withdraw after 1-year, you only earn ~3% return. If you withdraw after two years, you only earn ~7.5% return, whereas if you hold for the full 3-year term, you get the full 12.5% (which is a fixed minimum). I imagine this changes significantly from company to company.

    4) Stability. I know a few realtors (and other investors) who have been invested in MICs (not sure which ones) for many years. Based on discussions with them, I hear over and over that on average, even in bear markets – they’ve seen a 9% return on average, have never lost capital, and have never missed a distribution.

    5) Tax (in)efficiency. I agree that it’s a bit of a bummer that you’re paying full income tax rates.

    6) Security. For me, I’d rather have my money here than in the market – I guess it all depends on what you perceive to be a safer investment, or better protection of your capital. At least with a MIC – the debt is backed by a tangible asset (land) as opposed to a paper asset (the market).

    7) Transparency. MICs must have yearly audited financial’s, just like any publicly traded company.

    Just my $0.02. :)

  18. Aniz Vasanji on May 22, 2009 at 6:51 pm

    I work for a Private Equity REIT company
    – minimum investment is much lower – $1000
    – we have various investments – REITs, Real Estate LPs, Term Inv…
    – liquidity – 5% penatly in the first 3 years and 90 days notice
    – Stability – Term investments have principal protection and higher returns then the typical GICs
    – REIT pays a fixed annual distribution – current yield is 9.9% and also provides growth
    – Real Estate LPs target a return of 19%, last one had ROI of 30%
    – Tax Efficiency – income is predominantly RETURN OF CAPITAL (ROC) – much better tax-efficiency
    – Security – underlying investments are all invested in Real Estate so backed by tangible assets
    – Transparency – Stmts Audited by KPMG

  19. Jordan on May 26, 2009 at 4:14 am

    The thing that I don’t understand about a MIC is how can the annual return be so much higher then the current interest rate on mortgages? Considering the MIC just flows all of the income through, and has overhead of its own I would imagine the rate of return would always be lower then the average lending rate over about the past 5 years.

    Can Roy, Danial, Aniz or anyone else explain this to me?

  20. cannon_fodder on May 26, 2009 at 11:08 am

    Jordan,

    You’ll notice that in the first few paragraphs these aren’t mortgagees that can qualify for traditional mortgages at or near posted rates, let alone lower than posted rates.

    These could be 2nd mortgages, bridge loans, and first mortgages to people whose credit score is so low as to qualify for only higher rates from lending institutions still willing to take a chance.

  21. Alta Pacific Mortgages on May 28, 2009 at 9:21 pm

    I first came upon this post on the weekend and have been checking back often as I’m finding the dialogue very interesting and informative. A mature group of folks here talking (not like some comment strings that get off topic in a hurry)

    Here’s my quick story. I started buying RSPs out of college and tried SDRPs through a TD Waterhouse account. My performance was poor to say the least. I then transfered my RSPs to a financial planner that my family knew well (the guy is older, has done it his whole life and quite well off). I found mutual funds to be very benign and the performance was below my expectations (and excuses plentiful and complicated). During the same period, I invested my non_RSP savings in real estate (I bought a rental property in Chilliwack, BC) and made a nice chunk of change in the four years that I held it. This SOLD me on real estate as an investment vehicle. I wanted out of mutual funds, stocks or anything that I didn’t really understand (try reading a mutual fund report).

    So I called a long time friend that had moved to Edmonton (who I knew was very smart and savvy in real estate). I told him my story and he said, “we’re starting a MIC” … that was in 2007.

    Fast forward to 2009 and our MIC is up and running. It’s a young fund and yet the partners are experienced (not I mind you… but I’m no slouch and I’m getting up to speed fast! Plus, I love telling my story to potential investors). I appreciate Rory Campbell’s comments on this string and agree with his comments about transparency and full disclosure – something that we’re passionate about in our MIC.

    I just want to share my “gut thoughts” on investing (and especially in regards to investing in a MIC) … First off, we all know there are plenty of investment products in the market and all have their pros and cons. I like MICs because I understand how they work (and I like the returns they provide to investors). Some of the cons that FrugalTrader speaks of are only cons if the MIC is managed poorly… I’d say that “managed poorly” pertains not just to a MIC but to public and private companies in any market. I say, do your research on whatever product/vehicle/stock/company/fund/you_name_it you’re considering and get the real goods. If you’re considering a MIC, talk to the men and women that are running it and like Rory says, walk if you don’t like what you’re hearing. I know when it comes to “big” investment products there isn’t really anyone to talk to (that REALLY knows the details).

    I think I’m already getting long winded so I’ll keep checking back and perhaps chime in with more of my thoughts and comments later.

  22. maddog1965 on June 4, 2009 at 2:25 pm

    What I don’t like about REITs is that the share price rides with the real estate market and the stock market, and can be quite a roller-coaster. High liquidity is an advantage only if you can sell at any time without capital loss.

    REITs don’t always yield more than MICs. Before the crash from 2007 to 2008, few REITs had a yield of 8%. Also, you have to pay commission to buy REIT shares, but not to buy MIC shares unless within a registered account. MICs don’t pay advisors.

    I invested in REITs through real estate mutual funds. I got out at the top near the end of February 2007, and never looked back. For the past year, I have invested in a MIC that pays 8% with no volatility, and I’m happy with it.

  23. Aniz Vasanji on June 4, 2009 at 3:24 pm

    Maddog – your comments are true about Public REITs, but not true about Private REITs – you don’t experience the volatility of the stock markets with Private REITs

    Distribution wise, the distributions from a MIC are deemed to be 100% interest income. with both Public REITs and Private REITs, you will find that the composition of their distributions are Return of Capital (ROC), Interest Income and Capital gains – composition varies by company – I work for a company where the composition is 100% ROC – many people are under the understanding that ROC means that they are getting a portion of their capital back. Not true when it comes to REITs. Its is an accounting strategy that allows the company to convert interest income into ROC. When comparing distributions, you need to look at what your after tax return is (i.e. MIC vs. REIT)

    If I can offer you a REIT with a 9.25% yield and where the distribution is 100% ROC, would you be interested?

  24. maddog1965 on June 4, 2009 at 8:38 pm

    If the share price is fixed, I would be interested.

  25. Aniz Vasanji on June 4, 2009 at 8:51 pm

    yes share price is fixed at $1.00 per unit – this is a term investment and you get your principal back at the end of the term, plus the monthly income.

  26. Jordan on June 4, 2009 at 8:55 pm

    Aniz Vasanji, don’t you have a website for your MIC?

  27. Aniz Vasanji on June 5, 2009 at 4:01 pm

    Hi Jordan,

    Just to clarify, this isn’t a MIC – its a term investment, the underlying asset is a REIT – here’s a link to the information on it http://www.league.ca/pdf/IPUnit-highights-booklet.pdf – note that the rates will be changing on or about June 9th or 10th so the brochure will be updated so anyone interested can contact me for the new rates (one of the new rates will be a 5yr term @ 9.25%)

    By the way – would your name happen to be Jordan Frenkol?

  28. Aniz Vasanji on June 5, 2009 at 4:10 pm

    I forgot to mention – at the back of the brochure there is a page called Notice of Interest – anyone sending this in, just write my name on there and then I can send you more info

  29. FrugalTrader on June 5, 2009 at 4:22 pm

    Aniz,
    Soliciting business is not allowed, sorry.

  30. Maddog1965 on June 5, 2009 at 5:17 pm

    Aniz,

    Will you explain the accounting alchemy that transforms 100% rental income into 100% ROC for IGW REIT?

  31. Aniz Vasanji on June 5, 2009 at 5:39 pm

    If you purchase a property, each year CRA allows you to write-off 6% of the depreciation as Capital Cost Allowance, therefore any revenue you generate, can be off-set against the Capital Cost Allowance

    Sorry FrugalTrader

  32. Maddog1965 on June 5, 2009 at 6:51 pm

    Aniz,

    At 6%, CCA itself declines at a rate of 6% per year in dollars. If there is 9.25% cash income to distribute, how can you have enough non-cash expenses (depreciation) to offset all the income to make it 100% ROC? You may have 25%, even 50%, ROC, but if it is 100% ROC, the price can’t be fixed.

  33. Aniz Vasanji on June 8, 2009 at 12:57 pm

    there is a build up of depreciation as you buy more properties – each year you are acquiring new properties – the nature of this investment is a term investment with a fixed distribution, so the distributions will stay fixed till the end of the term similar to a GIC where the rate is what you get for the duration of the term. Also, like a GIC, the price will stay flat and will not fluctuate

  34. Maddog1965 on June 8, 2009 at 4:20 pm

    It doesn’t matter how many more properties you buy, each new property brings more rental income to offset with CCA, as one would hope. If everything goes right, each building always generates more income than CCA. The question is how much more. I think rental income should be at least twice as much as CCA. There simply isn’t enough CCA to provide 100% tax-free income (80% in the brochure) when occupancy rate is high and rental income goes flat or up while building book value and CCA go down. Either you are overstating tax efficiency (ROC), or your properties are not generating enough income to cover depreciation by a significant margin.

    I understand that the terms of the IPU imply your willingness to fix the price, but if ROC is more than what CCA alone can produce, there is a question of your ability to fix the price.

  35. Aniz Vasanji on June 8, 2009 at 6:56 pm

    The target is 80%, however the actual for 2009 will be 100% ROC – we buy under-developed,and under-capitalized buildings – the buildings are then, in most cases, re-developed (upgrading and modernizing the buildings – expanding the leasable spacing) all costs associated with each of the properties in the portfolio gets added onto CCA – while these properties undergo renovations, the occupancy rate is low, therefore the revenue from these properties in the first year is low, so in a lot of cases, in the first year, the CCA is more than the revenue from the properties – distributions are also paid out from investment income, resell of properties and 2nd mortgages – going forward your analysis will be correct where revenue will be more than CCA

  36. Maddog1965 on June 9, 2009 at 5:15 am

    Thanks, Aniz. That explains it. The IPUs do seem better than most, if not all, MICs, especially after tax.

  37. Aniz Vasanji on June 9, 2009 at 1:42 pm

    you’re very welcome – glad I could help answer your questions.

  38. BidAsk on March 12, 2010 at 2:39 am

    MICs are very different than REITs. The per unit/share price of REITs can fluctuate largely just like common stock. This is the same reason why contrary to popular belief certain bonds, like long-term 10 or 30-year bonds can be very risky for a conservative income investor – if the funds are required prior to maturity there can be large gains or losses associated with that situation.

    With MICs there is no capital gain/loss portion, just the income, with the original principal received upon redemption.

    This is a big difference and is a large reason why MICs can be a good product for certain people.

  39. FrugalTrader on October 17, 2010 at 8:54 am

    Reading through this thread again with great interest. With recent interest in private REITs, i’m especially interested in what Aniz has explained. My question is directed to Aniz, can the investor participate in the capital appreciation of the property like other private reits offer?

  40. fudgecake on November 18, 2010 at 10:29 pm

    Firm Capital Mortgage Investment Trust is converting to a MIC in January 2011. At this point it trades like a regular stock and apparently it will trade as a stock after conversion. It has an excellent reputation. I’ve owned it for years.

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