With the real estate market evolving, investors are searching for more ways to grow capital. Syndicated mortgages have emerged as a way to invest in large development projects without buying a property and provide high returns with real estate security. Nevertheless, there are some risks associated with these investments that are typically not made apparent when comparing them to private lenders.
This article considers the mechanics behind syndicated mortgages, the typical type of investors in them, and both the upsides and downsides. We will also compare them to private lending to help investors determine if they meet their goals and investment appetite.
What Is a Syndicated Mortgage?
In these mortgages, multiple investors collectively contribute funds toward financing a single real estate development or construction project. These are typically mortgages secured against real property and are offered by mortgage brokerages that require licensure under provincial regulations.
Syndication is for risk dispersal, providing opportunities to engage in large-scale projects without making heavy individual capital commitments. These syndicated mortgages are more commonly used for new condominium developments, commercial buildings, or multi-residential projects than for individual homes or smaller residential loans.
How Syndicated Mortgages Work
Syndicated mortgages are established when developers require funding but can’t access traditional financing. Investors pool funds through a legal agreement that outlines their shares and returns.
Loans are disbursed to the developer in stages, usually upon fulfillment of construction milestones. Investors may receive interest payments in return throughout the tenure of the loan, typically at rates higher than those offered by conventional fixed-income products. The principal will be returned to each investor alongside any outstanding interest.
The legal documentation should stipulate whether the investment is secured by a first or a second position on title. If the mortgage is in first position, it will take precedence in repayment if the borrower defaults. Second-position loans, on the other hand, are riskier and usually carry higher interest rates to compensate for this risk.
Who Can Invest in a Syndicated Mortgage?
Accredited and non-accredited investors can invest in syndicated mortgages, but there have been increased requirements in the last few years. The Financial Services Regulatory Authority of Ontario (FSRA) is the regulator for syndicated mortgage offerings in Ontario to protect investors. Any investment with more than one lender is subject to specific disclosure and suitability requirements.
The majority of the syndicated mortgage investors are individuals looking for a better return than they can get in a savings account, GIC, or a government bond. These syndicated mortgages tend to be marketed to people looking for passive income, such as retirees, or people with a moderate to high net worth. However, because of the risks involved, investors must prove that they understand the product and its financial consequences.
Potential Benefits of Syndicated Mortgages
The syndicated mortgage also has dozens of potential advantages, starting with generating income for incoming-seeking persons. Aspiring to yield anywhere between 8% and 12% or more per year, depending on the particular project and the lender’s position, syndicated mortgages offer significantly better annual returns than traditional savings or low-risk investments.
The second advantage is that they are secured by real estate assets, though this does not eliminate investment risk. This means that real estate assets back the investment. Hence, in the unfortunate event of the developer defaulting on their obligations, some degree of solace is imparted to the extent of the security. However, it does not end the risk. Investors also like that these syndicated mortgages provide channels for big-time developments that they could otherwise never sponsor alone.
Risks and Challenges of Syndicated Mortgages
While the returns from syndicated mortgages can be advantageous, they also carry many risks, with these risks being underestimated by many investors. Probably the biggest concern is project failure. The whole investment can be at risk if a developer fails to complete the project or is unable to sell sufficient units to cover project costs. Under the worst scenarios, investors may lose their interest income and principal.
Another risk involves liquidity. There is no public market for traded syndicated mortgages. Instead, investment funds are secured for three to five years. If one requires liquidity within the loan, it is frequently difficult or nearly impossible to withdraw early.
Legal risks also exist. Tabloid scrutiny has been cast on a few syndicated mortgage arrangements in the last few years for possible misrepresentation, overvaluation of projects, or failure to disclose the risk in the transaction adequately. This prompted regulatory reforms designed to protect investors, yet the obligation to educate oneself remains.
Syndicated Mortgages vs. Private Lending
Syndicated mortgages and private mortgages have some similarities, but also some differences. Both types of lending involve securing money with real estate, typically when a traditional bank is not involved. However, private lending usually involves a relationship between one lender and one borrower, usually on a residential or small commercial property.
Private mortgages provide investors with more control, and most are shorter-term. Investors look at a single property with a borrower so they can assess the risk. In contrast, a syndicated mortgage involves large and complex projects and allows the individual investors in the syndicate less ability to assess the risk as they should and creates a riskier investment for an arm’s-length investor.
If there are issues, investors of private mortgages typically have transparency with legal and mortgage professionals. Syndicated mortgages often lack transparency due to their complex legal and contractual structures. Additionally, they typically provide lower returns relative to the amount invested, accompanied by multiple layers of risk for potential investors.
Weighing the Opportunity Against the Risk
Syndicated mortgages can offer high returns for investors comfortable with risk and project details. However, they come with challenges like low liquidity, higher default risk, and the need for thorough due diligence.
Before you even consider investing in a syndicated mortgage, take time to review the project financials, check whether your investment has a first or second position on the title, assess the reputation of the developer and broker involved, and equally importantly, check that you are getting independent advice (from a qualified finance or legal professional).
Syndicated mortgages are great or risky investments, depending on the investor’s experience, research, and risk tolerance. Syndicated mortgages can add strategy to an investor’s portfolio. However, they can cause huge losses without proper understanding and due diligence.
