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The Rise of Commercial Mortgage Investments

The Rise of Commercial Mortgage Investments

Explore the strength and resilience of CMIs as Noni Martin of Omega Capital highlights their unique benefits for discerning investors amidst ongoing economic uncertainty.

27 September 2023

Our love affair with property as a go-to investment choice seems poised to reign unchallenged for many years to come. No other nation’s economy follows the success and failures of its property market more closely than ours. We just can’t seem to get enough.

While enthusiasm for property investment remains strong, our investment landscape is evolving at a breathtaking pace, driven by a whirlwind of unpredictable global events: pandemics, natural disasters, supply chain upheaval, inflation, and exponential impacts from digital disruption.

Ever-evolving economic volatility is now a permanent feature of the global investment frontier. Investors must make choices that will not only weather the storm, but also thrive in uncertain times.

Traditional Options

Generations of Kiwi investors have favoured three main property investment avenues:

1. Direct Property Purchasing - The classic method of acquiring physical properties, offering full control but often demanding substantial capital and management, with limited diversification.

2. Public Exchange-Listed Real Estate Investment Trusts (REITs) - A gateway to property ownership without property management hassles. It offers a low entry cost, diversification, asset quality, and ease of entry and exit. However, investors are exposed to stock market volatility, high management fees, and lack control.

3. Unlisted Property Syndicates - A collective investment structure where multiple investors pool their funds to invest in a portfolio of real estate properties. Syndicates are often professionally managed, offering the benefits of direct property ownership with shared responsibility, but they possess most of the same downsides as REITs for investors.

The Rising Star: Commercial Mortgage Investments (CMI)

Amid this evolving landscape, a compelling alternative (and lesser-known investment option)has silently risen to the challenge – Commercial Mortgage Investments (CMIs). CMIs are individual or pooled investor-funded loans which are advanced to commercial borrowers and backed by mortgages over their properties.

How CMIs Work

Investors can register to invest with Mortgage Investment Providers (MIPs) who employ experienced property financiers to source and select lending opportunities. There are two main types of providers:

1. Pooled Fund MIPs - Investors deposit funds with an MIP who pays them agreed interest rates for set terms (e.g., 7 per cent for 12 months). The MIP then on-lends these funds to third-party commercial borrowers in exchange for mortgages over their property assets. Lending criteria vary, but the MIP can take swift action if a borrower defaults to recover its debt and costs.

2. Direct Lending Agents (DLAs) - DLAs maintain a database of registered investors and identify and assess lending opportunities. They then present these opportunities to mostly wholesale investors on a loan-by-loan basis, offering the choice to participate individually or collectively. DLAs introduce curated loan opportunities, manage formal documentation, and oversee the portfolio of loans funded by their collective investors. Debt and cost recovery are also promptly handled by the DLA if a borrower defaults on their loan.

A DLA gives the investor more autonomy and control over their investments, including direct ownership of the property’s security. While a Pooled Fund MIP involves less direct involvement from the investor and places the responsibility for investment selection and management on the MIP provider, with the security held by them.

Why Are CMIs A Good Choice?

1. Superior Security Position - One of the primary reasons CMIs stand out is their exceptional security strength. MIPs who manage these offerings typically extend loans that account for only 50-65 per cent of the assessed property value. This conservative approach ensures that a substantial portion of the property’s value remains as the borrower’s equity. In the unfortunate event of a borrower defaulting on their obligations, a well-defined legal process allows the MIP to take prompt and decisive action. This often involves selling the property under the mortgage, with the MIP holding a front-row seat in this process. The MIP can recover its loan principal, outstanding interest, and all related recovery costs from sale proceeds. Only after these obligations are met do any remaining funds go back to the borrower. This robust security structure significantly reduces the risk to investors, making CMI investments a sensible choice for those seeking a secure and reliable investment option.

2. High Degree of Control - CMIs, particularly when offered through Direct Lending Agents, empower investors with an unparalleled level of control. While MIPs manage various aspects of the lending process, including identifying borrowers, structuring loans to mitigate risks, and overseeing loans from inception to maturity, investors maintain complete control over their lending decisions. This includes the ability to select loans and terms that align with their individual risk tolerance and financial objectives. DLAs offer investors a curated selection of credit-approved opportunities, allowing them to review comprehensive details about each lending opportunity before deciding to participate. This level of control ensures that investors can make informed decisions in line with their investment goals and makes CMIs attractive for those who value autonomy in their investment choices.

3. Balanced Risk/Return Profile - CMIs offer an appealing balance between risk and return compared with the other investment options mentioned above. One of their standout features is their alignment with changes in the Official Cash Rate (OCR). This alignment means that CMIs are a natural hedge for inflation and their returns increase in an inflationary environment. Also, returns for CMIs improve in a credit crisis because when bank funding sources dry up, borrower demand for loans funded by CMIs spikes. Lower risk opportunities become available at better returns as higher quality borrowers (who would normally qualify for bank lending), look to secure their funding through MIPs. On the other side of the fence, syndicates, REITs and individual property owners all experience diminishing returns in an inflationary environment as they must pay their lenders higher interest costs. Those interest costs increase even further during a credit crisis. The unique characteristics that hedge CMIs against these economic challenges put them in good stead with investors seeking a predictable and balanced risk-return profile amid economic volatility.

4. Simplicity in Risk Assessment - The simplicity of CMIs is another positive attribute. Investors can anticipate returns that are primarily influenced by supply and demand dynamics within the property lending market. This straightforwardness is in stark contrast to other property investment options, such as direct ownership or participation in syndicates and REITs, where the return on investment can be influenced by a complex array of factors. In the case of CMIs, returns are determined by the borrower’s ability to service interest payments and the likelihood of recuperating the investment in the event of a property sale. Both aspects are rigorously assessed at the outset, often backed by sound lending policies designed to manage associated risks effectively. Additionally, the relatively short tenor of most CMI loans (typically ranging from six to 18 months), means investors need not commit to extended investment horizons to realise potential capital gains. This simplicity and predictability in risk assessment make CMI investments a good option for investors that value transparency and clarity.

5. Enhanced Predictability - Predictable investment returns is a goal of many investors that is getting more difficult to achieve. CMIs offer better certainty then REITs and syndicates, which rely heavily on the availability of credit to borrow bank debt, low interest rates and the capability of managers. CMI investments offer a more straightforward and predictable path to returns. While the other investment vehicles may experience fluctuations in their returns due to external factors, CMI returns are primarily driven by the supply and demand dynamics within the property lending market. This straightforward relationship enhances the predictability of CMI returns, providing investors with a greater sense of confidence. In addition, while CMIs may not directly benefit from capital gains, they often enjoy increased demand when property values are on the rise, allowing them to adjust their rates. With most CMIs offering returns that typically range between 3 and 8 per cent above term deposit rates, investors can enjoy a robust and predictable income stream, all while benefiting from the strong security and resilience factors inherent in CMI investments.

Whether you consider yourself a small property investor or already have an extensive portfolio of assets, Commercial Mortgage Investments (CMIs) are an excellent alternative to traditional investment options. Look for a well-established and respected Mortgage Investment Provider who can deliver all the advantages mentioned above, and you can have confidence in your decisions despite the unpredictability of today’s economic climate and investment landscape.

New Zealand-owned company Alpha First Mortgage Investments offers wholesale investors Commercial Mortgage Investment (CMI) opportunities under the DLA provider model.

Alpha First Mortgage Investments do not provide financial advice. This article is the opinion of the writer, and each investor should consider their individual circumstances and seek out any necessary professional advice to determine whether CMIs are an appropriate investment option.

For more information visit www.alphafirst.co.nz or call 0800 555 621.

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