Understanding real estate investments

While real estate investments can offer a range of benefits, there is no guarantee that you will earn an income or profit and, like any investment, there are a number of risks and uncertainties that you need to carefully consider before investing. There are five different types of real estate investments to know more about.

Real estate investment trusts

A real estate investment trust (REIT) invests in income-producing real estate properties, such as shopping malls or multi-unit residential buildings. An investment in a REIT can offer investors income through payouts it receives from the properties it has invested in.

Investors can buy securities in public or private REITs. Public REITs are listed on a stock exchange and private REITs are traded in the exempt market. Buying and selling public REIT securities through an exchange is relatively straightforward, and its value is easily assessed through publicly- available prices. Private REITs are not listed on an exchange, making their securities more difficult to value and trade. Investing in a private REIT is different from and generally riskier than investing in a public REIT. There are also certain eligibility requirements that investors must meet before they can buy securities in a private REIT.

Generally, securities sold to the public in Ontario must be offered under a prospectus (a document that provides detailed information about the security and the company offering it), but there are some exceptions to this rule. For example, in Ontario, if a private REIT is looking to raise money from investors, they may be able to sell under a prospectus exemption in the exempt market. Learn more about how the exempt market works.

Some common risks of investing in private REITs

Lack of liquidity – Since private REITs purchased in the exempt market are not publicly-traded, they may be difficult to value and cannot easily be resold. You may have to hold onto the investment longer than anticipated.
Lack of transparency – Since private REITs are not subject to the same disclosure obligations as public REITs, there is less ongoing information available for you on how the REIT is doing, which may make it more difficult for you to assess how your investment is doing.
Decline in investment value – The amount of payouts you receive and the value of your investment is affected by the value of the properties that a REIT has invested in and the income it earns. Deteriorating conditions of the properties, higher vacancy rates or tenants that don’t make their rent payments can affect your payouts or investment value.
High fees – Private REITs sometimes pay higher management and other fees which can reduce the payout amounts to you and leave the REIT with less money to repair and maintain existing properties or invest in more properties.
Personal liability – You could be held personally liable for paying the obligations of a private REIT if the REIT can’t pay for its obligations. This is commonly known as a “capital call.”

You can face tax consequences if your real estate investment is held in an RRSP and can’t be sold. Consult a tax advisor for advice.

Real estate limited partnerships

A real estate limited partnership (LP) is commonly used to develop a real estate property or to manage completed real estate properties, such as a condominium building. As an investor, you can buy securities in real estate LPs. Real estate LPs are governed by the terms of a limited partnership agreement, which may be complex. The LP is controlled by a general partner who manages the development of a real estate property. For example, the general partner may use money from investors to buy undeveloped land with the expectation of developing it or selling it at a profit. This gives investors the potential for growth if and when the land or development project goes up in value.

Most real estate LPs are private. Their securities are not listed on an exchange, making them difficult to trade and value.

Some common risks of investing in real estate LPs

Lack of liquidity – Investments in real estate LPs that develop property are typically long-term investments that can extend for the duration of a development project. You may not be able to resell your investment when you want or at all.
No guarantee – There is no guarantee that projects will be sold at a profit because the real estate market fluctuates and development costs can go over budget. Although not a prediction of future returns on your investment, you may want to ask about past projects that were successfully completed to get a sense of the general partner’s experience. There are many factors that can impact the success of and returns from a development project and past performance is not a prediction of future returns on your investment.
Lack of diversification – Some real estate LPs develop one specific property or real estate project. If the development project is never completed or sold, you could lose some or all of the money you have invested.
Government approvals and market value – Some real estate LPs may not have obtained all the required government permits and zoning approvals they need to actually develop the land they own. Delays or denial in obtaining all permits and approvals can significantly impact the value of your investment.
Risk of capital call – If a project goes over budget, you could be obligated to contribute more money to cover the extra costs.

If you have been promised a monthly return or payment on an investment in a development project, you should ask where the cash for the payment will be coming from while the project is being developed and is not producing any income.

Mortgage investment entity

A mortgage investment entity (MIE), also commonly referred to as a mortgage pool or mortgage investment corporation, is a mortgage financing business that pools money raised from investors to lend to borrowers.

MIEs will often provide financing or mortgages to borrowers who may not be able to obtain a loan from conventional sources, such as a bank. Borrowers typically use this financing to purchase single-family residences, commercial properties or development projects. A MIE will often hold a number of mortgages in its portfolio, reducing the potential risk to investors compared to holding a single mortgage.

As an investor, you purchase a security issued by the MIE (e.g. shares of a corporation, limited partnership units, trust units). The security’s value is derived from the value of the underlying pool of mortgages that are typically secured by the real estate properties. Investors have the chance to earn income (such as dividends) from the interest earned by the MIE on its portfolio of mortgages.

Most MIEs are private. Their securities are not listed on an exchange, making them more difficult to trade and value.

Some common risks of investing in MIEs

Lack of liquidity – Generally, private MIEs are typically illiquid investments, meaning that you may not be able to sell your investment when you want to or at all.
Decline in investment value – Borrowers of an underlying mortgage may default on their mortgages or repay their mortgages sooner than expected, either of which can affect the value of your investment or the amount of income that gets paid out to you.
High risk loans – MIEs typically provide mortgages that are higher risk than mortgages made by a conventional lender such as a bank. If too many borrowers fail to make their mortgage payments, it can decrease the value of your investment and the MIE may not be able to make any payouts to you.
Low priority of rights – MIE mortgages can be second or subsequent to a first mortgage. If a borrower fails to make mortgage payments, and the property is liquidated, the lender that made the first mortgage will be first in line to receive its money back. The MIE that made the second mortgage will only receive its money if and when the first mortgage has been fully paid off.

Syndicated mortgage investments

A syndicated mortgage investment (SMI) is when two or more people lend money secured by a single mortgage against one property. Some of these investments are considered high risk. That is because some developers use syndicated mortgages to get funding for large real estate projects that may be considered high risk by banks. Or there may be risk because of the amount of money loaned compared to the actual value of the property.

In Ontario, only mortgage brokers and agents licensed with the Financial Services Regulatory Authority of Ontario (FSRA) can engage in certain lower risk qualified syndicated mortgage transactions on behalf of a brokerage. And only licensed mortgage brokers (not agents) can sign the required investor/lender disclosure statement forms. Mortgage brokers and agents licensed with FSRA can also engage in higher-risk, non-qualified SMIs sold to non-retail investors in Ontario.

You can check FSRA’s website to confirm a person or business is licensed.

Higher risk, non-qualified SMIs sold to retail investors in Ontario are overseen by the OSC. These investments are subject to the same or stricter requirements as other real estate investments. This includes enhanced disclosure and a current property appraisal prepared by an independent professional appraiser.

Only registered firms can offer non-qualified SMIs to investors. Check the OSC’s registrant search to view a firm’s or individual’s registration category and to see if there are any terms and conditions on their registration.

What are risks with syndicated mortgage investments?

Some syndicated mortgage investments, used for equity or mezzanine-style loans to land developers or construction companies, are considered high risk and may not be suitable for an average investor.

Risks can include:

‘Secured’ does not mean ‘safe’. Although the mortgage is registered and loan is secured directly with a land or a building, the value of that security is limited to the value of the land — and if it falls short of the loan amount, realized sales or refinancing payout might be not sufficient to pay you back.
Place in lineup for repayment. Your loan may rank behind other lenders, and you may even be further back in line behind other investors. If the project fails, there may not be any money left over to pay you. This is because the value of the failed project may be only enough to pay these prior-ranking lenders.
Investment is not liquid. If you want to withdraw your money before the end of the term, it can be restricted in your contract and there will be no market for the resale or transfer of the mortgage.
There is no investor protection in syndicated mortgage. Syndicated mortgage investments are not backed by the Government of Ontario or any other investor protection fund.
There is no guaranteed return. Although some companies or individuals offering syndicated mortgage investments may advertise ‘guaranteed’ high returns, it is actually illegal to do so. Any investment can fail, and the rate of return directly reflects the level of risk you are taking.

What are my responsibilities as an investor?

As an investor, your responsibilities include:

Check for a license of the syndicated mortgage investments seller. Only mortgage brokers and agents licensed with FSRA can engage in syndicated mortgage transactions, and only licensed mortgage brokers (not agents) can sign the required forms. You can check FSRA’s website to confirm a person or business is licensed.
Know where you are in line for payments. When project is complete and property is sold, you need to know which lenders and investors the borrower will repay, and in what order. Ask whether the syndicated mortgage is a first, second or subsequent mortgage. This is important because if the project fails, the first mortgage would receive any proceeds from the liquidation first. Second and subsequent mortgages only receive payments if and when the first mortgage has been fully paid off.
Research the property value. Mortgage is only as good as the value of the property. Ask to see the appraisal the brokerage used to determine the value. You want to ensure the appraiser has valued the property in its current “as is” state without any assumptions concerning the successful completion of the property. If the appraiser has made such assumptions, the sale price of the undeveloped property would likely be lower. By law, the mortgage broker must provide investors with a property appraisal prepared by a member of the Appraisal Institute of Canada in accordance with the Canadian Uniform Standards of Professional Appraisal Practice.
Get independent financial and legal advice. Get a professional advice from someone not connected to the seller or the borrower before investing in a syndicated mortgage. This includes getting professional advice on how your investment could impact your income tax.
Check investment limits. Some investors may not be able to put up more than $60,000 over a 12-month period.
Read and understand all associated paperwork. Your mortgage broker must complete investor/lender disclosure forms 3.0, 3.1, 3.2 and provide them to you.
- Form 3.0 collects investor information to determine if an investment is suitable for you.
- Form 3.1 documents your broker’s analysis of why the investment is suitable for you.
- Form 3.2 provides you with important information about the proposed investment.

You must sign all three forms. Before you sign, ask questions and make sure you understand them.

Mortgage brokerages are obligated to take reasonable steps to ensure that the mortgage investment they recommend is suitable based on your needs and circumstances. They must also advise you of the material risks of the investment, disclose potential conflicts of interest, and provide evidence of the borrower’s ability to meet the mortgage payments.

Real property

You can buy a property as an investment and generate income through rental payments from a tenant, assuming that you charge enough rent to cover all costs associated with ownership, including any mortgages, taxes, utilities and maintenance.

Some common risks of investing in real property

Significant expenditures and time commitment – Property ownership is an expensive and hands-on type of investment. Be prepared to devote a lot of time to managing the investment, from handling paperwork to finding a tenant and making repairs, regardless of whether the property is producing any income.
Tenant risk – You could end up with a tenant who doesn’t pay rent or damages the property. You could also have trouble finding a tenant and not earn any rent for a period of time. In both of these cases, you are still responsible for paying the ongoing mortgage and taxes, and covering the expenses of maintaining the property.
Market decline – The value of the property could fall below what you paid for it, and can leave you with a mortgage greater than the property’s worth.
Liquidity risk – You could have difficulty selling the property if your local real estate market is experiencing a period of low sales or declining prices. It also takes time to sell a property and complete the closing.

In Canada, anyone who sells securities or advises other people or businesses on securities must be registered with the securities regulator in each province or territory where they do business, unless an exemption applies. Always check the registration of any person or business trying to sell you an investment or give you investment advice at CheckBeforeYouInvest.ca.