When it comes to real estate investing, most investors first seek to take the property ladder by becoming landlords and then encountering all the hassles of legalities, tenants and maintenance, to name a few. This, however, is not the only route to getting started. Real estate investment funds including Mortgage Investment Corporations (MIC) and Real Estate Investment Trusts (REITs) offer an investment alternative to participating in real estate as an investor.
Difference Between MICs and REITs
Although both REITs and MICs revolve around the same asset class, there are a number of differences an investor should be aware of:
While holding income-producing properties is a stable investment strategy, being a landlord comes with its own set of challenges. This is where a REIT can alleviate an investor from the hassles of managing the ongoing operations associated with owning real estate.
Real Estate Investment Trusts (REITs) provide investors with a cost-effective means of owning property while typically receiving monthly income generated through rent derived from tenants occupying the space. This income is distributed to investors in the form of dividends.
To qualify as a Real Estate Investment Trust (REIT), both public and private corporations must meet necessary strict guidelines. For example, all REIT’s are required to invest 75% of their profits and capital in real estate. It also demanded that all of their shares are transferable and pay out 90% of their annual earnings in the form of dividends. Aside from the above-mentioned criteria, below are a few other key guidelines REITs must abide by:
- A REIT should have a minimum of 100 investors after the first year
- A REIT should earn 75% of its gross income and profit from real-estate-related sources
- A REIT must not have more than 50% of its shares owned by more than five people
- The board of directors and trustees should manage the REIT
Dividend growth can vary from year to year and takes into account a number of variables in addition to rental income as a REIT may contribute gains from the sale of its real estate holdings. The previous years’ yield rate may not necessarily be a prediction of future yields. It requires some further due diligence. To get a better handle on a REIT’s cash flow, the REIT world uses a different metric to measure performance – funds from operations (FFO). According to the NAREIT (National Association of Real Estate Investment Trusts), FFO is equal to a REIT’s net income, excluding gains or losses from sales of property, and adding back real estate depreciation.
There are many benefits to Mortgage Investment Corporations (MICs). If you are an investor that does not have any previous experience directly investing in individual mortgages, investing in a MIC allows you to gain access to mortgage investment with a hands-off approach. It relieves investors of all management responsibilities and allows them to pool resources in a collective effort to accomplish what they couldn’t necessarily have on their own.
Residential mortgage lending is the primary real estate sector of a MIC as stated under Canadian income tax law. MIC lending is restricted to the financing of real estate property in Canada where at least 50% of their assets should be invested in residential mortgages or insured deposits, credit union deposits, or a combination of both.
- A MIC must have at least 20 shareholders/investors
- No shareholder can hold more than 25 percent of the MIC’s total capital
- A MIC can invest up to 25 percent of its assets directly in real estate, but may not engage in construction or develop lands
- Tax Treatment- The dividends that investors/ shareholders receive from directly held shares are taxed as interest income
- The loans advanced by MICs typically have a lower LTV ratio, usually less than 80% of the value of the residential property
- A MIC’s annual financial statements should be audited
- MICs can exercise financial leverage by using debt to partially fund assets
MICs can often strategically improve profits by investing in a diversified and secured pool of private mortgages, which highly reduces their exposure to risk. MICs offer more flexible financing terms compared to traditional mortgage lenders and typically provide short-term mortgages, ranging from 6 to 24 months. Their lending terms and loan structures can be molded to accommodate many borrowers in personal situations.
RRSP Qualification and Tax Treatment
Both investment vehicles have special tax treatment in varying conditions. MICs offer payouts monthly, quarterly or annually based on the MIC fund. MICs are RRSP, RRIF, RESP, and TFSA-eligible to help you generate tax-free income.
REITs investors enjoy special tax favour through the distribution of 90% of the taxable income in the form of dividends back to their investors.
MICs also offer protection in the form of a mortgage charge with a defined interest rate and period of time. This provides a steady stream of regular cash flow that is typically predictable; as with REIT’s when the rental income or property value fluctuates the dividends tend to fluctuate as well. Meanwhile, the underlying mortgage asset within a MIC is still obligated to maintain ongoing payments on their mortgage.
With the recent bank rates increasing, MICs are gaining further ground with improving yields. As conventional mortgage rates rise and government-imposed regulations on banks increase, MICs become a more favourable option for borrowers and become more in demand.
It is critical that you look for MICs with a strong management team with vast experience and stable performance history. Not all MICs are created equal and CMI is on such MIC that prides itself on its transparency and encourages all its investors to inquire and educate them on their background and expertise.