For the average (non-multi-millionaire) investor, the idea of investing in real estate may seem risky at best, ill-advised at worst. Headlines about the real estate bust don’t counteract that impression and everyone’s heard about the friend or relative who bought a duplex thinking it would mean an easy income stream only to find themselves thrust into the role of an embattled landlord with wayward tenants and a property that always seems to need maintenance.

Contrary to those impressions, real estate investment vehicles offer investors the three things that matter most: wealth preservation, wealth growth and income generation and there are a couple of ways that a smaller investor can get in on the real estate market without the usual headaches and with as reasonable a surety as there ever is of making steady returns.

They are known by their acronyms:

• SMI – or Syndicated Mortgage Investment, and
• REIT – Real Estate Investment Trust

In short, both involve a form of shared ownership of income producing properties like shopping malls, apartment complexes and other building developments but there are some important differences between the two.

SMI or Syndicated Mortgage Investment

A syndicated mortgage takes the pooled funds of two or more investors to purchase a property. In that sense it acts like mutual funds in the equity market in that you can access ownership of properties that would be beyond your individual means.

• The pooled funds are treated as a single mortgage, but each individual investor is registered and secured against the property on a proportionate basis.

Building contractors are always searching for new ways of generating capital for larger projects and often look to a syndicated mortgage for what is known as ‘mezzanine financing’ which fills the gap between equity and the primary mortgage. It’s a way for a developer to raise close to 100% financing for a project and they’re becoming more and more popular as such.

Income – How It Works

Your income as an SMI investor will usually come from interest payments that derive from the project’s revenues and these are paid out typically on a fixed schedule and over a fixed term. Unlike a direct equity investor or mortgage holder, your returns aren’t based on the value of the property and so they are not immediately subject to ups and downs in the real estate market; that may come down the line however as property value affects costs and revenues.

What you can expect as an individual investor:

• Attractive returns typically over a fixed term in the form of interest payments
• Since there are no shares or units, your investment is not subject to changes or fluctuations in value in the same way as with mutual or segregated funds
• Every member of the SMI has the full principal of their investment registered in their name at the Land Registry Office
• SMIs are RRSP eligible

What to Look For:

• Some companies will include a fully funded interest reserve for the complete term of the mortgage, ensuring your interest payments at least for a specified term.

• Possible profit participation at the end of the project.
• Research the company offering the SMI – are they doing their due diligence in fully researching the property? How accurate do their projections seem and what are they based on?
• Is the company offering the SMI also a developer? If so, they have more control and more intimate knowledge of the project.

REIT or Real Estate Investment Trust

The REIT is another form of pooled investment in the real estate market and they are sold just like stocks on the major stock exchanges. REITs developed in the United States as an act of Congress in the 1960’s but due to legislative differences and subsequent changes, only began to take hold in Canada in the last couple of decades. The first Canadian REIT went on the market at the TSE in 1993.

As an entity, a REIT involves direct investment in real estate projects in various ways including outright ownership or via mortgage investment.

There are three types of REITs

• Equity REITs invest in and own properties outright. Their revenues come principally from rental payments.
• Mortgage REITS loan funds for mortgages to prospective property owners. They may also buy existing mortgages or mortgage-backed securities. Their revenues come largely from the interest that they earn on the mortgage loans.
• Hybrid REITs combine the investment strategies of equity REITs and mortgage REITs by investing in both properties and mortgages.

Federal legislation mandates the specific mix of income and investments that a REIT can include.

How it Works

Investors can purchase shares in a REIT directly on an open exchange. A REIT will use the funds available to invest in buildings such as shopping malls, apartment buildings, hotels or office buildings and they may specialize in a particular type of building or in a specific region or country. A REIT is a liquid investment that typically pays dividends.

Income

• Your income as an individual investor typically comes in the form of dividends and based on historical data, you can expect attractive returns and regular payouts.
• Since the dividends come from the revenues generated by the property (rents or mortgage interest as the case may be) and not from the market value of the property itself, you are protected from the immediate effect of market fluctuations.
• Rather than be afraid of real estate market swings, when times are tough, history shows that people tend to rent rather than buy which actually increases demand for rental properties.
• REITs have the potential for capital gains, but it’s by no means guaranteed.
• They can be RRSP registered.

What to Look For:

• Watch out for news on rentals and vacancy rates – lower vacancy rates and higher rents charged in general form favourable conditions for REIT income generation.
• Check the history of the REIT in question and look at the individual investments it’s made – know what you’re investing in.

As with any type of investment, your best bet is to get good advice from a financial advisor who specializes in this field.