Exempt real estate-based investments are sold to investors in the private placement market without a prospectus, without the BCSC’s review or approval, and usually, without the advice of a registered dealer.
Examples of real estate-based securities include investments in:
- raw land held for resale to a developer in the future (sometimes referred to as “Land Banking”).
- a real estate development project.
- a pool of commercial or residential rental properties (known as a Real Estate Investment Trust, or REIT).
- an interest in a pool of properties.
- a pool of mortgages, such as a mortgage investment company (MIC).
- a single mortgage (syndicated mortgage).
What Risks do They Have?
Exempt market real estate securities have higher levels of risk than products such as GICs or traditional forms of investment that offer a lower rate of return.
You do not have a direct interest in the underlying real estate assets. As a result, you cannot take legal steps to seize and sell the assets or foreclose on the borrowers.
Investments in real estate-based securities are not guaranteed. You may lose all your money if the company cannot sell its real estate assets, or recover your money it has loaned out.
Some companies offer a Dividend Reinvestment Plan (DRIP), under which you will receive a higher return if you agree to reinvest the income you earn into additional real estate-based securities. However, if you participate in a DRIP, you may not discover a company has financial problems until you try to cash in your investment (particularly if you do not receive audited annual financial statements from the company).
Finally, because exempt real estate-based securities are not publicly traded, the price you pay for your securities is usually determined arbitrarily – it may not bear any relationship to the fair value of the underlying real estate-based assets in which you are investing indirectly.
There are risks common to any exempt real estate-based security, such as the ones noted above. This chart shows specific risks of a number of types of exempt real estate investments.
|Raw Land, Development Projects, and Syndicated Mortgages
- Costs such as property taxes and management fees may be incurred on an ongoing basis even though the property may not be generating any cash flow.
- The developer may not be able to obtain permits for construction or secure construction financing.
- Cash you may receive during the development phase usually represents a return of your own money.
- If real estate values fall, the REIT may not be able to sell its properties for enough to fully repay you when the REIT is wound up.
- Newly formed REITs usually own fewer properties, exposing you to greater risk if a major tenant defaults on its rent or if the property must undergo significant repairs.
- While some REITs borrow money from third parties to increase the size of their property portfolios, if the market falls, the REIT may have difficulty meeting its monthly payments on the debt and could even lose the property in foreclosure.
- When interest rates are low, MICs may lend money on riskier terms to maintain higher returns (e.g. taking on second or third mortgages or making unsecured loans) – this could expose you to more risk of not earning a return or not recovering your investment.
- Some MICs make development or construction loans based on what the MIC thinks the property will be worth on completion. If these assumptions are unrealistic, you may not receive enough to repay your investments.
- Different MICs use different valuation techniques to determine a property’s value. If the valuator is not properly qualified, the value of the property, and the underlying security for the loan, may be overstated.
Can You Sell Easily?
No. Exempt real estate-based securities are not listed on a stock exchange and almost all have resale restrictions. This means you cannot sell your securities once you purchase them (unless a prospectus is filed). It may take you a long time to recover your money.
While many companies offer a redemption feature, there are often significant restrictions on redemption. If you need cash in a hurry, the company may not have sufficient cash to redeem your securities because the money is usually tied up in non-liquid assets, such as mortgages and development projects.
What are the Costs?
Administrative costs or management fees, which should be disclosed in the purchase agreement, and legal costs will reduce your returns.
What are the Expected Type of Returns?
If the real estate investment is based on mortgages or rental properties, you can expect to receive payments, similar to dividends, as long as the mortgage payments or rents are actually paid.
You can also expect to receive capital gains or capital losses when the property is sold or when you sell your investment – capital gains if the property value has increased, and capital losses if the property value has decreased.
During Your Review, Ask These Questions:
- Can I get my money back if I need it in an emergency?
- Can I see the redemption history for the past two years?
- How much money does the company owe to people seeking to redeem?
- Has the company diversified its investment portfolio in terms of types of loans, types of properties, and location of properties?
- Can I see the company’s mortgage or property portfolio schedule?
- For development projects or mortgages on those sorts of projects, can I see the valuation reports, including the supporting assumptions?