How to use your RRSPs to Invest in Real Estate

Answer: Private mortgage loans

Most Canadians have heard of REITs or Mortgage Insurance Corporations (MICs), but most are probably unaware of the investment vehicle called “private mortgage loans”. Even my private banker at CIBC did not know. However, this type of investment is commonly used by real estate investors. In my opinion, a private mortgage loan is a hidden gem in the real estate investment world I have been attempting to shed light on (see Investment Story 1 and Investment Story 7). If you attend costly real estate seminars (like a friend of mine did recently), this topic is usually covered.

Over the past year, I have been helping family and friends invest in private mortgage loans. I have noticed I have been repeating myself over and over to them with the same information, so I figure I would share this information in this post.

What is a private mortgage loan?

Essentially, you are acting as the bank to lend your money to others through private mortgage loans. Just like when you purchase your house, the bank lends you money for a specified interest rate which is secured to your property.

In a private mortgage loan, you are lending your money to a borrower (eg home/business owner, developer, real estate investor) for a specified interest rate, and your money is secured to the property the borrower owns.

I know what you’re thinking. “That’s risky!” And it can be (like the Fortress story) but it doesn’t have to be. With knowledge, the risk can be understood and controlled.

Vancouver, British Columbia

Private mortgage loans are not all equal

When you think about it, physicians from different specialties really only have 1 thing in common with each other. They have an M.D (or equivalent) behind their name. Beyond the M.D designation, physicians can have vastly different duties and responsibilities from one another depending on their specialty, such that their worlds are galaxies apart. Compare an ER physician to a public health physician. Or a neurosurgeon to a pathologist. Or a psychiatrist to an anesthetist. Their work days are completely different from each other.

Similarly, private mortgage loans have only 1 thing in common. They are secured by property. Apart from this, the loans can be vastly different from one another in term of their interest rate, duration, type of borrower, and the purpose of the loan.

The key to safe and successful investing in private mortgage loans is to find a trustworthy mortgage broker or real estate investor, who has a long successful track record of setting up private mortgage loans.

I will be honest. Finding the right person to work within the “Wild West” of real estate investing can be difficult. You will have to do a bit of digging around. Once you establish this relationship, then the rest is easy.

What are the returns? Who is the borrower?

The market rate for a private first mortgage loan is in the range of 8-10% annualized.

The market rate for a private second mortgage loan is in the range of 10-12% or higher annualized.

Whether it be a home/business owner, developer or real estate investor, the reason borrowers obtain a private mortgage loan is they do not qualify for a conventional bank mortgage. Don’t let this scare you away necessarily. There can be a variety of legitimate reasons why they don’t qualify, and the private mortgage loan is usually a temporary bridge until they can qualify for a conventional bank mortgage.

Why would a real estate investor use a private mortgage loan? Because it is easier and quicker to get access to private money. They use their existing rental properties to leverage other people’s money to fund purchases or renovations to grow their real estate empire.

The lender is essentially getting a piece of the real estate investor’s return, which I have shown in Investment Stories, is often 30% or higher. Giving up 12% temporarily for a year to secure/renovate a property, which will provide 30%/yr returns long-term, is simple math that is easy to comprehend. It is a “win-win” scenario for both the lender and the borrower (real estate investor).

Security is key. LTV is key.

The best part about private mortgage loans is your money is secured to a property the borrower owns. You want to aim for a loan-to-value (LTV) of the mortgage of no higher than 85% LTV. Preferably 80% LTV or lower is desired. Therefore, the lender has some “skin in the game” with approximately 15-20% of their own equity in the property. They will not want to lose their equity.

In the worst case scenario, the borrower defaults. Getting your money back via a power of sale of the property can cost up to 15% of the value of the property, hence the 85% LTV target. Owning land is more difficult to sell, therefore, one should consider this before investing in a private mortgage loan secured by land.

Scenery along Highway 99 British Columbia

What are the fees? What accounts are available?

The cost of setting up the private mortgage loan is the responsibility of the borrower. Typical costs include an appraisal fee for the property, mortgage broker fee, and legal fees. As a lender, you don’t pay a cent for the set-up!

The most trusted and longest standing Canadian financial institution which allows registered funds to be invested in private mortgage loans is Olympia Trust (I have no financial relationship to disclose). There are only a handful of other institutions, but my experience is only with Olympia Trust.

Private mortgage loans are RRSP, TFSA and RESP eligible and all of these types of accounts can be set-up at Olympia Trust. You can also use personal or corporate cash to invest in private mortgage loans but you will be taxed harshly since it’s interest income. If you are retired, and in a lower tax bracket, then investing with cash could make sense. If you use cash, then you simply write out a cheque from your bank account for the mortgage loan. You do not need to open an account at Olympia Trust.

I recommend physicians to use their RRSP and TFSA funds when investing in private mortgage loans, in order to shelter the interest income.

Please Olympia Trust’s fee schedule for more details, but briefly:

Annual fee for an account is $150 + HST.

Mortgage loan set-up fee is $125 + HST.

Monthly mortgage fee is $12/mth + HST.

Total yearly fee for a private mortgage loan for the lender = $473.47

A couple of things to note:

  • Although it depends on the terms of the private mortgage loan, you will most likely get paid monthly. The cash will accumulate in your account until your loan term ends and you invest into another loan. Or once you build up + contribute funds to invest in another loan. You have to get used to having cash sitting on the sidelines temporarily, which was a bit of an adjustment for me
  • For a TFSA account, any withdrawal will result in a $25 + HST withdrawal fee. Therefore, lump-sum withdrawals should be planned out, rather than frequent withdrawals, if cash is needed from the TFSA.

Is it worth it?

In my experience. Yes. Absolutely.

I realize that most physicians will NOT take the plunge into owning property by themselves or through a Joint Venture. Setting up a Holdco and the added accounting/legal fees is a hurdle most will not attempt to jump over.

For those who want to invest in real estate without direct ownership, then private mortgage loans using RRSPs or TFSAs are an excellent option to consider.

Anybody else have any experience with investing in private mortgage loans?

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Dr. G

Very insightful. Thank you. 1. Seems like the biggest hurdle is to find someone you trust. I see this same issue in general re: real estate. If you’re DIY, then you need to find contractor / specialists to trust. If doing a joint venture, it’s the same. Seems like, it’s the same for private mortgage loans. So how do you go about finding someone you trust? 2. I know you won’t become a real estate investor just reading something. There’s likely a lot more to it. It’s like you won’t become a surgeon just reading, you gotta do it. But… Read more »

Loonie Doctor
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Thanks for another very educational post, DN. I am learning a lot from your site. I guess this type of lending is another way to diversify real estate investment in an RRSP. I currently use REITs since very low effort. The question that I am pondering is how much of my overall net worth do I want to be real estate-based. There many ways to have that exposure as you pointed out in one of your first posts. For me, it is my principal residence (as a tax-free slightly-better-than-inflation capital-grower) and REITs for income. I haven’t used any of the… Read more »