Syndicated Mortgages Red Flags: Seven Questions to Ask before Investing

For sophisticated investors, a syndicated investment makes a lot of sense. I am approached weekly by colleagues of mine who have found excellent investment opportunities that are too large for them to invest solely in. They will then ask me to participate at the same terms as they negotiated and own a portion of the investment. From a diversification point of view, this makes a lot of sense. It gives me the opportunity to place capital into three or four different investments with others instead of just one by myself.

Many investors today are approached to invest along with hundreds or thousands of other investors in syndicated mortgages. Often, these are marketed as “safe” investments “backed” by titled real estate and suitable for RRSP accounts. These syndicated mortgages are often used by developers to fund soft costs for condominium, senior living facilities, or other real estate development projects. After reviewing a number of offerings lately, I would like to point out seven red flags that investors should watch out for.

Red Flag #1: Raising money based on future value appraisal

As a rule of thumb, current value appraisals are very useful; future value ones are not so valuable. For example, today, a piece of land may be worth $5M, but the completed development is expected to be worth $60M. Often, investors will be shown a future value appraisal and told there is plenty of protection for investors. But if for some reason, the project is not completed, the current value of the land is all that is providing protection. In this case, the future value of the development is useless information.

Syndicated mortgage offerings that are raising more money than their current value provides little protection to investors. In other words, if the total raise of a mortgage syndication is higher than its current land value, watch out, this is a big red flag!

Red Flag #2: Low-quality appraisal

If you are unfamiliar with a firm, ask how many appraisals they have conducted in the past. Is the appraisal firm reputable? Or is it an obscure firm that is difficult to find any information about? Was the appraisal done by a licensed appraiser or a non-licensed appraiser?

Red Flag #3: Negative background check of management

Use the internet to find out any potentially negative information regarding the principals. For example, search the principals’ names on the website of your provincial securities commission, insurance regulators, or other supervising bodies. A good start is the Canadian Securities Administrator disciplined persons list which can be found at this link: https://www.securities-administrators.ca/disciplinedpersons.aspx

Red Flag #4: Low exit percentage of former projects

Compare the number of exited projects with capital returned to investors to the whole list of projects. Is the exit percentage high or low? In addition, it is also advisable to determine what percentage of former projects have been delayed or have not broken ground.

Red Flag #5: Low returns compared to risk

Syndicated mortgages will often offer a return to investors of around 8%. That is a very low return for investing in a real estate project in development when the first mortgage investments on income-producing real estate offer a similar return range. Development projects are way riskier than previously developed income-producing real estate.

Red Flag #6: Missing permits and approvals

There is much risk in a development that does not yet have all required zoning, development, and building permits. As a rule of thumb, do not invest unless all approvals are in place.

Red Flag #7: Marketed as safe and secure investments

These investments are meant for sophisticated individuals who are capable to do their own due diligence and recognizing risks. The marketing that I have viewed on the internet by many salespeople, on the other hand, often glosses over the risks and important details that need to be considered. Investors should be careful if these investments are marketed as being safe and well-protected.

The concept of syndication investment makes sense as it provides entry points to investment that normally would not be accessible. But I would urge investors to carefully look for red flags when investing in any opportunity.