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Why Credit Risk with an MIC May be Higher than You Think

1 November 2013

An issue has cropped up in the real estate investing world that has some calling MICs the “canary in the coal mine.”

Rob Wessel is a managing partner with Hamilton Capital Partners, and he says that many real estate investors are undermining the real risk that comes with MICs, and that could be one of the biggest disadvantages of MICs.

“Of the several MICs that were reviewed, we observed two areas where a generalist investor may – incorrectly – surmise that a MIC investment has low credit risk,” says Wessel. “When in fact, the opposite could be true. These potential misunderstandings are more significant in a market where property values are declining.

“Some,” he continues, “have predicted that a correction in home prices could cause a credit downturn, or worse, some sort of systemic event – a view we do not share. This issue has gained further investor interest given the recent rise in mortgage rates, which, if this trend continues over the next few years, could place stress on a housing market that has experienced a near vertical rise in prices over the past decade.”

And, he says, the biggest problem of all is that investors are misunderstanding their portfolios, and what’s in them.

“First, we suspect many investors may believe MIC portfolios are dominated by lower risk owner-occupied residential mortgages, owing to legislated minimum requirements on residential content,” he says. “However, for some MICs we found, the residential content was primarily, if not exclusively, higher risk residential construction/development loans, including the riskiest category of all – undeveloped land.”

And, he says, that low loan-to-value ratio that many investors are counting on might not be enough.

“It is not sufficient for investors to accept the safety of a MIC’s yield based on this metric, which in many instances incorporates a significant number of subjective assumptions,” he says.

And, he continues on to say that many of the MICs he reviewed showed that “the risk profile of the underlying mortgage portfolios skewed overwhelmingly to higher credit risk.”

He says, “This was particularly true for those MICs with outsized exposure to construction and land development. The significant risk of certain MICs has been obscured by a robust real estate market supported by large increases in home prices and property values.”

All of these add up to one thing – just another reason to invest in private mortgages instead of MICs.

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