Four features to consider when investing in a mortgage trust
As you set yourself up for retirement, your financial goals and investment strategy are unique, and may vary significantly from other age groups. At this stage of life, income generation and diversification are two features that are often considered paramount when seeking an investment option.
If you’re seeking a real estate investment option to include in your Self-Managed Super Fund (SMSF) with the opportunity to provide competitive returns and diversification, but are not looking to own property directly, an Australian-based mortgage trust may be an option for you.
Mortgage trusts aim to provide investors with a low-maintenance investment alternative that provides competitive income and, depending on the type of trust, portfolio diversity. Read on as we discuss key features of mortgage trusts and factors to understand when considering investment in a mortgage trust.
What is a mortgage trust?
Mortgage trusts are designed to generate income for investors, derived from borrowers’ repayments, interest, fees and income from loans secured by mortgages over property as the primary security. These loans may be used for land subdivision projects or by a borrower undertaking construction of a property development.
Distributions (net of fees) may be paid monthly, quarterly, or annually, depending on the trust, and some trusts offer two options for payment of distributions – cash payments or reinvestment of the distributions.
Types of mortgage trusts
When investing in a mortgage trust, there are two main types of mortgage trusts to consider: pooled and contributory trusts.
In pooled mortgage trusts, investor funds are ‘pooled’ together and used to provide loans to borrowers to finance property development projects. As a result, investors receive distributions based on the overall income of all mortgages within the trust.
In contributory mortgage trusts, investors can decide which specific mortgage(s) within the trust to invest in and receive distributions based only on the income derived from those specific loans.
Below are typical characteristics of these two types of mortgage trusts.
Pooled mortgage trust
Contributory mortgage trust
Your investment is diversified across a range of mortgages, and other assets.
You decide which mortgage you invest in.
Income from the pool of mortgages, plus other trust income, is distributed to all investors based on the number of units they hold in the trust. (Investors in a mortgage trust are issued ‘units’ in the trust based on the amount they invest in the trust.)
The mortgage you invest in might generate a different return from other mortgages within the fund.
Investors share the risk associated with each of the mortgages in the pool.
You’re exposed to the risk of only the mortgage(s) you choose to invest in.
You can withdraw some or all of your capital subject to the trust’s liquidity (a notice period is usually required).
You can only receive your capital when the loan is repaid. This may be in tranches or in one lump sum.
Which type of mortgage trust is better suited for you?
Pooled and contributory mortgage trusts both have their advantages. The option that is best for you will depend on your personal portfolio, financial goals and risk tolerance. Below, we list some key considerations when choosing which mortgage trust may be more suitable for you.
Pooled and contributory mortgage trusts are both managed by a professional fund manager, who will source, acquire and manage the investment – so you don’t have to.
For investors seeking income, both mortgage trust options are designed to pay regular distributions. The level of yield, however, will vary depending on the performance of the individual trust or specific mortgage.
Yield versus diversification
By allowing greater discretion over which mortgage you invest in, contributory mortgage trusts may achieve higher yield, but are also exposed to concentration risk. Alternatively, pooled mortgage trusts enable diversification across borrowers and property type as they have a larger number of loans in the portfolio, each with their own risk profile. For example, a pooled mortgage fund may have loans across various geographic locations, property sectors (for example, residential, commercial, industrial), and/or loan sizes.
In pooled mortgage trusts you can withdraw some or all your capital subject to the trust’s liquidity after a required notice period. In contributory mortgage trusts, you can only receive your capital when the loan is repaid. It’s important you always take your cash-at-call requirements into consideration when planning to invest in a mortgage trust.
What to consider when looking to invest in a mortgage trust
It’s important to evaluate key features of any trust before deciding to invest to determine if it is a responsible investment. Below, we discuss four features to consider when looking to include a mortgage trust in your SMSF.
(1) Type of loans
The type of loans included in a mortgage trust may significantly affect its risk profile; based on the property sector, current market demand, stage of the property market cycle, and risks associated with the borrower. To reduce risk, some mortgage trusts diversify the loans in the trust over properties at various stages of property construction and development, or land subdivision projects.
(2) Loan-to-Valuation Ratio
The Loan-to-Valuation Ratio of the mortgage(s), which is used to describe the lending risk assessment, is calculated as a percentage of the loan amount, compared to the appraised value of the property.
Mortgages with lower LVRs are generally considered lower risk to the lender. This is because the ‘excess’ value of the property over and above the loan amount provides a buffer that can help protect the lender in the event of a loan default, which could potentially result in a forced sale of the property for a lower price than expected, as well as additional interest and other fees and costs.
(3) Geographic spread
The status of the property market in Australia differs between states, sometimes even regional and different parts of our capital cities. Depending on their position on the property cycle clock, some states may find themselves in a downturn, whilst others a boom.
Mortgage trusts with geographic diversification spreads this risk across various property markets reducing the risk of one market not performing and therefore minimising investors’ exposure to any diluted returns.
(4) Investment & portfolio management
An experienced investment manager underpins the success of any investment as the decisions they make impacts the way the trust’s portfolio is managed and ultimately, the returns it provides to investors. Traits of a strong fund manager may include:
- Experience: your investment manager should have developed an in-depth understanding of how the market and mortgage trusts work, so they’re well placed to make calculated investment decisions in your best interest.
- Discipline: the ability to adhere to their investment mandate, criteria, and representations to investors.
- Proactive risk management: the ability to identify risks and proactively manage their impact on returns.
- Customer service: proactive communication about the trust and your investment.
We always recommend investors obtain, read and understand the relevant Product Disclosure Statements and seek advice from a licensed financial adviser before investing.
This article has been prepared by Trilogy Funds Management Limited ACN 080 383 679 AFSL 261425 (Trilogy) and does not take into account your objectives, personal circumstances or needs, nor is it an offer of securities. Investments in Trilogy’s products are only available through the relevant PDS issued by Trilogy and available at www.trilogyfunds.com.au. All investments, including those with Trilogy, involve risk which can lead to loss of part or all of your capital or diminished returns. Investments with Trilogy are not bank deposits and are not government guaranteed.