High-Yield Alternative Lending in Commercial & Land Development

Report Highlights

• At the end of 2024, two out of 54 mortgages were classified as stage 3 (impaired). We believe the fund’s low LTV (45%) puts them in a comfortable position. 
• Since May 2024, the BoC has cut rates seven times (225 bp), with the potential for one or two more cuts this year, due to slowing GDP growth, high unemployment, and cooling inflation. Although mortgage delinquencies remain a concern for lenders, we believe the risk is easing amid falling mortgage rates. We anticipate a gradual rebound in pre-sales, and reduced financing costs for developers, and a moderate increase in transaction activity for real estate lenders this year. 
• We find high-yielding funds, like VMT, increasingly attractive in the current declining rate environment. This is because MIE lending rates are less elastic, meaning their yields tend to decline less in a falling rate environment, and rise more slowly in a rising rate environment.
• We are forecasting a yield of 9.2% in 2025 (2024: 10.5%) vs management’s guidance of prime + 5%, or approximately 9.0-10.0%.

 Risks

• Highly competitive sector
• A downturn in the real estate sector may impact the fund’s deal flow
• Principal is not guaranteed; no guaranteed distributions
• Default rates can rise during recession

The yields presented above reflects the weighted average for all share classes.

An Overview of Mortgage Investment Entities (MIEs)

Short-term loans secured by real estate. 12 employees

MIEs provide short-term loans, typically one to two years, secured by Canadian real estate. With more flexible lending guidelines than traditional lenders, MIEs can offer tailor-made solutions to meet specific borrower needs. Unlike banks, which have lengthy due diligence processes, MIEs can respond quickly to urgent capital requirements. As a result, they are able to charge higher interest rates than banks and other conventional lenders.

Key features:

• External Management Structure: Most MIEs are externally managed by their founders through a separate management company, which earns management and/or performance fees, as well as a share of the origination fees paid by borrowers.
• Revenue Generation: MIEs generate revenue primarily through interest income earned on loans extended to borrowers.
• Capital Structure: Mortgages are financed through a combination of debt (typically from banks or traditional lenders) and equity (raised from investors).
• Tax Efficiency: To maintain tax efficiency and avoid entity-level taxation, MIEs generally distribute 100% of their taxable income to investors.

MIEs are audited and regulated by their respective provincial securities commissions. However, they are not subject to federal mortgage lending rules, such as reserve requirements or LTV limits, because, unlike banks and other financial institutions, MIEs do not accept public deposits.

In a recent market study conducted for the Canada Mortgage and Housing Corporation (“CMHC”), we estimated that there are approximately 200 MIEs in the country managing approximately $20B, accounting for 0.9% of the total residential mortgage credit in Canada ($2.3T).

Company Overview and Manager Background 

Founded in 2022 and based in Toronto, the fund is managed by the Vector Group—a private mortgage lender established by the Oelbaum and Laurie families in 1969. Serving the Greater Golden Horseshoe Area (GGHA) in southern Ontario, Vector has originated over $1.25B in loans to date. The group currently manages approximately $500M in mortgages, with roughly half allocated to the fund, and the remainder in syndicated deals funded by high-net-worth individuals, and family offices.

Management have invested $16M in the fund, and owns 6% of the fund’s units. Allows investors to gain exposure to a diversified pool of mortgages, providing access to real estate-secured lending 

VMT is a mutual fund trust with a business model similar to that of a Mortgage Investment Corporation (MIC). Unlike MICs, which must hold at least 50% of their assets in residential mortgages and are restricted to Canadian investments, a mutual fund trust like VMT has greater flexibility, including the ability to invest internationally. To maintain its tax-exempt status, VMT must distribute 100% of its taxable income to investors.

Corporate Structure

Vector and its affiliates receive 1.10%-1.60% p.a. of mortgages outstanding as management and other fees (depending on unit class), along with 100% of origination/renewal fees charged to borrowers (which are typically 1%-2% of the mortgage amount), and nil performance fees. Overall, we believe the fund’s fee structure is in line with other MIEs of comparable size.

• Class A - offered to investors directly
• Class B - offered to investors who purchase units through dealers (IIROC and Exempt Market Dealers)
• Class F - offered to funds managed by portfolio managers, and other fee-based investment advisors.  
• Class I – reserved for large investors ($5M+)

Offers four classes of trust units. Focused on short-term loans to developers 

Investment Strategy

• Primarily focused on first mortgages on commercial and land development properties in southern Ontario, with an emphasis on the Greater Toronto Area, and the Greater Golden Horseshoe Area
• Loan sizes range from $2.5M to $25M
• The weighted average loan-to-value (LTV) of the portfolio will not exceed 75%
• Maximum initial loan term is 36 months; typical terms range from 12 to 18 months
• No more than 10% of the portfolio will be invested in any single borrower or mortgage
• Debt-to-capital ratio will not exceed 30%
• Like most MICs, loans are interest-only with principal repaid at maturity
• Loans are floating rate, allowing the fund to adjust quickly to changing market conditions

Benefits of land deals include:

1. Lower holding costs if foreclosed, largely limited to taxes and insurance
2. Can be sold relatively quickly (depending on market conditions) due to fewer complexities
3. Fewer operational risks compared to income properties (rent/occupancy risks) and construction projects (delays, cost overruns, and pre-sale risks)

The main risk for land deals is that they generate no revenue, so borrowers must have cash reserves to pay mortgage interest. Additionally, there can be delays in the borrower’s exit strategy, usually through a sale.

The fund focuses mainly on pre-development and raw land for residential use, with selective exposure to income-producing properties

Source: Fund - https://vectorfinancial.com/recent-transactions/

The following table shows how Vector’s portfolio compares to other MICs (with AUM of $100M+) focused on residential construction/development mortgages.

Vector’s yield has consistently outperformed, driven by lower loan loss provisions. Its portfolio features a lower LTV, fewer stage 3 (impaired) mortgages, and a smaller average mortgage size. The fund does not use leverage to enhance yields 

Its portfolio demonstrates intra-provincial diversification, yet it remains heavily concentrated within Ontario

Portfolio Details (YE: December 31st) 

Mortgage receivables rose 65% over two years, from $138M at the end of 2022, to $228M by the end of 2024

In 2024, originations were up 51%; repayments were up 90%. First mortgages (“A” position) accounted for 90% of total mortgages

* “A” lenders hold a priority (senior) position over  “B” lenders. - Source: Fund / FRC

Focuses almost exclusively within a one-hour radius of the GTA. Residential land accounted for 73% of the portfolio. The weighted average LTV was just 45% vs the sector average of 62%

Stage 3 (impaired) mortgages accounted for 4.4% of the portfolio vs the sector average of 5.6%

Financials 

2024 revenue was up 23% YoY, driven by higher mortgage receivables. Distributions were up 28% YoY. Distributions per unit were up 1%

The yield increased from 10.39% in 2023, to 10.51% in 2024 (Class F/I)

FRC Projections and Rating

Management is targeting a yield of prime + 5% p.a., or 9%-10% this year. With rates trending downward, we foresee yields declining in 2025 and 2026

We are projecting yields of 9.2% in 2025, and 8.7% in 2026. Our estimate for the 2025 yield varies between 8.2% and 9.6%, as loan loss provisions and lending rates vary

We are initiating coverage with an overall rating of 2-, and risk rating of 3. We find high-yielding funds, like VMT, increasingly attractive in the current declining rate environment. This is because MIE lending rates are less elastic, meaning their yields tend to decline less in a falling rate environment, and rise more slowly in a rising rate environment. Given the BoC’s recent and anticipated rate cuts, yields are set to decline. However, we believe the risk of higher default rates is easing, and the mortgage origination market is likely to gain momentum in 2025. 

Risks

We believe the fund is exposed to the following key risks (not exhaustive):

• Operates in a highly competitive sector
• Investments in mortgages are typically affected by macroeconomic conditions, and local real estate markets
• A downturn in the real estate sector may impact the company’s deal flow
• Principal is not guaranteed; no guaranteed distributions
• Land deals generate no income, so borrowers need reserves for interest, and exit strategies, typically via sale, and can also face delays.
• Timely deployment of capital is critical
• Default rates can rise during recession

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