Investing in Commercial Mortgages in the 60 ‘, 70’s and 80’s.

Twenty or thirty years ago, private investors gained access to the returns from this form of investment via what were known as ‘contributory mortgages’, typically offered by solicitors. A client of the solicitor sought to borrow money secured by way of a registered first mortgage over a commercial property e.g. office, retail shop or factory. The solicitor offered this to other clients of the legal firm in amounts of $5,000 or $10,000 and once the monies sought were fully raised, the loan was made and the investors received regular income. At the end of the loan term, the loan was repaid via sale of the asset or refinance, the monies repaid to investors and they could invest in another mortgage or indeed elsewhere. This form of investing was generally quite successful in providing clarity as to risk and reward and met the needs of borrowers and investors alike.

In later years these contributory mortgages were replaced with mortgage trusts which created large pools of mortgages and generated income payments from portfolios of loans. If an investor needed to exit before the end of an agreed term, (usually 3 years), they paid a penalty.

The liquidity problem

The advent of investor administration platforms (Master Trusts/Wraps) which sought immediate liquidity from underlying investment funds saw this change. The better managed mortgage trusts began to offer immediate liquidity, relying on new investment into the fund and loan repayments for the cash to meet these requests. It worked very well for many years.

However, the GFC caused investors to seek to use this liquidity to get their monies back and as liquidity disappeared, the funds were forced to close and pay investors out as and when loans fell due, which took several years or longer. Fundamentally there was nothing wrong with these trusts or their underlying investments, rather the structure did not work in the environment created by the GFC.

With Australian interest rates at their lowest level historically, is it time to re-visit?

Official interest rates hitting their lowest level ever in August 2013 was not good for investors requiring income to fund their retirement. There is no doubt that bank term deposits have served investors well over the last few years, however with returns in the latter part of 201typically between 3% p.a. and a tad over 4% p.a. what else can investors consider?

Investing in individual mortgages supported by commercial real estate may be one answer. It’s now possible to invest in commercial mortgages offering returns of between 6% p.a. and 8% p.a. with income paid quarterly and terms of ranging from a few months to several years.

It’s important to note that commercial mortgage investments don't offer the same low risk profiles of bank term deposits so investors should ensure that any premium they receive offsets any perceived changes in risk.