Fund Announcement
At Covenant Capital Management, we strive to ensure our clients have access to investment options that assist in providing excellent portfolio diversification. To this endeavor, on July 29th, we launched our 6th investment pool entitled the MarshallZehr First Mortgage Fund.
The primary objective of this Fund is to provide a stable stream of income and to preserve capital by investing in a diversified portfolio of low-risk development and construction based mortgages. Targeting a 5% (net) rate of return, this pool differentiates itself from our other mortgage pools by the fact that it competes with traditional Tier 1 lenders such as Canadian banks, Trust Companies and Credit Unions for the most secure portion of the debt stack.
Fund Highlights
- Construction and development financing typically only available from banks
- Provides real property as security
- Good capital coverage / protection
- Low loan to value ratio (real property)
- Deposit coverage
- Sales coverage
- Low correlation to traditional equity and fixed income markets
- Attractive risk adjusted returns
- Provides insulation against interest rate change (short mortgage maturity cycle and low correlation to movement in bond yields)
- Strong ability to asset/liability match due to stable monthly cash flows
- Eligible for non-registered accounts
- Liquidity is bi-annual (January and July, 180 days after purchase with 90 days' notice)
Each of you should give what you have decided in your heart to give, not reluctantly or under compulsion, for God loves a cheerful giver.
2 Corinthians 9:7
Real Estate Q&A
Why did you launch another Mortgage Pool?
We believe there is still exceptional opportunity in the private lending arena and we wanted to ensure that clients can diversify their positions appropriately. Our other pools provide great exposure to a broad range of mortgages, whereas this new MarshallZehr First Mortgage Fund provides a specific, low risk exposure for those who can accommodate the liquidity constraints (which is bi-annual plus 90 days’ notice).
What happens to the mortgage pools if housing prices and sales decrease?
Over the past year, we have been proactive in implementing defensive measures in our pools. The First Mortgage Fund is likely to withstand any market changes with ease because of its low-risk nature. We believe the construction-based mortgages held in the other mortgage pools are safe for the foreseeable future as long as we strive to keep the debt to equity ratio low, insist on strong pre-sales across a diversified portfolio, maintain high underwriting standards, and preserve the flexibility to adjust mortgage covenants as market conditions evolve. However, even if we do everything right from a portfolio management perspective, if the housing market suffers a massive shock, we would expect to see our traditionally stable returns decrease. We believe it would take a significant and prolonged downturn, combined with a rising interest rate environment before principal in the pools would be at risk.
Do you still see opportunities in the Real Estate market?
Yes, while we are preparing our real estate debt exposure to be fairly agnostic to normal price fluctuations in the GTA, we could be described as at least relative bulls on Toronto and relative bears on Vancouver (as it relates to housing prices and sales volumes). Briefly, here are a few reasons why:
Land Constraints Directly Affect Supply: Where Vancouver land is bound by oceans and mountains, the GTA has implemented green belt areas which has artificially created land constraints for development. In addition, a trend towards city densification is certainly a prevalent theme in both the East and the West.
Direct Foreign Investment: While Canada has been an attractive place for foreigners to purchase real estate, perhaps more than ever, the GTA may have an extra bright spotlight on it due to Vancouver’s recently implemented 15% foreign buyers tax.
Affordability Ratios: Toronto Price-to-Median Income ratios are around 9.6, while Vancouver is at a historic high of 13.9. Although these are high numbers when compared to the next tier down in Canadian cities (which are generally in the 4.0 to 7.0 range), the reality is that Toronto is still more affordable than Vancouver. For primarily this reason, we are not discounting the possibility of a real estate trough, but we do not expect a “bubble” to burst.
Interest Rates: Adjusting for inflation, the cost of overnight borrowing targeted by the BOC has been negative for most periods since 2009.There is no doubt that this has contributed to the steepening slope of the home price charts in Canada. Don’t expect this to change anytime soon, as consensus has it that Canada will wait until at least 2018 to initiate a rate hike.
While it’s possible that the GTA may see a slowing of growth or a plateauing at any time, we don’t expect anything near the largest historical drawdowns. We will remain optimistic of growth in this region until we have at least one rate rise with the expectation of sustained further rising.
Honor the lord with your wealth, with the firstfruits of all your crops.
Proverbs 3:9
Economic Update
After a sleepy Summer with lower than usual trading volumes, the markets are back to risk-on mode. Since reaching a bottom at the end of January, due to a global decline in oil prices earlier this year, the TSX is up 24.3% through the end of this quarter. Looking back at the second quarter, the Canadian economy contracted by 1.6% (annualized), the largest quarterly decline since 2009. The decline was largely due to the wildfires that swept across Northern Alberta this past May, halting many oil sands productions, and with that, weak exports. As rebuilding around the Fort McMurray area continues, it is expected that third quarter growth will rebound.
Weak oil prices have had a negative effect on the energy industry and employment. Alongside this, household debt-to-income ratio reached a record high of 167% spurred by a combination of continued low interest rates and stagnant wage growth. With this backdrop in mind, Governor Stephen Poloz is poised to remain accommodative if necessary.
When examining the Canadian economy, it’s difficult to ignore real estate, especially if you live in the Vancouver or Toronto areas. Although it remains too early to tell, we believe that Canada is in for a soft landing. The newly introduced Foreign Buyers Tax came into effect on August 2nd, causing Vancouver to undergo a moderate correction. Meanwhile, Toronto home sales hit a record high in August with appreciation in prices since early 2015 now exceeding Vancouver’s.
Canada’s Finance Minister, Bill Morneau, announced some new rules on October 3 rd that require borrowers with insured mortgages (higher risk) to demonstrate the ability to service their mortgage as interest rates begin to rise. The rules also tighten the loophole allowing those unqualified to benefit from the exemption that lets Canadians and Canadian residents avoid paying taxes on the profit earned from the sale of a primary residence. While the Toronto market is still hot and will likely remain so in the short term, we believe that these new regulations and the eventual increase in interest rates will eventually cool the Toronto housing market.
Globally, while the general stance has been largely accommodative, we are witnessing a shifting of sorts. Accommodative monetary policy actually began in Japan with a zero interest rate policy (ZIRP) and was later implemented by the US in 2008. This led to large-scale asset purchases or bond-buying programs (QE) which has most recently led to negative-interest rate policy (NIRP).
But with many considering NIRP the last ‘throw of the dice’, leaders are now turning to fiscal policy as the answer. At the September G20 meeting in Hangzhou, the consensus was that monetary policy had run its course. Leaders must now look to fiscal policy to spur economic growth. While it will take some time to see the effects of fiscal policy, the global economy is still looking at a ‘lower for longer’ environment.
These lower for longer rates have, in part, fueled the shift into equities as investors continue their search for yield; and market levels, as they stand today, are in large part a result of that search. So, while investors have been enjoying the rally in the markets, the question remains as to whether market levels reflect the upcoming risks. There are reasons to be cautiously optimistic; OPEC met this past September and has come to an agreement to cut oil production and impose limits. Time will tell whether or not this can be successfully implemented and how this may affect oil prices.
Markets remain on standby as a number of key event risks play out within the short term, including the ever-looming US election, concerns over Deutsche Bank’s credit issues, and a potential rate hike by the Fed. Investors ought to be cautious as the next quarter could prove tempestuous. Ensuring your portfolio is diversified and risk-appropriate is essential in seasons of uncertainty.
When pride comes, then comes disgrace, but with humility comes wisdom.
Proverbs 11:2
Reflection on Giving
As the year winds down, people begin to assess their annual charitable giving intentions. In many cases, decisions will be determined based on tax incentives, and often a pre-determined giving strategy will be implemented. If you’re in the midst of planning your annual giving, here is some food for thought:
In the Old Testament, the tithe was introduced as a 10% minimum for Israelites to give back to God to show thankfulness and their dependence on Him. Additional giving, a freewill offering, was also encouraged. This was not an easy mandate to follow; the Israelites frequently went through seasons of war and poverty, and there was certainly no tax break offered at the end of the year.
Whether tithing is mandated today is a hotly debated topic, but what should not be debated is the discipline of giving that the tithe promoted. Making regular giving a natural, normal part of your financial routine is critical to promoting generosity. We encourage our clients to give strategically, rather than simply planning and hoping to give “one day.”
In the end, it is not about the amount that is given, but the willingness of a person’s heart. It is the sincere act of giving and living generously. Would you still give without a tax incentive? Many who argue against giving regularly, as a percentage of their earnings, do it to justify their own lack of giving, and this could be revealing of a heart that is not generous or free to give.
At Covenant Capital, we are blessed to work with many clients who live and give generously. If you are seeking to increase your charitable giving, perhaps you might consider the following:
- Give annually a percentage of your total net worth and growth of assets (investment accounts and real estate)
- Build into your giving a percentage of your retirement income (RRIF/LIF drawings or government benefits)
- Consider starting a foundation for you and your family
- Give on the growth in your business and personal income
At Covenant Capital, we would like to encourage you to give generously, regularly, and intentionally. If we can help in that endeavor, please contact us.