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What you need to know before investing in mortgage trusts

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If you're looking for a way to get your foot in the door as an investor in the Australian property market but you're not ready to make a direct purchase, a mortgage trust may be an option for you.

A mortgage trust is an investment vehicle that lends investor money to borrowers in exchange for a registered first mortgage over improved or unimproved property as the primary security. In return for their investment, investors receive a regular income called a distribution which is generally derived from the interest paid by borrowers.

New to the idea of a mortgage trust and wondering if it's right for you? We've compiled a list of key things for you to consider when considering this style of investment.

sponsored what you need to know before investing in mortgage trusts

Pooled or contributory

There are two types of mortgages trusts; pooled and contributory.

In a pooled mortgage trust, your money is pooled with that of other investors to invest in a portfolio or pool of loans. You do not hold an ownership right in respect of any particular loan, just a right to the number of units in the trust that you subscribe for.

Together with the other investors, you share in the income generated by the entire pool of loans proportionately to the number of units you hold. The risks associated with the individual loans are diversified across the portfolio. You're able to redeem your investment subject to the terms and conditions outlined in the Product Disclosure Statement (PDS) for the trust.

In a contributory mortgage trust, you, or the fund manager, decide which mortgage loan to invest in after reviewing the specific features, benefits, and risks associated with that loan. Your money is then pooled with other investors to lend to the borrower.

You receive a distribution return that reflects the nature of the loan that you have selected. The mortgage loan you invest in may generate a return different from others in the mortgage trust and it's important to note that this style of mortgage trust can carry a higher risk because your investment is concentrated in one mortgage loan.

Types of loans

Generally, a mortgage trust is exposed to the risks related to lending money and the types of underlying assets to which the loan relates.  Importantly, some mortgage trusts lend money in respect of development activities, with security interests over properties at various stages of property construction and development, or land subdivision projects.

These may include residential, industrial, retail and commercial property which vary in their stage in the property market cycle.

It is important that such projects are managed by experienced developers and that you understand the additional risks of exposure to such activities. The PDS for the mortgage trust will set out the types of loans to be funded. It will set out details of the fund manager's approach to valuations on the security properties.

It will also state the manager's policy on seeking first or second mortgages. Whilst a first and second mortgage may use the same property as security, the first mortgage has priority over the security should the borrower default on their repayments.

Loan-to-valuation ratio

Loan-to-valuation ratio (LVR) is a term used to describe a lending risk assessment examined before providing approval for a mortgage. The LVR is calculated as a percentage of the loan amount compared to the appraised value of the property. A mortgage with a high LVR is associated with a higher risk.

An LVR can be calculated two ways. For development and construction loans, the LVR represents the maximum loan amount as a percentage of the "as if complete" valuation. The LVR for completed properties represents the maximum loan amount as a percentage of the "as is" valuation of the security property.

A mortgage trust will generally have specific criteria providing strict limits for LVRs to assist with risk management of the portfolio. Understanding these criteria and the current weighted LVR of the entire mortgage loan portfolio can help you make an informed decision about your investment.

Before deciding to invest, it's important to read the PDS and any updates on the portfolio to find out the LVR limits. You should also research the average LVR of the mortgage loan portfolio to ensure you're comfortable with the associated risks.

Geographic diversification

As a property investor, no doubt you're aware that the status of the property market in Australia differs between states, sometimes even regional territories. The markets in Sydney and Melbourne differ significantly from those of Brisbane or Perth and depending on their position on the property cycle clock, some states may find themselves in a slump whilst others a boom.

A mortgage trust with an appropriate level of 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.

The right investment manager

A strong investment manager underpins the success of any investment, in any class. The decisions an investment manager makes impact how your money is used to generate returns. Traits you may look for in an investment manager may include:

Experience: An investment manager's experience in their market means they should have developed an in-depth understanding of how it works, so they're well placed to make calculated investment decisions in the best interests of their investors.

Discipline: An investment manager should follow their investment mandate, criteria, and representations to investors so they benefit from transparency and confidence in their investment manager.

Risk management: There are inherent risks with any investment. The investment manager's ability to identify risks and proactively manage their impact on returns should provide added security for investors.

Distribution yield

"Distribution yield" is the income paid to investors and is derived from the interest payable on the mortgage loans made by the mortgage trust net of fees. The distribution yield is generally expressed as an annualised percentage and paid either monthly, quarterly, half-yearly, or annually. Many trusts offer two options for payment of distributions.

You may either nominate to have distributions paid to your financial institution account or reinvested into the mortgage trust so you are able to harness the benefits similar to those of compound interest.

Redemption terms and conditions

A mortgage trust is generally an illiquid investment, meaning that, unlike a cash investment, you're unable to redeem your investment and get instant access to your money. This is due to funds being lent out to borrowers and the fund manager's processes for managing liquidity and protecting the integrity of returns paid to investors.

It's important to understand the redemption terms and conditions outlined within the mortgage trust's PDS and consider, with professional financial advice, your budget and need for access to your money before making an investment decision.

Learn more about investing in Trilogy's range of mortgage trusts, diversified income funds and property trusts. 

This article was 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. Application for investment in the relevant product can only be made on the application form accompanying the Product Disclosure Statement (PDS) available at www.trilogyfunds.com.au. The PDS contains full details of the terms and conditions of investment and should be read in full, particularly the risk section, prior to lodging any application or making a further investment. All investments, including those with Trilogy, involve risk which can lead to loss of part of or all your capital or diminished returns. Trilogy is licensed to provide only general financial product advice about its products and therefore recommends you seek personal advice on the suitability of this investment to your objectives, financial situation and needs from a licensed adviser to conduct an analysis based on your circumstances. Investments with Trilogy are not bank deposits and are not government guaranteed.

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Philip Ryan is the managing director of Trilogy and is the fund manager for Trilogy's trusts. A solicitor for more than 30 years, he has experience in commercial and corporate law. Philip is a Fellow of FINSIA and has qualifications in mortgage lending and financial services. His experience in the financial services industry dates back to 1986. Philip was a founding director in 1998 of the funds management entity which evolved into Trilogy.
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