What are first mortgage investments?

In today's multifaceted investment landscape, sophisticated investors are seeking alternative investment opportunities which provide a more attractive return for risk proposition with lower volatility than what is currently available in the public markets.

Among the various options available, “first mortgage investments”, as a subset of alternative real estate investments, have gained significant traction given its unique attributes offering regular, defensive income with a focus on security. First mortgage investments are typically short-term, income-focussed investment strategy that can provide investors with stable, passive income via monthly interest payments.

In this blog, we’ll delve into first mortgage investments as an alternative asset class, uncover the mechanics and explain their differences from second mortgages, as well as look into the risks, benefits, and key considerations for discerning investors.

Understanding the mechanisms of first mortgage investments. How do first mortgage investments work?

First mortgage investments entail lending capital directly to borrowers, typically individuals or businesses, in exchange for a first registered mortgage over a specific property or asset which has been offered as the collateral for the loan transaction. This arrangement provides the lender, and the underlying investors, with the highest priority in terms of repayment as the investment is secured by a mortgage over the property. This gives the lender recourse over the property in the event the borrower defaults on the loan. Such investments are commonly employed in real estate transactions, with the property itself serving as collateral. Loan amounts are often determined by the loan-to-value (LVR) ratio, representing the percentage of the property’s value that the loan constitutes.

Because of its lower relative risk, returns for such first mortgage investments are generally lower than investors in the other layers of the capital stack.

Read our blog, 'Understanding the capital stack: A comprehensive guide for all commercial real estate investors', to understand more on how this works.

Differentiating first and second mortgage investments

The primary distinction between first and second mortgage investments lies in their repayment priority in the case of default. 

A first mortgage investment takes precedence and is repaid before any other claims on the property.

In contrast, a second mortgage investment holds a subordinate position and is repaid only after the first mortgage has settled – subject to there being residual funds remaining from the sale of the property. Due to the higher risk associated with second mortgages, they generally carry higher interest rates to compensate for their lower priority in default scenarios.

Assessing the risks and benefits of first mortgage investments

First mortgage investments present a compelling opportunity for investors seeking attractive investment returns without a disproportionate increase in risk. First mortgage investments typically offer a regular, monthly income stream via the interest payments with competitive returns to investors who seek capital preservation and capital stability. It can provide investors with exposure to the property market without needing to own the assets. It can provide equity-like returns with the added security via the first mortgage security. However, like any investment, first mortgage investments come with their own set of benefits and risks.

Understanding both sides of the equation is essential for making sound investment decisions. 

All investments carry risks. Different investment strategies may carry different levels of risk, depending on the assets acquired under the strategy. The risks associated with a first mortgage investment – either as a direct, single-asset investment, directly or via a first mortgage property fund – include possible delays in repayment and a substantial or complete loss of income or principal invested. 

A first mortgage investment can offer investors an avenue to diversify their portfolios, benefit from professional management, and gain exposure to the real estate market without the costs associated with direct ownership. The potential for stable income, capital appreciation, and risk mitigation make a first mortgage investment an attractive investment option. However, it is crucial to consider the associated risks and perform due diligence before making any investment decision. You can read further in our Investment FAQs or if you’d like to schedule a call back please click here.

Rising popularity in Australia

Alternative real estate investments, especially in the form of first mortgage investments, have experienced a surge in popularity in Australia. This alternative asset class provides access to an alternative form of real estate investment without the costs and risks of direct ownership and not only has it proven its ability to ride out periods of rising interest rates but could actually benefit, making it increasingly popular to a growing range of investors. 

There aren’t many opportunities for investors to achieve stable, risk-adjusted returns with debt security, but alternative real estate investment managers offer exactly that.

For investors who are attracted to property and real estate investments and the returns it can deliver, but dislike the risk of rising rates and how they might affect it, professionally managed first mortgage investments, especially the commercial real estate debt sector, may be an appealing alternative.

In a rising interest rate environment, first mortgage investments and alternative real estate investments like CRED, have the potential to offer attractive yields but with greater capital preservation, whilst still maintaining exposure to property.

It’s an income-focused investment with a proven ability to ride out periods of rising rates.

With various investment options available, it is crucial to conduct thorough research, seek professional advice, and understand the associated risks.

Get in touch with one of our Investment Directors today to find out more about the first mortgage alternative real estate investments we offer at Zagga. 

This article is for information purposes only. It does not take into account your objectives, financial situation or needs. Any opinion expressed in this article are of the author and is subject to change without notice. Readers are reminded to exercise caution and use their own judgment when interpreting and applying the information contained in this article.

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