UNDERSTANDING PRIVATE MORTGAGE

INVESTMENTS

IMPORTANT NOTE

The statements herein are based on information that we believed to be reliable at the time of publication, but we cannot represent that they are complete or accurate. This document is subject to revision without notice. This document is for informational purposes only and shall not constitute an offer to sell or a solicitation to buy any securities. No offering will be presented except in accordance with governing securities laws. This guide has been prepared for informational purposes only and does not purport to be complete. The presentation contains statements that, to the extent that they are not historical fact, may constitute “forward-looking

statements” within the meaning of applicable securities legislation. Forward‑ looking statements in this presentation include, but are not limited to, statements regarding potential return on investment and the future prospects for mortgage lending and investment strategies. In addition to these statements, any statements regarding future plans, objectives or economic performance of the Trust, or the assumption underlying any of the foregoing, constitute forward-looking information. This presentation uses words such as “may”, “would”, “could”, “will”, “likely”, “expect”, “anticipate”, “believe”, “intend”, “plan”, “forecast”, “project”, “estimate”, “outlook” and other similar expressions to identify forward-looking statements. Actual results, investment performance, or achievement could differ materially from that expressed in, or implied by, any forward-looking statements in this presentation, and, accordingly, readers should not place undue reliance on any such forward-looking statements. Forward-looking information involves risks, assumptions, uncertainties and other factors that may cause actual future results or anticipated events to differ materially from those expressed or implied in any forward-looking statements and, accordingly, should not be read as guarantees of future performance or results. These risks and uncertainties include the business of acquiring and owning real property including: government regulation and environmental matters; illiquidity; uninsured losses; investment concentration; competition; lending strategy; borrower credit stability; reliance on key personnel; integration of additional properties; debt financing; interest rates; litigation; syndicated mortgage investments; potential undisclosed liabilities associated with secured assets; reliance on a lines of credit for liquidity and other factors. Due to the potential impact of these factors, any forward-looking statements speak only as of the date on which such statement is made and any intention or obligation to update or revise any forward-looking information, as a result of new information, future events or otherwise, is hereby disclaimed. New factors emerge from time to time, and it is not possible for management to predict all of such factors and to assess in advance the impact of each such factor on the mortgage lending business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

Introduction

Dear investor,

Thank you for taking the initiative to learn more about Mortgage Investing. This guide to investing in

mortgage funds was written with the goal of providing discerning investors further knowledge to help

them confidently select a performing mortgage fund. We have scoured the marketplace looking at a

wide array of mortgage investment options, and along with the selection criteria described herein, we’ve

highlighted characteristics the top performing funds share.

Mortgage companies and mortgage funds have existed for more than 150 years. Since the creation of

government sponsored home loan insurance organizations, chartered banks have become a more popular

mortgage lender. With the banks’ mandated liquidity requirements, they are forced to lend using specific

ratios based on taxable income, which has left them only able to fund 60-65% of the market. This

constraint on the banks’ lending ability leaves a chunk of the market underserved. Real estate owners

who fit into the category of having equity but don’t match the banks’ other requirements still present a

worthy mortgage lending opportunity. Investment security for those “equity lending” opportunities can

be realized through a diversity of mortgages by property size, location and strength of legal covenants

registered against title.

A good mortgage fund manager only selects loans for a portfolio after assessing both the underlying

property’s potential to generate the targeted interest return and the borrower’s credit meeting their

criteria for repayment. Our advisors have sought out to model the best practices which ensure the highest

probability of uninterrupted interest revenue for investors, and have provided those details in this guide.

Mortgage funds fulfill an important role in the real estate markets. These mortgage funds provide

financing for construction, renovation, and the supply of new housing. All of this activity creates new jobs

which help the economy grow. This guide covers the important factors which drive mortgage fund

performance and qualify them as a credible investment. Given the lack of volatility within a diversified

mortgage pool, a well selected allocation to this investment class can be considered for a core part of

every portfolio.

Best regards,

Yari Nieken

Foremost Capital Inc.

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Table of Contents

7

Introduction 4

Table of Contents 6

Value from This Guide 8

Principles of this Guide 9

Direct Mortgage Lending Background & Landscape 10

Individual Mortgages vs. Mortgage Trusts 11

Mortgage Trust Investments 13

Mortgage Trust vs. Mortgage Investment Corporation 14

Owning Trust Units 15

Investment Objectives 17

Direct Mortgage Investing vs. Investing Through a Trust 19

Why do borrowers apply to Mortgage Trusts instead of Banks? 20

Borrower Motivations 21

Security and Mortgage Trust Selection Criteria 24

Optimal Security 25

Top Selection Criteria 26

Critical Managment Expertise 27

Top Tier Investment Security 29

Looking for Alignment 32

Different Investment Options 33

Summary: Trust Advantages 34

Frequently Asked Questions 36

Peace of Mind 40

Notes: 41

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Value from This Guide

Understanding the Basics

Some of the most important aspects of investing in mortgage funds include the loan to value ratio of all loans in the

overall portfolio, the type of property the loan is secured against (residential, commercial, development), and the

use of leverage within the fund. All the fancy marketing materials some funds use can distract investors from seeing

through to the most meaningful facts that matter to long-term return on investment.

Be Sure to...

Read this guide more than once. Some things will be more easily understood after you have had the chance to

review the information a second time.

Legally Speaking

This guide does not take the place of a “Declaration of Trust” or “Offering Memorandum”, that are provided by

each mortgage fund manager and contain a list of all of the legal rights an investor has when investing into that

specific fund, as well as the responsibilities of the trustee or mortgage manager.

Purpose of this Guide

This guide is intended to give any non-finance-professional a clear idea of how a diversified portfolio of mortgages

is organized and managed. The intention is to do away with as much industry jargon as possible and convey a

straight-forward description of how a mortgage fund operates. Some of the areas covered include:

• An appreciation of the return-on-investment potential

• How a mortgage fund can be legally structured

• The investment approach and operational management philosophy of a well-run portfolio.

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Principles of this Guide

Every Investor Should Fully Understand Their Investments

In our experience, informed individuals can make decisions confidently when provided a thorough explanation or

a particular kind of investment. To further aid in this understanding, information provided is written plainly in

everyday language without heavy use of business-speak or technical jargon.

We Do Not Guess

Any figures representing financial results to be achieved are based on actual experience with similar mortgage

portfolios in the same target markets and interest rate environment. Both interest rates on loans and operating costs

are based on first-hand knowledge of mortgage funds. The leadership and management teams surveyed have a

history of consistent returns and predictable collection rates.

All invested capital is treated with respect, and investor’s selection criterial should include mortgage funds run by

managers who also have a significant amount of their own capital invested too.

The Information is Reliable

The statements contained in this book are based on information believed to be reliable at the time of publication.

Supply and demand can swing back and forth and there is always an element of uncertainty in any investment, as

a result all investors should decide prudently on the right amount of their portfolio to place in any one investment.

The Information is Complete

This book outlines the key characteristics of mortgage portfolios, management teams’ approach to running a

mortgage fund, and the investment opportunity they afford. A full reading of this guide will provide a solid basis

for understanding these mortgage investments and the potential for profit to be earned.

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Direct Mortgage Lending Background & Landscape

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Individual Mortgages vs. Mortgage Trusts

Individual Direct Mortgages

Lending for interest is a form of investment that has been around for 5,000 years — even before currency was invented. Many very successful individual investors have built their wealth by earning interest on loans. Albert Einstein is quoted as saying, “Compound interest is the eighth wonder of the world. Those that understand it, earn it, those that don’t, pay it”. The advantage that a mortgage lender has comes in the form of a fixed/contracted interest rate that is due whether or not the rental income for the property is collected each month. Any money the real estate owner invested into the property is considered their equity and acts to protect the mortgage capital from short-term fluctuations in the market value of the asset securing the loan.

Direct mortgages are simply mortgages held by individual investors, groups of investors, or non-exchange traded investment entities, such as a mortgage trust or corporation, rather than a chartered banking institution. Regardless of who holds the mortgage, the legal status of any mortgage is the same: the mortgage borrower is legally obliged to repay the loan to the mortgage lender at the agreed upon interest rate and within the time period stated in the mortgage agreement.

The mortgage loan is secured by a charge on the title to the underlying real estate owned by the mortgage borrower, and often by personal covenants and other collateral. So, if the loan payments go into default, the mortgage holder has the right to foreclose on (force the sale of) the property and/or other collateral as contracted in the mortgage agreement.

Typically, direct mortgage interest rates are higher than mortgage rates offered by the chartered banks or credit unions. For investors, this creates a potential to achieve appreciably higher investment returns than those earned on other fixed-income investments, such as GICs, bonds and preferred shares.

An individual mortgage investor lending directly, is solely responsible for all aspects of the underwriting process, including:

reviewing the real estate being offered as security,

scrutinizing the mortgage application, including the borrower’s credit history,

verifying the borrower’s income and employment,

assessing the borrower’s overall financial capacity to repay the loan, and

negotiating the interest rate and other terms of each loan.

When properly chosen, direct mortgages offer a contractually fixed interest rate secured by virtue of the borrower’s personal covenant and income, plus any rental income that comes from the real estate itself.

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Once the loan is made and secured an individual mortgage investor then begins to administer the loan. While this is nothing like managing rental property or running a business, there are still payments to coordinate, records to keep, and in the case of a default, there is work involved in collecting on the loan and selling the property.

An individual investor is required to fund 100% of an individual mortgage and hold the mortgage directly. The investor would be solely responsible for sourcing and evaluating the mortgage, negotiating the conditions of the mortgage, and instructing the lawyer preparing and registering the mortgage.

So why doesn't everyone have their own direct mortgage portfolio?

Given the typical loan amount for mortgages in today’s real estate market, an investor would require a large amount of capital to fund the even a small mortgage portfolio. In the case where an individual concentrates their capital in a limited number of whole loans they will negate the potential for diversification.

This individual investor is also responsible for collecting the monthly payments and dealing with any arrears or problems that may arise. While doing all of this yourself might seem like it could save money and increase your investment returns in the short-term, the risk, the amount of capital needed to properly diversify, and the hassle are just too great for most people.

There is a better way to invest in mortgages…

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Mortgage Trust Investments

While a sole investor may only be able to fund one or more small mortgages, investing in a mortgage trust offers those with limited capital an opportunity to invest in a well-diversified, income-yielding, and real estate secured portfolio. By pooling capital with others in a mortgage trust, the collective can profit from a number of professionally selected mortgages and take advantage of the economies of scale that balance potential returns with reduction of risk.

Mortgages have long been a proven investment offering predictable returns. Managed mortgage trusts represent an opportune investment vehicle for investors who wish to reap the benefits of mortgage investing, but who may lack the expertise or required capital to hold a portfolio of individual mortgages directly.

The structure of a mortgage trust is similar to a mutual fund. The main difference is that instead of the money going into stocks, bonds or other instruments, the capital from a combined group of investors is used to fund a large pool containing multiple mortgages, inherently reducing risk through diversification.

Because a trust is managed by professionals in the industry who have extensive knowledge of financing and mortgage analysis, they are able to make informed decisions based on ongoing active experience with safe loans. Hence, having a team of professionals who select deals to reduce the risk, will save the individual from having to decipher all available information themselves. A trust also contracts for all administrative duties, saving investors considerable time and worry.

A trust provides a convenient investment vehicle, in that management is fully responsible for all operations, including sourcing the mortgages, making the lending decisions, instructing and interfacing with lawyers, and administering the mortgage portfolio.

The reason for using a mortgage trust is because it is entitled to special tax treatment. A trust is a flow-through investment vehicle, which means that all revenues generated can be distributed to investors without experiencing painful double taxation. The trust itself does not pay income tax as long as the taxable income is paid out to the unitholders on an annual basis.

There is another special kind of company, called a mortgage investment corporation, that is also used for pooling mortgages. The table on the next page provides a simple comparison between a mortgage trust and a mortgage investment corporation.

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Mortgage Trust vs. Mortgage Investment Corporation

Feature Mortgage Investment Corp Mortgage Trust

Minimum Shareholder Requirement 20 No minimum

Per Share Holder Cap on Ownership 25% No cap

Minimum Residential Mortgage Allocation

50% No minimum

Ownership of Land or other Real Estate

25% for Income Producing/ Land Restricted

Not until a minimum of 150 unitholders

Flow-Through Tax Treatment Yes Yes

Non-Resident Investor Access Closed to non-residents Open to non-residents

Dividend/Distribution Tax Treatment Interest Income Interest Income

Use of Leverage Allowed Allowed

RRSP/RRIF Eligible Yes Yes

Restricted from Public Listing No Yes

Mortgage trusts provide the vehicle of choice for direct mortgage portfolios. They offer complete flexibility in the range of property types that mortgages can be secured against.

In order to protect capital in the case of a recession, if an individual mortgage loan goes into default, a trust can assume ownership of the property securing the loan and can hold it for a longer period of time to realize more value. A mortgage investment corporation cannot do this, but instead would have to sell the property immediately, taking a write down on that individual loan. This is one of the most compelling reasons to use a trust when one is focused on protecting capital invested in every way possible.

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Owning Trust Units

What is a mortgage trust and how does it work as a mortgage investment vehicle?

A mortgage trust is a investment vehicle wherein individual investors pool their capital through unit subscriptions. The trust employs a professional manager to source, scrutinize and lend on individual mortgages with the best risk/return profile. The manager is responsible for all aspects of the mortgage portfolio. The mortgages are continuously managed, using newly sourced investment capital along with the proceeds from repaid mortgages to fund new ones.

All of a trust’s yearly net income, as verified by an external audit, is paid out to unitholders by way of a distribution. Like any company, a trust’s net income is equivalent to its revenues less its expenses. Revenue is earned in the form of mortgage interest, lending fees, and penalties charged, with the primary expenses being management costs as well as annual audit and professional fees.

A trust may also use funds raised from a bank in the form of a warehouse line of credit, in addition to its unitholder capital, to fund a portion of its mortgage portfolio.

While the mortgage portfolio manager handles all administration, investors become unitholders in the trust, not the management company. The trust is a separate entity that in turn lends on a "pool" of many mortgages, and receives an interest in all registered mortgages as security for its investments. Combined interest payments from all of the borrowers become income for the trust unitholders.

The interest income collected each month is deposited automatically to the mortgage trust’s account. Some mortgages manager’s payout their portfolio distributions quarterly and while rare, some payout a distribution monthly. Along with receiving the cash distribution, investors are provided access to statements confirming mortgage portfolio details and their personal account balance.

A trust is for investors who want a predictable investment, by holding a diversified mix of mortgages risk is reduced and returns are kept consistent.

Tax Advantages for the Investor One of the greatest advantages gained through the use of a trust is its tax-efficiency. Unlike stock-issuing corporations where tax is paid on net income prior to paying out a dividend which is then taxed again in the hands of the investor, a trust is a flow-through investment vehicle under the Income Tax Act. This means it does not pay tax before the distributions are paid to unitholders. The Income Tax Act requires 100% of a trust’s annual taxable income be distributed to its unitholders. Distributions are taxed as interest income in the hands of the unitholders, as they essentially represent a flow-through of the interest earned from the trust’s mortgage portfolio. Like any company, a trust’s net income is equivalent to its revenues less expenses. A trust’s revenues are comprised primarily of mortgage interest and fee income which can be 10%-15% of the total. The expenses of a trust using a line of credit will also include interest if the trust is employing debt to manage liquidity. The interest rate on the line of credit will be far lower than what is charged on the mortgages, creating another way for unitholders to earn a profit.

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If you are a unitholder of a trust, significantly more income will flow through to you at each disbursement, than would have if it was first reduced by taxes paid first inside the company. Moreover, the units of a trust are an “eligible investment” for investment savings plans, including registered retirement savings plans (RRSPs) and registered pension plans (RPPs). This means you can have your distributions deposited into your RRSP or RRIF. Investment in a trust is particularly attractive for these types of plans because the plan beneficiaries do not pay tax on the deposited distributions until they start to draw money out of their plans and actually receive the funds personally.

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Investment Objectives

Consistency: insulated from stock market volatility

Especially in times of economic uncertainty, the consistency that comes with a diversified pool of mortgages secured against tangible real estate assets — often with the borrower's personal and/or corporate guarantee as additional security — makes mortgage investments a valuable component of a well-balanced investment portfolio.

Predictability: Regular income based on contracted interest

Whereas stocks or mutual funds tend to experience volatility, mortgage investments offer more predictable, contracted returns not based on a market index. With a healthy property equity cushion, a portfolio of mortgages contain pre-determined interest rates so an investor knows what return to expect each and every month. Unlike marketable bonds issued by governments or corporations, mortgage trusts are not immediately affected by changes in the prevailing interest rates.

Security: Backed by tangible assets

As mentioned, good mortgage trusts invest their funds in residential first and second mortgages with the total loan to value of the mortgage not exceeding 75%. This means explicitly there is always at least 25% of equity remaining in the property, which essentially serves as a margin of safety for the loan. All properties are confirmed to be in sound physical condition and are appraised by accredited appraisers to determine their current market value.

In a scenario where the borrower has accumulated extended non-payments, cancelled the property insurance, or failed to pay the mortgage balance on maturity, the lender may initiate foreclosure proceedings to have the property sold or the title transferred to the lender. The 25% minimum remaining equity in the property is used to cover the legal costs that a mortgage fund would incur in this event. Mortgage agreements contain clauses which allow all legal fees to be added to the outstanding principal balance on the mortgage and would be repaid upon the sale of the property.

Having a mortgage as security on an investment is a unique advantage. Anyone who invests in stocks should understand that, if a problem arises with the company, the money at risk is the common share holder’s, followed by unsecured creditor’s. Creditors with security (i.e. mortgage or secured bond holders) are paid first. Legally speaking, the term “mortgage” represents the security over the asset or property but the “loan” is what actually generates the interest revenue and subsequent distributions. As with bank mortgages, all documentation, security registration and disbursement of funds are prepared and handled by a lawyer.

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Mortgage Lending Strategies

Stringent Qualifications for every Mortgage

The best security, first and foremost is from urban residential home mortgage loans. Mortgage funds also provide residential construction financing and commercial real estate mortgages. One definition of a commercial mortgage is a loan against a property that the borrower owns for the purpose of making money rather than as a home to live in. This includes rental apartment buildings, retail shopping centers, office building, or industrial warehouses.

Many mortgage funds provide loans with terms rarely exceeding one year. This strategy serves to increase

returns to the unitholders keeping the portfolio of mortgages turning over more frequently, increasing fee revenue while reducing the risk of holding a mortgage for too long should the value of a specific property decline.

Splitting mortgages into two parts and selling one part to another mortgage lender can be way to reduce loan advance size and increase yield (when keeping the higher interest rate paying portion of the mortgage).

Issuing a revolving stand-by commitment is a strategy to generate lending fee revenue without having advanced the entire amount of the loan upfront. While the whole loan isn’t advanced the percentage fee revenue is higher and the risk is lower as the loan to value of the partially funded mortgage is well below the full approved amount.

Before any mortgage loan is approved, each property/borrower must:

• meet the security and debt service coverage requirements and have the capacity to ensure repayment;

• have the potential to deliver an interest rate that meets distribution payment requirements;

• advance successfully through each stage of rigorous due diligence, risk and future income analyses; and

• be a suitable borrower management would consider lending to on future loans following successful repayment on the first loan.

If the loan cannot reasonably be expected to achieve the prescribed results, then lending on a property will not proceed.

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Direct Mortgage Investing vs. Investing Through a Trust

Direct Investment Trust Investment

Investment Amount Difficult for individuals to achieve even minimal diversification (Larger Investment Required)

Relatively small

Management Individual investor wholly responsible

Professional manager

Return

Depends on mortgage type as well as the expertise and diligence of the individual investor

A professionally managed trust, employing the prudent use of financial leverage (debt) should achieve higher returns with lower risk

Risk

Depends on portfolio size and composition along with the expertise and diligence of the investor

Portfolio size, and the underwriting and portfolio administration expertise of the manager, serve to reduce risk

Liquidity Mortgage repaid at maturity, subject to borrower’s capacity

Units may be redeemed

RRSP/RRIF Eligibility Yes Yes

Flexibility Large principal amounts reduce flexibility

Any unit amount may be deposited; greater flexibility

Sourcing good mortgages is no small task. It is not as easy as it sounds to find suitable mortgage loan opportunities. Professional managers have taken years developing relationships with mortgage brokers who will actively send through loan application files. In many cases a manager will review 8-10 application files before they find one that meets all of their criteria.

Having the volume of application inflow that it takes to turn down 8-10 for every one accepted requires a tremendous amount of management effort. This one factor alone could be the deciding reason why someone would choose to invest in a trust rather than try to run their own mortgage portfolio.

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Why do Borrowers Apply to Mortgage Trusts Instead of Banks?

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Borrower Motivations

Direct mortgage lenders offer flexibility and speed that many banks cannot. Direct lenders can work "outside the box" and consider loans that make sense on a local level. Banks have rigid lending criteria dictated by government regulation, international banking practices, and corporate guidelines that often do not incorporate local market conditions or unique loan factors — which, of course, limits their ability to take advantage of many potentially profitable opportunities.

Borrowers may also apply for bridge financing from direct mortgage lenders. If a borrower has a source of funds that will not be available until after their contracted property purchase closing date, a trust can provide a “bridge” loan to close the gap in timing.

How do mortgage funds compare to banks when it comes to lending criteria? Banks are major players in the mortgage markets. They are also the most standardized lenders. Their rigid computer-generated, “one-size-fits-all” lending policies are based on international banking standards. Chartered banks function in a tightly controlled regulatory environment. Given their size and structure, banks are not equipped to underwrite mortgages on a “deal-by-deal” basis, carefully scrutinizing individual applications to ascertain whether real risk is within reasonable limits.

Fundamentally, banks are not “equity lenders”. A bank’s initial focus is on the borrower, not the property acting

as security for the loan (equity). In assessing a mortgage application, a bank’s first concern is whether the prospective borrower has excess income over what is required for the mortgage payments. They place their focus on factors relating to the borrower, such as income, employment stability and credit history. Only after the borrower meets or exceeds the requisite computer-generated credit score will the bank consider the adequacy of the real estate that would secure the loan. Banks routinely decline mortgage applications for borrower-specific reasons including credit history, self-employed applicants’ income verifications, job tenure, and debt service ratios that exceed regulatory and corporate policy limits. The fact the underlying real estate security adequately limits the real risk is irrelevant to them in such cases.

Direct mortgage lenders are typically “equity lenders”, who primarily focus on the strength and quality of the real estate securing the mortgage. In this approach, risk is limited as long as the real estate is sufficient to protect the lender in the event of a default. Equity lenders can have more flexible criteria with borrowers as long as there is substantial value in the real estate. Decisions to offer a loan can also be informed by experience and professional judgment, in addition to qualifying criteria. For example, if a larger portion of a loan portfolio is composed of mortgages on owner-occupied single-family homes, experience and common sense tell us that borrowers will default on other obligations, such as credit cards and unsecured loans, before missing a mortgage payment.

Banks also operate in a very narrow policy box with respect to mortgages and property types, preferring to avoid or limit loans on second homes, building lots, construction, and second residential mortgages. These types of assets can also provide good value for mortgage security and are therefore worthy lending opportunities. The real issue is whether the mortgage investor has the expertise to carefully scrutinize and negotiate the loan to mitigate risk to an acceptable level.

While most of us don’t remember the time before government mortgage insurance programs (starting between 1913 and 1934), the banks were actually the smaller player in the mortgage markets. Prior to the banks becoming the popular lenders in the market place, mortgage funds and mortgage companies were one of the most active sources of loans. Now, the banks only fund loans which fit into their narrow guidelines otherwise they are required to take more risk weighting on their balance sheets resulting in more capital reserves and lower

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profitability. In short, banks are precluded by government regulation and corporate policy from underwriting a wide variety of mortgages wherein investor risk may be limited to reasonable levels, largely by virtue of the strength and value of the underlying real estate security.

Are these Different Than Sub-Prime Loans? With the credit crisis still close in the rearview mirror, some may ask how the mortgage lending discussed in this book compares to the sub-prime loans that were being made up until 2007.

The key term in for the mortgages discussed in this book is “equity”. With 25% equity in a property, a borrower has significant incentive to continue making payments keeping the mortgage up to date. The loans most affected by the credit crisis were the ones made for 100% of or in some cases more than the purchase price of the property. When a property owner is able to obtain a loan equal to or greater than the value of the home there is less motivation for them to continue making payments if the value drops or their income drops. Conversely, where a lender has provided a loan of no more than 75% of a property’s value, they will be able to collect all of the principal and legal costs if the property is sold.

The Market of Borrowers Who would be willing to pay a higher interest rate on a mortgage through a trust?

There are many cases in which a borrower/property owner would be willing to pay more interest on a mortgage. Quick closing is one advantage of direct mortgages. Conventional mortgages granted by banks can take a long time to fund, especially if the deal does not fit their rigid criteria. When time is of the essence, borrowers are willing to pay a higher rate in order to obtain the needed financing on time, or they could face losing the property along with any deposit they put up.

Borrowers also may not want or be able to provide personal financial information or go through the application process associated with obtaining an institutional mortgage loan. For example, a borrower who is going through a divorce or business separation may not be able to produce the income documentation normally required by banks. The borrower also may not have all their financial information up to date or complete and as a result don’t qualify for a conventional bank loan.

With the growing trend of self-employment in today's marketplace, many lenders have tried to accommodate this niche of borrowers. However, many new entrepreneurs fall through the cracks of conventional lending programs. In some cases, the individual may not have been in business long enough or their declared net income might shown as low as possible for tax purposes. Direct mortgages are sometimes the best, if not the only alternative.

Another reason a borrower would need a direct loan could be because of the type of property being purchased. Institutional lenders are quite specific on the class of property they will finance, the acreage they will consider, or the zoning of the property. Any one of these factors deemed "unusual" would most likely result in a declined loan application by the institution and create a need for direct mortgage funds.

Some of the property types trusts participate in financing are residential single-family loans, renovation or construction financing, and bridge financing. These loans can be labour intensive to administer and manage, and there are variables in construction which do not occur with existing buildings. Banks often pass on financing construction and prefer to loan against a property once fully built.

A direct lender, such as a mortgage trust, will fund these types of loans while charging a premium interest rate, thereby creating a better return for the participating unitholders. One should look for a management team that has specialized experience in the real estate business, which allows them to manage financing opportunities with a heightened level of understanding.

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When financing is needed for an income-producing property, such as an office or apartment building, the property must satisfy the lender’s financial performance ratios. Occasionally, there are finite periods of time, during renovation or re-tenanting for example, during which these ratios cannot be met. The property owner may then need an "interim" solution. The more flexible financing option can provide a “bridge" through this period until bank financing becomes available.

You may have noticed the examples listed above involve short-term solutions. Direct mortgage lenders do not usually compete with lenders like chartered banks or insurance companies for borrowers seeking "term" financing of three to five years or more. The interest rates charged on these loans are far below what a mortgage fund requires to achieve a satisfactory return for unitholders.

Choosing a mortgage trust...

Now that we have covered how a mortgage trust works, in the next section we’ll discuss the specifics of how to choose the right trust.

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Security and Mortgage Trust Selection Criteria

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Optimal Security

Capital preservation is the most important component of the investment decision. All new loans should be made based on a property appraisal from accredited appraisers. A lender will limit their loan-to-value ratio (the loan amount as a percentage of the appraised value) for a given type of property and location. A good equity lender will never exceed 75% loan-to-value expressed as a total of the amount of mortgage principal registered against the value of the property and in many cases stay below 65%.

The primary risk to the lender is where the borrower becomes temporarily unable to make their payments, resulting in an interruption of income or, worst case, a complete default. Specific risks vary with the type and location of the property or purpose of the financing. To simplify, some risk factors can be summarized under the following categories.

Borrower income stability risk – Mortgage borrowers may not make all of the interest payments on what they

owe. Mortgage funds claim to be very careful about who they lend to, but some are explicitly in a niche where the banks don't tread. The lender gets a higher interest rate, but comes associated with higher risk. Generally, the impact of any single mortgage is small on the overall fund if loan limits are established for the maximum percentage of the total pool to any single loan. A fund with a smaller average loan size is more work for management but safer for investors.

Construction risk – This is present whenever construction/renovation projects are undertaken. Construction

projects can experience unexpected delays and cost overruns that eat away at the borrowers’ equity, increasing the mortgage loan to value. A good direct mortgage lender minimizes these risks by ensuring an experienced contractor is used to produce all budgets along with analysis by a third-party cost consultant. This is done to ensure the budget is adequate and sufficient contingency funds are included. These risks are also managed again through a low loan-to-value ratio for the property pledged as security, that is low enough to make sure the borrower’s equity will more than cover any surprises. It is important the principals involved in managing lending activity have experience with construction themselves. If they poses a high degree of knowledge they will better manage the risk.

Market risk – Whenever a property needs to be either leased or sold to pay off the mortgage, market risk is

added to the scenario. It could be the leasing of an office or retail property, or the sale of single or multi-family units in a residential development. In these cases, a market analysis by way of a completed 3rd party appraisal which includes absorption forecasts is obtained to ensure there is enough demand for the property in question leading to a high probability of mortgage repayment.

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Top Selection Criteria

#1: Loan to Value (LTV) of the underlying mortgage security. A true measure of risk that investors are taking by

investing into a specific portfolio of mortgages.

#2: Property types. Most of the defaults which have impacted total rate of return within mortgage funds over the

last 10 years trace their source to larger commercial real estate loans or land development financing. Investing in funds with diversity and smaller average loan sizes, targeting urban residential lending is the best way to ensure predictable returns.

#3: “Skin in the game”. While occurring less than one would hope, there are a few managers who have a

significant amount of their own capital invested in the mortgage fund they manage. An investor should take comfort from the knowledge their manager has a clear conscience when picking loans they would feel comfortable funding with their own money (because in fact they are).

#4: Quality and cost of warehouse line of credit for managing liquidity. Line of credit availability is required

within a portfolio to manage both mortgage funding timelines as well as the timing of investors investments and redemptions.

#5: Monthly distributions/dividends. Most mortgage funds these days pay only quarterly distributions as it

saves on administration time by reducing the number of payments made each year. Since normal living expenses occur monthly it may make sense to select a fund that has a monthly distribution of collected interest.

#6: Number of years the management team has been in the business. Performance and capital preservation

tend to favour long standing experienced managers.

Fund Comparison

Return LTV Manager Invested

Monthly Distributions

Years Experience

Asset Types Rank

Fund A 7.5% 65% No No 12 Residential, Land Development

4

Fund B 6% 62% No No 6 Residential 3

Fund C 7.7% 55% Yes Yes 15 Residential 1

Fund D 8% 70% Yes No 10 Comercial, Land Development

2

Sample ranking of fund criteria based on investor preference:

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Critical Managment Expertise

If you have ever taken out a loan for real estate, you’ve personally experienced what the mortgage application process is like and the differing requirements of various lenders you may have approached. For anyone who has owned a home, trust investments can be especially attractive because you already understand the basics. You remember what it was like to work with a broker or bank representative to find the right mortgage you could qualify for on terms suited to your particular needs. And thanks to your first-hand experience, you can easily appreciate why there will always be a market for varying types of lenders offering different loan products and options.

Homeowners can also easily translate personal experience of having to meet the collateral, credit risk and repayment requirements lenders have when granting mortgage loan funding. They also know what its like providing a personal guarantee — so besides foreclosing on your home, if you defaulted on the loan, the lenders could claim against your other personal assets too. This spotlights some of the concerns all homeowners know intimately.

The happy difference, though, is that the tables are turned when you invest as a unitholder of a mortgage trust. You are the investor/lender, and you’re the one with the best experienced legal, accounting and management professionals working on your behalf. The team hired to run a mortgage trust is employed to find the best qualified applicants for collective mortgage loan capital, namely those who have total assets that exceed all outstanding loans against them (including the trust’s) and can be secured by strong legal covenants.

Most homeowners who’ve had a mortgage also have a good understanding of what a mortgage is and how it works. Most other investments, such as stocks, bonds, income trusts and mutual funds, are affected by variables not always readily understood.

Mortgage Trust unit values do not fluctuate in response to market forces like publicly traded stocks, bonds, or mutual fund unit values. The unit values are equivalent to the outstanding mortgage loan balances that are considered collectable by the auditors of the trust.

Preservation of the trust unit value is a function of the quality of the mortgage portfolio, which is principally determined by the value of the real estate acting as security. Real estate values are affected by a number of factors, including the condition, location and type of the property, and local market conditions. These are factors that can be readily seen, measured and compared. Real estate values tend to be much less volatile than stock and bond prices. Even if the borrower defaults, the mortgage investor is protected by collateral that is clearly identifiable, insurable, and immoveable.

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The Manager’s Role

A trust’s objective is to generate returns for its unitholders by lending their invested capital in return for lending fees and interest income. Therefore, a manager’s responsibility is to source, select, and negotiate the right mortgages to achieve the unitholders’ objective.

The probability of loan loss is dramatically reduced in markets characterized by stable or appreciating property values. Accordingly, a trust’s management should avoid the volatile smaller city markets. In short, better trusts maintain high quality, well secured mortgage portfolios, with a heavy emphasis on single-family residential mortgages and mortgages secured by properties located in stable larger urban real estate markets.

After individual mortgages are advanced, the trust manager is responsible for all facets of portfolio administration, including collecting payments; ensuring that property taxes are paid, adequate insurance coverage is maintained, and any prior encumbrances are up to date.

Fee income is also an important contributor to profitability and return on investment with a mortgage fund. Fee revenue sources included the following and are influenced by management:

• Lender Fees: An application or loan fee, calculated as a percentage of the mortgage principal, is

collected when the mortgage is advanced. This can usually be 1-2% of the loan amount and is the largest of the fee revenue streams. Loans are specifically written on a short term basis so that every 12 months a new set of lender fees can be collected.

• NSF/Late Payment Fees: Mortgage payments are collected electronically through pre-authorized bank

debits, with fees levied in the event of NSF or late payments.

• Fees for Tax Arrears: Property tax arrears can result in significant penalties to the owner and fees apply

in the event that municipal property tax instalments are not paid in a timely manner to add further incentive for a borrower to stay up to date.

• Insurance Placement Fees: These are applied in the event that adequate property insurance coverage is

not maintained and/or insurance coverage must be paid for by the mortgage lender. A good mortgage manager will get an umbrella policy which covers at least the mortgage amount in case a borrower lets their property insurance lapse.

• Early Repayment as an incentive for Re-lending Fees: The vast majority of direct mortgages are open,

meaning they can be repaid at any time without penalty. Management will have priced their mortgages and the fees charged to take this possibility into account. A trust will benefit by earning additional fees when re-lending the funds prior to the time the original mortgage term would have expired.

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Top Tier Investment Security

The Professional Standard Approach to Protecting Capital Invested The best mortgage trust portfolios have managed security programs created to protect principal capital invested. A professional standard of mortgage security includes 5 areas as follows:

1. New Loan Underwriting (credit and security review)

2. Security Documentation and Registration

3. Mortgage Loan Monitoring and Administration

4. Loan Collection and Security Release

5. Portfolio Protection along with Trust Design

The 5 key areas of security include the work done before a loan is advanced, documentation for when the loan is advanced, management oversight once a loan advanced, collection of interest and principal of the loan on repayment, and the design of the overall trust holding the portfolio of loans on behalf of unitholders. Each of the 5 areas detailed below describes the right approach to mortgage security management.

1. New Loan Underwriting

Underwriting is a term used to describe the process of collecting all the supporting documentation for a new loan application: like a statement of borrower net worth, property appraisal, tax returns for income verification, financial statements for business position, and any other background on the property needed to asses the credit worthiness of the borrower and value the real estate.

The principal area of concern for the mortgage fund management team is the existence of at least 25% equity value in the property after the new loan is provided. This is an especially important benchmark when one looks back at the time during the credit crises where residential real estate indexes fell upwards of 20-25% in some regions.

The minimum 25% equity requirement should be based on the lower of three benchmarks. The first two are the purchase price of the property in the case of a new acquisition by the borrower and a 3rd party appraisal which the lender obtains from an approved appraiser. The last of the three benchmarks used is an internal value derived from management’s first hand knowledge of property markets including current market return expectations based on income or per acre/per unit valuations for construction lending.

In addition to the equity buffer, a “belt and suspenders” approach to doubly secure the return on investment includes a requirement for the borrower to have enough net worth, excluding the equity in the subject property, this excess equity would cover all of the interest and administrative costs incurred through the term of the loan. This way, even if a surprise occurs with the property, the mortgage trust will still be able to achieve a return on the investment through the borrower’s guarantee of the loan.

2. Security Registration and Documentation

Direct mortgage lending requires additional security over that of a conventional bank approved loan. Good security documentation not only provides different ways to collect an outstanding loan but also ensures all individuals involved in the real estate project are focused on its success.

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The minimum security required includes: a mortgage charge on the subject property, a General Security Agreement signed by the borrower which pledges any shares in holding companies or other investments the company may have, a personal guarantee, and an unlimited covenant from each of the directors or officers of the company that owns the property in the case of a commercial real estate. Part of the process of getting registered security against the title for the property includes obtaining title insurance for every mortgage loan provided. Title insurance covers any issue with the registration of the mortgage charge as well as any problem with the property title arising from unregistered easements or encroachments from neighbouring buildings.

Besides the land title registration system there is also the lesser-known “Personal Property Security Act” which is referred to as a PPSA registration. In the case there is a challenge in collecting on the mortgage balance outstanding, legal documents will allow a mortgage fund to make a PPSA registration and use it as a tool protect the capital investment. This usually allows the lender to collect on any vehicle, machinery, or equipment sales which involves assets not registered with land titles.

3. Mortgage Loan Monitoring and Administration

Active and assertive management of the loan portfolio is an important area underlying successful returns. Mortgage security management includes weekly monitoring over items like the borrower’s property insurance coverage, property tax payments, mortgage maturity, and of course interest collection. Disciplined active oversight catches areas of exposure early when management takes steps to remedy issues quickly before they become a bigger problem.

Additional monthly monitoring activity, include a selection of random property visits for those secured within the loan portfolio. These visits help ensure any delays or issues borrowers aren’t telling the lender about can be caught quickly. Random Inspections can also help to turn up issues before they impact the portfolio or its returns.

Not only does the fund’s senior management have active monitoring, but also any line of credit provided to the fund will be monitored by the facilitating bank. Credit officers from the bank will come into a fund manager’s office for physical inspection each quarter to review the financial performance of the mortgage portfolio as well as examine the security documentation and mortgages files. Knowing that a mortgage fund has a line of credit, one can rely on the high underwriting standards needed to satisfy a bank — further acting as a check and balance.

4. Loan Collection and Security Release

On any final repayment of any loan, a good lender uses a triple redundancy approval process before security is released from a property the mortgage is registered against. The triple review covers collection of all calculated interest, any 3rd party professional fees, any legal costs, any uncollected appraisal costs, and any late fees or insurance gap fees.

With the triple check and sign off complete as well as all funds accounted for in trust with the lawyers, the security on the property is released and the loan is officially considered repaid.

5. Portfolio Protection and Trust Design

The following checks and balances, together with the previously outlined security measures, are infrequently seen within mortgage portfolios. A quality trust design includes the following security protocols:

a) A third party trustee for the "Declaration of Trust" and stakeholder to ensure the legal form of trust outlined in the declaration is adhered to on behalf of the unitholders. The trustee for the Mortgage Trust can be a regulated trust company like Computershare Trust Company of Canada (Computershare). Computershare provides trust services and also acts as transfer agent for more than 75% of the companies listed on various Canadian stock exchanges.

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b) In addition to the trustee services, a 3rd party can act as the registrar and transfer agent for all of the unitholders to make sure every unitholder's investment position is tracked and accounted for.

c) On top of the third-party trustee services and registrar transfer agent services, a good Mortgage Trust places policies for three different kinds of insurance:

• Portfolio impairment insurance, which is a back-up policy that covers all of the real estate securing the loans, in case any of the borrowers do not renew their insurance policy properly. This covers the risk of a fire or significant damage incurred that could make it more difficult to meet the repayment terms of the loan.

• Directors and Officers insurance, which provides further protection against any income tax or other potential liabilities.

• Fidelity bond and errors & omissions insurance, which protects against any third-party theft or misconduct during any loan processing advance or repayment.

All of these protection efforts are important to ensuring the strong results for an investment into a mortgage fund. But there is something else just as important to predicting financial success…

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Looking for Alignment

Commitment and Peace of Mind Through Unitholder Super Priority The management team behind the mortgage funds show that they believe in the mortgage portfolio’s return potential, and that they are committed to dedicated management, by investing their own money in the fund. Even more rare is a management team with enough conviction to sign a contract placing the return of capital to all unitholders ahead of their own.

By way of example, lets look at how this would work if a management team has $100,000 of their own money invested in a pool of $1,000,000. In the case of a mortgage payout, the first $900,000 would be paid out to the unitholders and only if there is enough with any remaining funds would the $100,000 be returned to management. This super priority for the unitholders provides both financial protection as well as a big management incentive to protect the fund from accepting risky mortgages.

Incentive Performance Reward for Delivering Profit to Unitholders In some mortgage funds there is further alignment by incentivizing returns above a base return called the “hurdle” rate. The hurdle rate represents the minimum return which must be achieved by the fund in any given year before management can receive their incentive performance reward. The incentive performance reward is based on the profit realized from the mortgage portfolio above the contracted "hurdle" return threshold.

The minimum return hurdle needed before paying out additional profit for unitholders, can be calculated on a quarterly or yearly basis. Any unitholder who invests prior to the end of the previous period will benefit from any additional profit earned. The incentive performance reward a manager earns should only be paid at the end of the year, after all of the results are known and the auditors have completed their review.

The carrot and stick approach has been shown to work well at holding the attention of the mortgage fund’s managers and keeps them vigilant on protecting the portfolio from any downside while striving to achieve the best total results for all.

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Different Investment Options

Customized Choices Between Certainty and Reward Within pooled mortgage vehicles, a trust is able to uniquely apportion risk and returns to provide options for additional investment stability. In some trusts there is an added benefit provided through a two tier investment structure allowing individuals a customized choice of risk and reward. Individuals can manage their own portfolio by changing the amount of capital they allocate into either tier. Examples of two tiered unit class types and sharing qualities are outlined below.

Two Choices for Custom Allocation Because no two investors’ preferences or needs are the same, mortgage investments should allow for customizability. In selected trusts, Investors can choose from two levels of participation — a preferred unit class and/or a profit participating (common) unit class — depending on individual’s investment security/return preference. The name of each unit class also corresponds to the level of safety those units enjoy or the return they provide.

Preferred Units The first class units represent the highest level of safety that can be achieved inside the mortgage pool. These units can earn a fixed annual interest rate typically set in the first year, and/or re-adjusted every 12-24 months to track any change in the prevailing market interest rate.

Preferred class units receives distribution before the common class, and receives priority repayment of principal

upon any mortgage repayments or redemption.

Profit Participating (Common) Units The next class of units are the higher returning choice of the two options in this example, but also come with a higher loan to value. Profit participating class units receive a return based on the performance of the underlying mortgages with interest paid monthly or quarterly and any additional profit realized distributed after all of the required return is paid on the preferred class units.

This class receives payment of interest and repayment of principal after the preferred class upon any mortgage repayments or redemption.

Capital Ratios In well run trusts which offer two or more unit classes there will be a policy for the ratio of investment between the classes. For example, a maximum of 1.5 preferred unit for every 1 profit participating unit would put the ratio of preferred units to total capital in the fund at 60%. This ratio confirms what additional amount of security an investor can count on within the preferred class of units.

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Summary: Trust Advantages

Diversification/Risk Reduction

Starting with even a small initial investment amount, mortgage trust unitholders share a proportional interest in a diversified, professionally managed, pool of mortgages. Conversely, direct mortgage investing requires a substantially more money, and has a far greater potential for headaches.

Professional Management/Management as Owner The best mortgage trusts are managed by very capable professionals with substantial career experience in all facets of the mortgage business including: real estate appraisal, banking and mortgage law. Management of this caliber affords a number of advantages.

• Mortgage Sourcing: Mortgage trust managers source loans through a significant network of mortgage

brokers. The manager's team is responsible for all tasks involved in mortgage origination, ensuring a steady flow of attractive mortgage investment opportunities, consistent with their prescribed underwriting criteria. To maximize profitability, the trust needs to be fully invested on an ongoing basis.

• Mortgage Pricing: Because trust managers are active in the mortgage market on a daily basis, they have the

expertise and knowledge to ensure the most favourable interest rates, fees, and other terms are negotiated.

• Portfolio Cash Flow Management: The portfolio is monitored daily to ensure an optimal mix of different

mortgage types. Similarly, cash flow is monitored daily to ensure that the mortgage portfolio is always as fully invested as possible. The trust’s line of credit helps immensely in the management of cash and liquidity for the unitholders.

• Portfolio Administration: Mortgage payments are generally collected electronically by pre-authorized

bank debit. Any arrears or potential default situations are dealt with promptly, proactively, and effectively. Discharge statements are prepared for mortgages not being renewed with legal discharges executed for security release.

To summarize, mortgage trust investors have the opportunity to achieve higher returns on relatively small amounts of capital, with potentially lower risk through much greater diversification, than those available through direct mortgage investment and without expending the personal time and energy required to source and manage direct mortgage investments.

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Table On Trusts

The chart below shows the features of a typical mortgage trust

Feature Trust Unit

Income Return Based on interest collected from mortgages

Distribution Payment Frequency Usually quarterly, sometimes monthly

Invest from RRSP Yes

Minimum Investment Can be as little as $10,000 and up

Liquidity Redemption allowed

Redemption Value Based on adjusted book value per unit based on annual audit results.

Term of Investment Unlimited

Security Type Trust unit

Company, Personal, Family Trust, Registered Retirement Plan

All can own

Foreign Investment Allowed Yes

Early Redemption Discount Usually - see Offering Memorandum for details

Tax Preparation and Auditing When distributed with an Offering Memorandum annual audits are required.

To Sum Up... Like mutual funds that invest in stocks or bonds, mortgage funds provide a convenient way to diversify one’s investment and thereby reduce the risk. Unlike mutual funds however, your investment is secured by tangible real estate and therefore not subject to the pricing volatility that comes with publicly traded stocks.

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Frequently Asked Questions

Regarding Investing into Mortgage Trusts Who can invest in Canadian based Mortgage Trust units? Non-residents and Canadians, living in any province, territory or other country, may subscribe for units. Units may be held individually, jointly, in a partnership, in trust, in a corporation, or in a self-directed RRSP, RRIF, or TFSA.

How can I monitor my investment? All unitholders receive a copy of the annual audited statements, as well as an individualized distribution calculation statement. Investors holding their units outside of a registered plan also received a T3, reflecting their share of annual taxable income.

Activity pertaining to units held within an RRSP, RRIF, or TFSA will also be reflected in the statements provided by the registered plan trustee.

Fee Structures

How much is paid for management? Basic management fees are calculated as a percentage of assets. Common management fee amounts range from 1% to 1.5%, with an additional incentive performance reward in the event unitholder returns exceed the minimum “hurdle" return threshold. The performance incentive is usually calculated as 20% to 50% of any amount of return generated in excess of the hurdle return. Historical unitholder investment returns reflect the deduction of all operating expenses, including management fees calculated as above.

When is mortgage fund management incentive reward realized? The incentive performance reward — is usually paid out on an annual basis only if the trust has surpassed the return benchmark confirmed by the auditors.

Good fees to watch out for: An area of fee revenue that is important to understanding the return potential within a mortgage fund is the “Lender Fee”. In the direct mortgage lending industry, much like the construction lending departments of the major banks, lenders charge fees in the range of 1-2% of the loan amount when the mortgage is advanced.

A point to look for in any mortgage fund is where the lender fees go and who gets the benefit of them. In some cases, the lender fees are taken directly by the manager of the fund and not shared or contributed towards overall returns. In the best mortgage funds, the lender fees are 100% paid into the fund to form part of the total return, which if higher than the hurdle would earn the manager the right to share in some of the excess profit, creating further alignment with unitholders.

This alignment of interest with the lender fee does not immediately stand out in fund documentation but is worth digging to find, as this fee stream could make up 10-15% of the revenue of the fund in any given year.

The Offering Memorandum and Subscription Agreement What is an Offering Memorandum?

An Offering Memorandum provides investors the required disclosure mandated by the securities commission. This

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Offering Memorandum (OM) document is filed with the provincial securities commission in which a mortgage trust is located. The OM includes financial statements and other important financial disclosures about the trust and people composing the management team. It allows both accredited and non-accredited investors to subscribe to investments offered by a non-exchange traded issuer — such as a mortgage trust.

What is a “Risk Acknowledgement Form”? A special acknowledgement form is required by the securities commissions when investing in mortgage funds. It contains a clear statement of the risks associated with investing in securities when they are purchased by investors. It has only two pages — short enough to ensure that it is read. Each investor must sign this as part of the subscription package.

This strongly worded document helps ensure that investors don’t jump blindly into an investment without properly understanding it, giving it due consideration.

What is an “Accredited Investor”? To qualify as an accredited investor (and be allowed to invest less than $150,000 if you are a resident of Ontario or Quebec), the securities commissions require you meet at least one of the various criteria and complete a Certificate of Accredited Investor form.

The most common definition of an accredited investor includes:

• individuals who have at least $1 million in net financial assets (cash and securities);

• individuals whose net income before taxes exceeds $200,000 (or $300,000 combined income with spouse) in each of the two most recent years and who reasonably expect to exceed that net income in the current year;

• individuals who have at least $5 million in net assets; or

• corporations, trusts or estates having net assets of at least $5 million.

Why are there resale restrictions? These restrictions are a requirement of securities laws based on the need for updated disclosure information. When trust units which are offered by an Offering Memorandum, they are subject to restrictions on transfer and may only be sold as described in the Offering Memorandum.

To provide investors with “liquidity”, many mortgage trusts have redemption rights allowing you to request that the fund redeem your units. Alternatively, the manager may elect to find an arms-length, third-party buyer who will purchase the units under the accredited investor guidelines.

Due Diligence

Why haven't I heard of these types of investments? Mortgage fund investments are direct issuers, so you won’t find them listed on the stock exchange. Non-exchange traded investment companies must advertise to gain public awareness or go by word-of-mouth referrals through existing unitholders or industry professionals.

The provincial securities commissions have allowed mortgage portfolio managers to raise equity capital from anyone so long as their offering documents are properly filed and all non-accredited investors sign a prescribed Risk Acknowledgment Form.

What if I need help understanding an Offering Memorandum? This may be your first experience with a direct investment and thus your first exposure to offering memorandums

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and subscription forms. Due to the strict rules of provincial securities commissions, the legal framework and accounting guidelines for a direct offering are onerous. The Offering Memorandum is designed to provide required disclosure of the investment, but in some cases this disclosure may be aided by professional advice or review from accountants.

How do I do my due diligence on a mortgage fund investment? Review the disclosure for the investment as provided by the Offering Memorandum in accordance with all securities commission regulations. A copy can be sent to you by request.

You may desire independent counsel to explain certain elements of these documents and how it can fit your personal situation. It should be noted that not all lawyers and accountants have experience with mortgage trusts.

Please note that your mutual fund financial advisor is restricted by regulations from providing advice about this or any other investment offering under the rules of their licensing. As a result, if you ask for their recommendation they will tend to steer you away from this kind of investment towards something they are licensed to advise on, namely mutual funds.

Ownership and Redemption

What is the minimum time period to hold the investment? Most mortgage funds hope their unitholders will hold onto their stake for 3 to 5 years or more as a long-term investment, there is no minimum time period that an investor must hold their investment.

What fees are involved if I need to cash out my investment early? To prevent “day-traders” from buying and selling units, making it more difficult to manage the underlying portfolio of loans, mortgage funds will typically impose an early redemption discount based on the unit class. This is not a fee but instead goes to the benefit of all remaining unitholders to cover the costs of an investor exiting early. The early redemption discount is withheld by the fund. It remains in the trust to cover the costs of establishing the trust and organizing the capital into the trust. The specific redemption discounts will always be spelled out within the Offering Memorandum for a given trust.

Income, Profits, and Taxes

How and when are a mortgage trust’s profits paid out to unitholders? The Income Tax Act requires that 100% of a trust's taxable income be distributed annually to unitholders. This distribution is taxed as interest income in unitholders’ hands, as it essentially represents a flow through of the mortgage interest received.

A mortgage trust’s fiscal year end is December 31st, as a flow through entity, it corresponds with personal tax year end. All unitholders, regardless of how their units are held, have the option of receiving their monthly distributions in cash, in the form of additional units, or in some combination thereof through enrolling in a “Distribution Re-Investment Plan” (DRIP).

Is a A Mortgage Trust investment RSP eligible? Yes. A mortgage trust is 100% eligible as Canadian content for registered portfolios (including RRSP, RESP, DPSP, LIRA, TFSA). To invest from one of these plans an account must be held through a firm like Olympia Trust or Canadian Western Bank where “self-directed” accounts are available.

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Are the returns stated in the Investment Overview before-tax or after-tax returns? Mortgage fund investments always state returns to investors before income tax is paid. The returns are not taxed within the trust and each individual’s situation is different, so the managers won’t be able to tell you what your after tax return will be.

If I use the Distribution Re-Investment Plan (DRIP) program, will there be a tax liability on income earned that is not deposited to my bank or retirement account? Yes. You are receiving the income, but for your convenience, it is being reinvested for you. At the end of the year, the trust will issue to you certificates for the new units purchased using your re-invested distribution and you will receive a T3 slip which shows your income allocation for the year.

How does the re-investment plan and the units issued impact the overall net asset value per unit of the trust? For example, a trust commences operations with $1 million in unit capital, comprised of 1,000 units issued for $1,000 each, contributed by a number of individual investors. It utilizes the unit capital to acquire a mortgage portfolio in the amount of $1 million. At the end of the first operating year, the trust earns an annual net income of $70,000, or $70 dollars per unit, representing an annual unitholder return on investment of 7.0%. The Income Tax Act requires that all net income must be paid to unitholders in the form of a distribution. If all unitholders take a cash distribution, the trust’s assets would remain at $1 million, which when divided by the 1,000 units outstanding means that the units are worth $1,000, consistent with the issue price. Conversely, if all of the unitholders elected to receive their distribution in the form of additional units, the trust’s assets would be $1,070,000, which when divided by the 1,070 units now outstanding, would equate to a unit value of $1,000.

What happens at tax time? At tax time, our accountants will issue you a T3 Supplementary slip. When completing your taxes, either you or your accountant will simply transfer the contents of three boxes to your return and complete the rest as usual.

Will the mortgage fund manager’s accountants help me prepare my taxes? No. The tax slip you receive will come with instructions, but if you need more help or information you must seek independent advice from your accountant.

Subscribing Jointly

What’s the difference between investing as “joint tenants with rights of survivorship” with my spouse/investment partner versus investing as “tenants in common”? Joint Tenancy With Rights of Survivorship is a way for two people to hold ownership of an investment. When one owner dies, the other automatically acquires the deceased owner's share. Because of this right of survivorship, no will is required to transfer the asset; it goes directly to the surviving joint tenant without the delay and cost of probate. While probate on these assets will be avoided there can still be estate taxes due for the deceased.

In the case of Tenants in Common, two or more owners each own some designated and distinct percentage of the investment. If one owner dies, the deceased’s percentage becomes part of his or her estate. The survivor(s) retain only those portions originally designated on the certificate of ownership.

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Peace of Mind

Receive a Personal Response

We thank you for taking the time to study this information. If you still have questions, we would be happy

to answer then directly, either by phone, or better still by meeting in person.

Our main office number is 1-604-899-1144 and our office is open weekdays between the hours of 8:30

a.m. and 5:00 p.m. Pacific Standard Time.

Rest assured, any inquiry will receive prompt and professional attention.

Sincerely,

Yari Nieken

Foremost Capital Inc.

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Notes:

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UNDERSTANDING MORTGAGE

INVESTMENTS