Contributor: Pension lawyer Jean Pierre Laporte, BA, MA, LLB. (Jp.laporte@integris-mgt.com)

Last week we reviewed how a pension plan could become a source of capital for investments in private real estate. This week we look at how a pension fund can lend out money for investment purposes in the form of private mortgages.

Once the REALTOR® has established his or her pension plan through a Personal Real Estate Corporation (PREC), the plan can set aside funds to deploy in the form of first or second mortgages, with private real estate as collateral to secure the loan and protect the investor.

The pension plan can be an attractive alternative to other lenders who might have more stringent underwriting requirements imposed by their corporate head office or the regulator. The interest charged on such private mortgages can be lower than traditional “A” and even “B” lenders since there is no tax drag imposed on the interest revenues generated by the pension plan, unlike a bank, credit union, or private lender that must pay tax on the interest collected.

While pension funds can invest in private mortgages, certain types of loans are not permitted, such as loans back to the PREC or to related parties of the REALTOR®, such as spouses or children. This type of “self-dealing” is not permitted by pension legislation and could cause the pension plan to become taxable, among other consequences.

Also, unless a Pension Realty Corporation is first used, there are limits on how much of the pension fund’s assets may be extended in the form of a private mortgage. The general rule is that no more than 10 per cent of the total pension fund may be lent in the form of a mortgage to a single borrower.

That 10 per cent rule does not apply if the pension fund first purchases shares of a Pension Realty Corporation. In that case, the entire pension fund could be used to purchase Pension Realty Corporation shares, and in turn, that entity could lend to various mortgages.

Given that interest income is highly taxed, being able to shelter all of the interest income earned from a private mortgage under a pension plan gives the REALTOR® saving for retirement a way to diversify away from stock market volatility while building annual income with the added security of collateral to reduce risks.

Click here for previous articles about the pension plan.