The other characteristics of real-estate mortgages may be passed over more briefly. It is generally conceded that mortgages return a higher rate of income than can be obtained upon any other form of investment which affords equal security. This constitutes their chief advantage.
Their chief disadvantage, on the other hand, lies in their entire want of convertibility. There is no market for real-estate mortgages, and except in special instances they can not be readily sold. The fact that they are not subject to quotation prevents them also from holding out any prospect of appreciation in value. Their very deficiency in this respect, however, constitutes an important advantage from another point of view. Since they are not quoted they can not shrink in market price in obedience to changes in financial and business conditions. The buyer of a mortgage is assured that he can carry his mortgage at par through periods when it may be necessary to mark down all negotiable securities subject to changing market quotations. This is frequently a matter of great importance.
The general characteristics of real-estate mortgages may be summarized as follows: (1) When carefully selected and purchased under favorable conditions, great safety of principal and interest; (2) a relatively high return; (3) a low degree of convertibility; (4) no prospect of appreciation in value; and (5) the practical certainty of maintaining the integrity of the principal invested.
Is a security possessing these characteristics a suitable investment for a business surplus? Only to a limited extent. The safety, high return, and assurance against loss in quoted value of principal are all highly desirable qualities for this purpose, but the lack of convertibility is a fatal defect. No consideration is of greater importance in the investment of a business surplus than a high degree of convertibility, so that if the need should arise the investment may be instantly liquidated. The fact that real-estate mortgages can not be readily disposed of makes it practically impossible to employ them for the investment of a business surplus.
Where convertibility is not an essential requirement, and where the want of promise of appreciation in value is not a serious matter, mortgages afford a very desirable form of investment. The characteristics which they possess in an eminent degree—safety, high return, and assurance against loss in quoted value of principal—are exactly suited to the ordinary requirements of savings-banks. Generally speaking, only a small proportion of a savings-bank's assets need be kept in liquid form or readily convertible, and accordingly they find mortgages highly desirable.
For the purpose of private investment the attractiveness of mortgages is not so easy to determine. Ordinarily, fluctations in quoted values are of no great importance to the private investor, so that the absence of quotation which mortgages enjoy is not especially valuable. Their safety and high return are attractive qualities, but their want of convertibility and of prospect of appreciation in value are drawbacks. On the whole, the private investor may probably employ with advantage a certain part, but not too much of his estate in mortgage investments.
As part of a scientific and comprehensive scheme of investment, the special advantages of real-estate mortgages appear most prominently in the years following a business depression. During such a period real-estate values are usually relatively low, but beginning to advance, so that mortgages present their maximum margin of security. At such a time they compare most favorably with bonds and other investment securities which are subject to changing quotations, because such securities are then apt to be at their highest point under the combined influence of restored confidence and the low money rates which usually prevail. After several years of continued and increasing business prosperity the positions are just reversed.
No discussion of real-estate mortgages would be complete without allusion to the guaranteed mortgages which have been placed upon the market in great quantities within the past few years. Guaranteed mortgages are real-estate mortgages guaranteed as to principal and interest by substantial companies having large capital and surplus. In addition to the guaranty, the companies usually search and guarantee the title, see to it that the taxes, assessments, and insurance are paid, and perform the other services of a real-estate broker. Their compensation varies somewhat, but probably averages ½ per cent—that is, for example, they loan at 5 per cent and sell guaranteed mortgages to the investor at 4½.
The value of the guaranty may be considered from two points of view—first, in the event of a general decline in real-estate values, and, secondly, when a fall occurs in a particular piece of property or in a particular locality.
If a severe decline in real-estate values takes place, affecting all localities, it might become necessary for the holders of guaranteed mortgages to test the value of their guaranties. In such a case the question would arise how far the capital and surplus of the guaranteeing companies would extend in liquidating the mortgages which they had guaranteed. This would depend entirely upon the proportion between the capital and surplus of the companies and the total amount of outstanding mortgages guaranteed. Ordinarily the capital and surplus do not exceed 5 per cent of the mortgages, so that the average guaranty is good for about 5 per cent additional equity. On a piece of property worth $100,000, upon which a guaranteed mortgage of $60,000 exists, the guaranty would be worth $3,000, and would margin the property down to $57,000. This additional equity is of little value. It is probably unlikely that a 40-per-cent depreciation in value will take place, but the guaranty is not needed unless it does, and if it should occur, the depreciation is quite as likely to go to 50 per cent or more as to stop at 43.