Private-money lenders have been chasing direct sales for years, providing
niche, mezzanine, and hard-money financing with direct investor capital.
When the market is good, the business is profitable for both the broker
and the investor. Though more recently, there seems to be an increase
in the amount of brokers looking to transition from direct investment
into mortgage pools. With the stock market stagnant or wildly fluctuating,
investors are becoming more open to mortgage funds as a way to offer stability
and year-round consistent returns. If the idea of not having to sort through
stacks of loan documents each month is not appealing enough, investors
also like the idea of having their capital invested in a diversified portfolio
of loans, rather than placing all their eggs in the one proverbial basket.
So, with so much interest being generated with this emerging opportunity,
is starting a mortgage pool the right choice for your business? As a broker,
you have a fiduciary duty to your investors to ensure your paperwork is
bulletproof, to protect their capital as best as possible. What they probably
like most about you is the fact that you consistently earn them money.
What if you could earn them more money with better security and less paperwork?
A mortgage fund offers them a great investment opportunity with better
than average returns, while providing peace of mind that comes with a
diverse pool of loans, and about a 95% reduction in paperwork.
Now that we understand what makes mortgage funds appealing to investors,
we can take a look at them from a broker’s point of view. There
is a reason why more and more dealers are attending seminars on how to
become a pool manager and structure mortgage funds. Mortgage funds provide
brokers with several benefits over direct investment lending. For one,
the paperwork duties just got a whole lot easier. Under a direct private
loan, dealers are required to send a loan package to every contributing
investor for each loan the broker books. With a mortgage fund, the pool
manager issues a Private Placement Memorandum and Subscription Agreement
to each participating investor only once. After the agreement is signed,
the pool manager may allocate funds for new loans as they are approved.
For the investor, this process is far more convenient than sorting through
stacks of new loan packages every 90 days.
Mortgage pools also provide the manager with the ability to fund multiple
deals without as much liability if one fails. The diversity of the fund
portfolio will protect investors if one loan sours, but also takes the
onus off of the broker who may otherwise face litigation from unhappy
investors who lost money on a direct investment. The average performance
of the fund is taken into consideration rather than a single loan, and
it is much easier to explain a failed deal to investors while they are
still receiving their monthly disbursement check. Not only is this good
for the reputation of the broker, but it also helps avoid costly litigation
that may originate from disgruntled investors. If the fund has obtained
a credit facility, it can quickly replace a loan that may not be performing.
A mortgage fund also makes for good marketing. Running to investors to
seek approval for single-investor deals can be frustrating and time-consuming.
With mortgage pooling, a pool manager can leverage his capital by obtaining
a low-rate credit line, thereby reducing the cost of funds, and effectively
offering more competitive financing options to his clients. The credit
line can then be paid down over time using investor funds. The process
allows brokers to be more selective with whom they lend funds, with the
ability to offer attractive terms, and reducing the likelihood of a non-performing
loan. Considering that the fund manager has the right to collect an asset
management fee as a percentage of the entire fund, he will continue to
receive payments even if new private money deals are not landing on his desk.
Another reason more brokers are attracted to mortgage pools is the licensing
change. Private-money lenders are required to operate under a broker license
from the Bureau of Real Estate. This BRE licensing requirement makes a
creditor liable for loan disclosures, ATR qualifiers, reporting requirements,
and a myriad of other rules that go along with being a broker. By creating
a mortgage fund, a firm can now register as a direct lender and qualify
for a California Finance Lender’s license.
The CFL license provides a direct lender with the ability to set up a corporate
account that allows them to conduct all of their lending operations, including
taking in payments, issuing disbursements to investors, and rolling over
money for future opportunities. As long as the rules outlined in the Subscription
Agreement are followed, the fund manager now has all the tools necessary
to become a full-service direct finance company.
While the benefits are plenty, there are some hurdles you will need to
address before entering the space. You will have to spend some capital
to establish your presence. Bring in legal counsel to help you set up
your fund and create your disclosures and subscription agreement, expenses
that can be paid back from the pool at a later date. Utilizing a third-party
servicer is a good option for who seeks to delegate the collection of
their mortgage payments and manage investor distributions. However, by
delegation you give up control of the funds and the accounting. For those
who seek more control and complete management, there are powerful software
options that will allow you bring your servicing and investor distributions
in-house. You will need to hire an competent accountant; a person that
will manage your accounts, protect your cash flow, and ensure you have
access to capital when you need it. If possible, you will most likely
want to secure a credit facility. If you have a sustainable cash flow
and are well capitalized, it should not be an obstacle. After obtaining
a credit facility, you will have some breathing room to lock up more deals,
stabilize your reserve account, and give comfort to investors who are
considering contributing more funds.
So how will your direct sales investors feel about your move to a direct
lender? Some may be confused, but most will follow you after they get
a grasp the concept and benefits. Once you have made the move and have
your fund established, you can start the marketing process to bring more
investors on board. As your borrowers satisfy their direct investment
loans, you can fund their future deals out of the mortgage pool. As additional
loans are paid back and you continue to build up your fund, you will be
closer to completing the transition to direct lender. The pool manager
can then devote the majority of his time to filling up the mortgage pool
with solid deals. During this period, your team can then work on your
existing investor base to offer assurances about your change of direction.
Many brokers complete the full transition to a mortgage fund within two
Mortgage funds are not for everyone, but for brokers who want to free up
time, reduce the amount of paperwork, limit liability, reduce risk, and
build a bigger and more sustainable private lending business, then starting
a mortgage fund is a no brainer. Once your fund is well established, you
can work on strengthening the fund or creating new pools. Data shows that
more brokers are now moving away from direct investor sales and making
the jump to mortgage pools. There is plenty of investor capital just waiting
on the sidelines for a sound investment. While demand for mortgage pools
is high, the time is right to begin the process of taking your organization
to the next level.
Taking the next step is not always easy, but thankfully you have people
who have been there before and can help guide you through the setup process.
Geraci Law Firm has an experienced team that is ready to help you establish
your mortgage fund and get you off and running quickly and effectively.