By Dennis Doss
It’s no secret that Doss Law, LLP has been a big supporter of the California Mortgage Association (http://www.cmabrokers.org) since 1984. At least two meetings per year feature a meeting of mortgage pool managers. We have noticed a steady uptick in the number of CMA members that attend the pool manager meetings. In the early days it was only a handful. Now it seems like a good third of over 200+ members attend the pool manager meetings regularly, typically on Thursday mornings. In the early days the meetings were about an hour and a half. The most recent ones lasted a good three hours and went through lunch time. Indeed they consume nearly a quarter of a typical two day CMA event. The hard money loan industry is transforming itself.
There are solid reasons for this exodus from direct sales to private investors. From the investor’s standpoint, a mortgage pool offers a good return (6.5-8% is typical) 365 days a year. Investors compare that with the stock market that has been flat for nearly two years and bank deposits that pay nothing. Investors also prefer their money to be diversified over a portfolio of hard money loans rather than concentrated on a few borrowers and a few properties. And, while mortgage pools are certainly not ATM machines, an investor can usually exit a pool after a relatively short lockup period. Lastly, investors really don’t like to waste their time looking over the huge stack of loan documents, title reports, appraisals and disclosures the typical broker bombards them with, only to then sign another wad of papers and trudge down to the bank to wire money to a title company. That’s a lot of work to make one short term investment.
From the broker’s standpoint, managing a mortgage fund has many advantages. First, the broker can lease a smaller copy machine because he or she doesn’t need to photocopy 200+ pages every time they send an investment package to an investor. Pool managers email the Private Placement Memorandum and Subscription Agreement one time only and their paper work is finished. Second, managing a mortgage pool takes the bull’s eye off the broker’s back. In a fund the broker is judged by the average performance of the loans in the pool. The broker avoids costly lawsuits from investors who have lost money on hard money loans the broker sold to them (after making tons of money on many earlier loans). Third, a fund gets respect as a direct lender—the guy known to have powder to quickly pull the trigger on a deal. Time is everything in this business; raising funds from private investors on a loan-by-loan basis is time consuming. Fourth, if the fund obtains a credit line, it can lower its cost of funds, making it more competitive. No one could argue that private money rates have never been lower and more competitive. The lenders with lowest cost of money get the best deals; those with yield-hungry private investors are left in the dust. Fifth, managing a fund will enable the manager to keep the lights on even when he or she is not making new private money loans because the manager is receiving a monthly asset management fee, computed as a percentage of all assets they are managing: loans, cash, real estate.
Most importantly, because a fund is a direct lender it can qualify for a California Finance Lender’s license which means the broker can finally say adios! to the burdens of operating as a Department of Real Estate broker: say goodbye to DRE restrictions on construction loans, the inherent liability of Investor Questionnaires, threshold reporting, arcane trust accounting rules and the rest of the technical nonsense that goes with operating under that license. A fund only needs a simple operating bank account to do everything, including taking in money, making loans and collecting loans. Lastly, once the broker has raised money for the fund, he or she can roll that money over from hard money loan to hard money loan, as long as the manager follows the parameters in the Private Placement Memorandum—we are talking about the gift that keeps on giving.
Are their barriers to entry? Of course, but they are surmountable. Many one man shops have made the transition. Yes, you will have to spend legal dollars to create your fund and its disclosures but the pool can reimburse you for that at some point. Think of it as an investment towards a better and less riskier life. There are at least two service providers that will service your loans and make distributions to your investors so you don’t have to buy expensive software or hire people to do it for you. There are at least three accountants that will hold your hand. It is true you will have to manage cash so you don’t have too much of it while having access to it when you need it. A secured credit facility will fix that. You only need a few million dollars in capital to qualify for one. Just keep a balance on it to keep the balances in your operating account low. Cash is dead money in a mortgage fund. Fund a loan on the credit facility and then hustle your investors for more money to pay it down.
Will hard money investors buy into the concept? Some won’t but many will. There is more money than loans right now. We get many more phone calls from investors looking for private mortgage funds than we do for investors looking for hard money brokers. The broker who has just opened a fund can usually transition away from direct investor sales in an average of two years. In our experience, they never look back. Once the fund has some momentum, the fund manager can focus his or her complete attention on finding good loans as a direct lender with competitive rates; the investment side of things will be the easiest part of the manager’s life.
So there are reasons for the exodus we are seeing: mortgage pooling is a more efficient use of capital, it makes a broker more competitive, it reduces his or her risks and reduces the broker’s workload. CMA has smartly adjusted to the exodus. It is not always smart to follow the crowd—but sometimes the crowd is worth following.