By: Dennis H. Doss and Christopher J. Donovan
Distressed assets funds rise in popularity during a recession. Banks are eager to purge their portfolios of labor-intensive mortgages that punch holes in their balance sheets and increase their reserve requirements. Private equity funds must liquidate non-performing loans to meet capital calls from their credit facilities and to satisfy investor redemption demands.
A panicked rush for the exit doors is a private money lender’s dream. How can you take advantage of the carnage? One of the best ways is to pool money, so you qualify to participate in the auctions of distressed asset portfolios. The sellers of these portfolios (see below) will not even talk to small players. After you acquire a portfolio, you must have the staff and a plan to maximize the value of the assets you purchased. You will attempt to modify mortgages to get them back into a performing status long enough to enable the property owner to refinance your loan. You make money when you are paid off because you bought the mortgage at a sizeable discount. Sadly, some owners will not be able to pay, so you may be forced to foreclose. After you take back the property, you can enjoy the rental income while you wait for prices to improve. After the market stabilizes, you can sell the property for a nice profit.
How are these investments structured? A fund (aka pool) is limited to accredited investors and must be created in full compliance with state and federal securities laws. That requires a Private Placement Memorandum (“PPM”), other legal documents and filings. Here is a sample outline:
|Acquire portfolios of distressed assets consisting of defaulted mortgages and foreclosed real estate. Attempt to convert non-performing loans into performing loans, and induce refinances to pay off mortgages. If you must foreclose, then you can rehab and resell, or rent out the real estate for cash flow and appreciation.|
First Financial Network (FFN)
Mission Capital Advisors
Newmark Knight Frank
The Debt Exchange (DebtX)
|Likely a 5-10 year process.|
|Limited liability company; investors are members; sponsors are managers.|
|New LLC or S-Corp for pass-through taxation.|
|Asset Management Fee (“AMF”) computed as a percentage of all fund assets consisting of cash, loans and real estate (covers all personnel, overhead, loan servicing); Acquisition Fee; Disposition Fee; percentage of profits over a cumulative Preferred Return to investors.|
|Third party expenses paid (legal, accounting, property and mortgage related expenses, LLC tax, etc.), then AMF, then all profits to investors up to a Preferred Return, then split 50/50 with Manager; paid quarterly.|
|In-house servicing, except in those states where a servicing license is required, in which case, a nationwide servicer must be used.|
|Pool management software for unitized pools. For investors going in or out, unit values need to be manually adjusted at least quarterly to mark-to-market in fairness to existing investors sitting on appreciated assets.|
|2 years, best efforts basis.|
|Up to 1-1 with equity (up to $1 debt to $1 equity).|
PPM Legal Fees
|Contact Us: email@example.com or 949-214-4399.|
|As a general rule, the mere acquisition and ownership of mortgages does not require a lending or broker’s license. Some states require licensing to service consumer loans.|
If you feel you missed out on the profits made by your peers in the last downturn, broach your largest investors about the opportunity of investing in distressed assets. You might find that they are already thinking about capitalizing on the opportunity to acquire real estate at substantial discounts. For the past 20 years, we have helped create some of the largest private money mortgage pools that still exist today, as well as creating many distressed asset funds during the Great Recession.
© Doss Law, LLP. Attorney advertising materials. These materials have been prepared for educational purposes only and are not legal advice. This information is not intended to create an attorney-client relationship. Consult a knowledgeable lawyer before implementing any of the ideas in this publication.