Over two-hundred new hard money mortgage funds have arisen from the ashes of the Great Recession. After all, its relatively easy to hire an attorney to create the legal documents to form a new mortgage fund, and private investors are flocking to these brand new outfits for a chance to earn double-digit returns. Unfortunately many of these private mortgage investors may be doomed to suffer large lossess when these new mortgage funds almost inevitably fail.
Here's why: Most hard money mortgage funds only make bridge loans - loans with terms of two years or less. The sponsor makes two to three points for originating each loan, plus maybe 75 bps. for servicing. The bottom line is that the sponsors of these mortgage funds make 70% of their dough from originating new loans, as new deposits flow into their pools and as old loans pay off. Okay. There is nothing morally wrong with this, right? Right?
Unfortunately, horrible real estate slumps seem to hit every seven to twelve years. Blackburne & Sons has been in business for 37 years, and we have suffered through three commercial real estate crashes of 45%.
When real estate values fall 20% to 45%, the losses to these hard money mortgages funds start to mount. Once the investors start to smell these losses, they panic and demand their money back. Millions of dollars flow out of these mortgage funds, and hardly a penny flows back into them.
Soon the Sponsor has no new money with which to lend, so his loan fee income virtually disappears. This last sentence is so important that I ask you now to please read it again. Remember, this loan fee income used to constitute 70% of the Sponsor's income. Without nearly enough income to pay salaries, rent, and overhead, the Sponsor is eventually forced to close his doors.
Without the sponsor to shepherd the collection efforts- making collection calls, filing foreclosure, getting borrowers out of Chapter 11 Bankruptcy, hiring attorneys, hiring foreclosure companies, hiring contractors, hiring property cleanup crews and hiring real estate brokers - this portfolio of once decent loans invariably gets crushed. Eventually the government moves in to clean up the mess. Greedy attorneys, trustees, and accountants then feast, the investors get fleeced.
Am I exaggerating? There were aound 150 hard money mortgage funds in business before the Great Recession. Fewer than six survived. The next time you get solicited to invest a large portion of your retirement funds into a mortgage pool yielding 10%, ask the Sponsor, "Was the fund operating in 2007?"
Are you a very accredited investor? Please write to me.