Here is one of the best pieces of advice that I will ever give you about investing in first trust deeds. Never-ever-ever invest in a hard money mortgage fund. They tend to collapse horribly when real estate crashes by 45%.
Real estate crashes seem to occur every ten to fourteen years. It would be great if real estate just marched upwards 3% every year, but life doesn't happen that way. There always seems to be a speculative bubble that bursts, and then real estate crashes by 45%.
During the S&L Crisis, real estate crashed by 45%. During the Dot-Com Bubble, real estate crashed by 45%. During the Great Recession, real estate crashed by 45%. No guarantees, folks, but Carnac the Magnificent (from the famous Johnny Carson skit) predicts that real estate will fall by around 45% during the next real estate crash.
Never invest in a hard money mortgage fund. They tend to collapse.
You would think that a hard money mortgage fund would be a great idea. The investors would enjoy diversification. A bad loss on a single deal could easily be absorbed by the income from other deals.
But hard money mortgage funds never seem to survive real estate crashes. Most of the properties securing their hard money loans fully-recover within three to four years after the crash, but by then the hard money shop itself is long gone.
You would be hard-pressed to find a single hard money mortgage fund that survived the Great Recession, and there may not be a single hard money mortgage fund in the entire country that survived both the Dot-Com Bubble and the Great Recession.
We are talking about the failures of hundreds of mortgage funds. When a hard money mortgage fund collapses, the losses can sometimes be horrific - often into the tens (hundreds?) of millions of dollars. Many times there is outright theft from the trust accounts; but more often the biggest losses occur when the fund manager fails.
Suddenly there is no one left to service the portfolio: to make collection calls, to place forced-order fire insurance, to pay the real estate taxes, to file foreclosure, to execute on the Assignment of Rents, to hire bankruptcy counsel to get the borrowers out of Chapter 11, to supervise the foreclosure sale, to install locks and alarms, to renovate the property, to interview and hire a real broker, to lease the property, and to sell the property.
It's often a bloodbath, and the only people who get rich are the the attorneys, trustees, auditors, appraisers, and selling real estate brokers.
Do You Own a Big Mortgage Fund? Angry?
The best thing that the owner of a hard money shop can do for his investors is to stay in business to perform the aforementioned tasks.
You are almost certainly charging much too low of a loan servicing / property management fee to survive the next real estate crash, which could hit at any time. Many hard money shops are charging only 1% per year. Some idiots, who will make us all look bad, are only charging 50 bps.
A very good argument can be made that some hard money mortgage fund operations are almost Ponzi Schemes. You will recall that the operator of a Ponzi Scheme constantly needs money from new suckers to pay the outrageous returns to his old investors.
Many, if not most, hard money fund managers need to be constantly making new loans and earning new loan fees to service its existing portfolio for just 1% per year. As soon as real estate starts to collapse again, new deposits will quickly dry up. Payoffs will almost completely disappear. With no fresh funds to lend, new loan fee income will simply stop. These foolish funds will then quickly collapse.
If you sponsor a hard money mortgage fund, here is the best advice that anyone will ever give you.
The next time real estate starts to crash, you must immediately raise your loan servicing / property management fee on your funds to at least 2%, if not 3%.
"But George, my investors will scream bloody murder." Uh, huh. You love your kids, right? Do they like the taste of medicine? Of course not. But it's for their own good.
The best thing that the owner of any hard money mortgage company can do for his investors is to stay in business. I predict that most fund sponsors will wait too long to raise their fees. As a result, they will fail. By doing so, they are totally shafting their investors. They need to stay in business!
We here at Blackburne & Sons proudly charge the highest loan servicing fees and property management fees (1.9%) of any hard money shop in the country. That's also why we have survived more real estate crashes than any other hard money shop in the country (since 1980).
Are you invested with a competitor? Is it possible that this competitor was not in business in 2007? Hmmm. Maybe it's time to move some money over to a company with some staying power? It's been 14 years since the last real estate crash. The next one is about due. You may want to hurry.
Gee, George, You Clearly Hate Mortgage Funds. How Should I Invest in Trust Deeds?
It's far better to invest directly in a fractionalized first mortgage; e.g., each of twenty investors takes $10,000 in a $200,000 loan. The advantage here is that you get to pick your own loans.
You should pick lower-yielding loans, which are usually the good ones. Take a small piece in lots of different loans, spread geographically all throughout the country.
If your hard money shop fails, you and your fellow investors can always service the loan yourselves. (In real life, you would simply hire a contract loan servicing agent, like an accountant.)
At a Ukrainian Army training camp...
Why Even Bother With Trust Deeds?
Monthly income. If you pick a nice 7% to 9% first trust deed, and the loan performs as agreed (no guarantees, folks), you will receive a handsome interest check every month. There are very few stocks or bonds these days paying 7% to 9% per year.
But Wait, Doesn't Blackburne & Sons Have a Mortgage Fund?
We have a very tiny mortgage fund that our investors use to collect monthly payments until they have a large enough stake to invest in a loan. The difference with our fund is that it is pocket change. We don't rely on it to keep the doors open.
What Are Trust Deeds?
Trust deeds (or mortgages, depending on the state) are investments in a loan, secured by real estate, directly to the borrower. Rather than putting your money in the bank and having the bank make the real estate loan, private investors can actually make the loan directly.
The trust deed investment business is huge in California, and it has been around at least 80 years. Recent law changes now allow investors from every state to invest in trust deeds, as long as they are accredited investors. The good news is that you can earn 7% to 12% interest in first trust deeds. The bad news is that you, not the bank, take the loss if the loan goes bad.
Final Thought From the Old Man:
When real estate crashes again by 45%, my sons may reach out to you to join a syndicate to buy some property. I encourage you strongly to ignore your terror and invest. Nathan Rothschild, a 19th-century British financier and member of the Rothschild banking family, is credited with saying, "The time to buy is when there's blood in the streets."
Scary Disclosure Stuff:
Investing in first trust deeds involves substantial risk. A large and prolonged decline in real estate values is possible. Always maintain some liquidity. Foreclosed property always needs to be renovated. Before you invest with Blackburne & Sons, my own hard money shop, or any other reputable hard money outfit, you will be given a huge Offering Circular, which discloses many of the risks. Please be sure to read it carefully, especially the Risk Factors section.
BLACKBURNE & SONS REALTY CAITAL CORPORATION
Address: 555 University Avenue, Suite 150
Sacramento, CA 95825
Since 1980
George Blackburne IV
Phone: (916) 338-3232 x 314
georgeiv@blackburne.com
Real Estate Broker — California Dept. of Real Estate License: 00829677
Arizona Dept. of Financial Institutions License: MB-0909472
Florida Mortgage Brokers License: MLD1726 / MLD519
NMLS ID: 382122
