What is a private real estate lender?
A private real estate lender is a non-bank lender that provides loans collateralized by real estate, but usually with different underwriting standards than a bank or other conventional lending sources.
What is a private mortgage?
A private mortgage is a real estate loan, secured in the same way as a bank’s loan. A mortgage secures the lender’s funds with real estate. In California (and other ‘trust deed’ states), a ‘mortgage’ is a promissory note secured by a deed of trust. The deed of trust is an instrument used to secure a loan on real property and is filed with the county recorder’s office to let the public know that there is a loan on the property. Private loans are normally relatively short-term and can be secured by residential or commercial properties. Because the borrower is usually looking for a quick, short-term financing solution, there is typically a higher interest rate and fee associated with the private loan compared to a bank’s loan.
What is the difference between first and second position?
The difference between a first and second position trust deed is the priority of the lien based on the date the trust deed is recorded. The loan with the earliest recording date has priority (i.e. is in first position). If a lender has a second trust deed and the borrower fails to make payments on the first, the lender could lose its investment if the first lender forecloses prior to the second lender doing the same. If appropriate documentation (a Request for Notice) is filed, the first lender is required to notify the second lender when starting the foreclosure process (by filing a Notice of Default). If the borrower isn’t making payments on the first, the second lender has the right to foreclose even if the second lender is receiving payments on its loan. Therefore, if the borrower isn’t paying on the first, the strategy for the second lender is usually to make payments on the first and keep it current, while the second lender proceeds to foreclose.
Red Tower Capital usually makes first position loans, but occasionally second position loans.
Why would someone borrow from a private lender?
- Simpler application process
- Quick close
- Usually less stringent 'credit' underwriting
- If the property isn't currently generating sufficient income
- If the property is in need of repair
- To purchase a 'good deal' quickly
- To receive needed funds in a hurry
- For properties otherwise hard to lend on
What does Red Tower Capital look for when evaluating a property for a private loan?
Red Tower Capital looks at several factors when evaluating a potential loan investment. Initially, property type and location are the first items we examine. We usually favor mainstream real property in metropolitan areas where there is a resale market. This includes properties such as: homes, apartments, commercial, retail and industrial buildings. In the targeted metro locations, these types have greater mass appeal, an active market and more widely available financing. The next significant item is the ratio of the loan amount to the value of the real estate being pledged as security. This is referred to as the loan-to-value ratio, or LTV. For example, a loan of $300,000 secured to a property valued at $500,000 would have an LTV of 60%. All else being equal, the higher the LTV, the greater the lending risk generally. There are other factors also.
What other considerations are there when making an investment decision?
We evaluate the borrower's 'exit strategy'. How will the loan be paid off? Depending on the loan scenario, we also look to the borrower’s credit and other particulars such as income and liquidity to determine the safety of the loan. For loans with higher LTV and/or larger loan amounts, we look more carefully at the borrower's ability to pay now and/or the property's ability to pay now or soon (e.g. after needed repairs).
What information does Red Tower Capital require and review prior to making an investment decision?
Red Tower Capital collects various information on potential loan investments during its due diligence process. The amount and specific information required varies by property type, loan amount and perceived risk. If the loan amount, LTV and/or risk is relatively low and the property is a home, for example, we might collect less information than for a larger, higher LTV complicated commercial property. Information includes such items as: loan application, appraisal or other evaluation, preliminary title report, credit report and additional title information. In many cases, we may obtain further information such as tax returns, other income documentation, further MLS/real estate sales information, purchase contract (for purchases), leases and rent roll (for a rental property) and bank statements, etc.
What happens if the borrower does not pay?
While most loans pay on time, some loan payments may be late. In rare cases, after attempting to contact the borrower, he or she becomes unable or unwilling to pay (as potentially with any loan or outstanding credit) and is subject to having the pledged property foreclosed on. In such cases, Red Tower Capital will start the foreclosure process to recover the value of the investment, unpaid interest and late fees, etc. This is a relatively quick and efficient mechanism in most circumstances. Red Tower Capital takes precautions to protect against potential borrower default, including active loan servicing and communication with the borrower, in addition to underwriting.
What are the benefits of investing in private mortgages?
Private mortgage investing is a secure way to achieve a solid yield and consistent cash flow. When properly underwritten, there is relatively low risk of loss because any given loan is secured by real property with value in excess of the loan amount. They are also a safe and convenient way to invest in real estate without having to manage or maintain a property.
What are the risks of investing in private mortgages?
Risks associated with private mortgage investing can include cash flow disruption and property devaluation. Red Tower Capital mitigates these risks through its investment criteria, evaluation process and diligent servicing.
Fund Investing: What is a private mortgage fund?
A private mortgage fund, or mortgage pool, is a fund that allows many investors to combine their assets and fund multiple individual mortgages. They can offer the benefits of stable income, diversification, simplicity and liquidity.
Fund Investing: What return can I earn on my mortgage fund investment?
In today’s market, the net return to mortgage funds investors typically ranges from 6% to 10%. However, like other investments, returns on such investments are often based on risk or perceived risk and can change due to market conditions.
Fund Investing: How does investing in private mortgage funds compare with other types of investments?
Mortgage funds offer security, convenience and usually, stable, predictable income. They are not FDIC insured like traditional bank accounts, but they generally have much higher yields. They are usually safer than real estate equity investments since mortgages are in a “senior” position versus real estate equity. The value of the underlying mortgages and their payment history over time is usually less volatile than the stock market.
Fund Investing: Is it like a mutual fund? What are the similarities between a mortgage pool and a mutual fund?
A mortgage pool is similar to mutual fund in that through either strategy, multiple investors invest in multiple investments and thereby receive diversification and other benefits. Unlike a mutual fund, however, private mortgage funds are secured by real estate and less subject to the volatility of the stock market. On the other hand, most mortgage funds are generally private investments and mutual funds are generally public, so mutual funds usually have the benefit of greater liquidity / ease of sale.
Fund Investing: Who is eligible to invest in a private mortgage fund?
A wide range of investors are able to invest in mortgage funds. Depending on the fund, membership can be purchased by individuals, trusts, corporations, self-directed IRA’s, SEP IRA’s, pension plans, LLCs, etc. Investors must meet certain minimum standards of income and/or net worth for most mortgage funds and many mortgage funds require investors to be "accredited."
Fund Investing: Can I use my IRA or pension plan funds to invest?
Yes. Many of Red Tower Capital's investors use their retirement funds to invest, provided these are in a self-directed IRA or similar. Investing in a private mortgage fund can help balance and grow a retirement portfolio while maintaining applicable tax-advantages. Please see the Self-Directed IRA section for more information.
Fund Investing: Is there a minimum investment amount?
Investors can invest with as little as $25,000 in our fund, RTC VI. Additionally, we offer more specialized investment opportunities for qualified investors.
Fund Investing: How and when do I receive distributions?
Income is generated from payments received on the loans made by the fund and thereafter is distributed to the investors. Distributions are dependent on the performance of the total loan portfolio and calculated based on the amount each member has invested in the fund. Investors in RTC VI have the option of receiving cash distributions quarterly or reinvesting them.
Fund Investing: What if I need to liquidate? Can I increase my investment?
Liquidity requirements differ based on the investment vehicle. Investments in RTC VI, for example, can begin to be redeemed after an initial 12-month period, subject to fund liquidity. Investors can increase their investment at any time if membership interests are still being offered.
Fund Investing: How does the fund manager get compensated?
Different funds are structured in similar but different ways. For many mortgage funds, it is common for managers to receive loan fees paid by the borrowers (not fund investors), some portion of the yield after a certain 'preferred return' is paid to investors and/or a servicing or asset management fee or similar. These are more completely spelled out in the fund's Operating Agreement and/or PPM. Please review those for details.
Fund Investing, for Self-Directed IRAs and 401ks: What is UBIT?
UBIT is "Unrelated Business Income Tax". UBIT applies if ALL of the following are true:
- Income is derived from “trade or business” activity (i.e., sale of goods and services).
- Business activity is not substantially related to exempt status.
- Business is regularly carried on by organization.
- Limited Partnerships (LPs),
- Limited Liability Companies (LLCs), and
- Any investment that incurs debt financing and/or is involved in an unrelated business.
Fund Investing, for Self-Directed IRAs and 401ks: Does your fund have debt? Is it subject to UBIT?
RTC VI has some leverage (but also good returns). Here are a few notes related to UBIT you might want to run by your tax professional:
- For RTC VI in 2020, the debt-related earnings were approximately 15% and the net yield to investors was 9.23%
- If $100,000 was invested for all of 2020, it would have earned approx. $9,230 before any tax. Of that, approx 15% is UBIT for about $1,384.50 in total. The $1,384.50 would be subject to tax at 15%, in that first UBIT tax bracket, for approx. $208 in taxes. So $9,230 - $208 = $9,022 on the $100,000 investment or about 9% net of UBIT assuming that bracket for 2020 for RTC VI, before other income taxes.
- Alternatively, if $50,000 was invested for all of 2020, it would have earned approx. $4,615 before any tax. Of that, approx 15% is UBIT for about $692.25 in total. However, as this UBIT amount is less than $1,000 and assuming this is the taxpayer's IRA's only UBIT, this is below the taxation threshold, so the tax wouldn't be due. So $4,615 - 0 = $4,615 on the $50,000 investment or about 9.23% for 2020 for RTC VI, before other income taxes.
- Please double-check this with your Accountant as your circumstances may vary and the rules may have been changed since publication.