Individual Trust Deeds vs. a Mortgage Pool Fund – An Investor’s Perspective
Having been in the real estate secured private lending space for many years now, I get asked a lot (by both investors and private lenders alike) what I think is better – investing in individual trust deeds or in a mortgage pool fund? We have originated and sold loans to (and serviced for) individual investors as well created and run (and raised investor capital for) multiple mortgage pool funds over the years. They are very different investments with very different risks, even though the asset type is fundamentally the same. So my answer is always, “It depends” – on the individual investor, that investor’s profile, his or her investment objectives, on the originator (their underwriting capability, their integrity, their administrative ability), and other factors.
Each option has both its strengths and weaknesses for both the investor and the originator. Here I am focusing on the relative advantages and disadvantages from the investor’s perspective, although I also think it is helpful for an investor to understand the advantages and disadvantages from the originator’s perspective as I believe it helps the investor make a more educated choice. Generally speaking, the individual trust deed route may be better for investors who are very experienced in real estate and who want more direct control over the specific individual properties being used as collateral for their investment. The mortgage pool route is generally better for a more passive investor, those with less experience in real estate matters (valuation, marketability, foreclosure processes, etc.) but want some real estate based investments in their overall portfolio, and those who want to focus more on choosing a manager than necessarily individual investments.
An investment in a single trust deed has the primary advantage to the investor of knowing precisely which property secures his or her investment. If you are highly confident in your ability to assess real estate value, marketability, and risks, you may be more comfortable picking and choosing your own individual deals. But it also concentrates the risk of all of the money invested in that single deal. If you make an underwriting mistake (such as believe a potentially inaccurate valuation that supports your investment and come to find out later it was wildly inflated), the result can be very painful. If your borrower stops paying, your cash flow from that one investment can go from 100% of interest to zero very quickly, whereas in a pool if one loan, or even several loans, stops paying the mortgage pool investor does not necessarily see any interruption in cash flow. As a single trust deed investor, you may (or may not) ultimately recover that interest, but it can take a long time while you battle it out through foreclosure (and have to personally advance the costs of doing so which actually can make you cash flow negative).
There are many potential advantages of a mortgage pool investment over individual trust deeds including diversification, cash flow, potentially the returns, longevity of investment, various liquidity options (instead of just one), and more. But there are also significant risks that must be considered. A mortgage pool fund is a much more sophisticated capital structure and managing one effectively can be an extremely difficult challenge for the originator who is used to just “doing deals.” Just structuring the fund properly in the first place is a huge challenge for most trust deed originators turned first time fund managers. Well intentioned managers often set up a fund with difficult and unwieldy structures or bad economics. This can unwittingly tee it up for problems later during the life of the fund, often completely unbeknownst to both the manager and the investor. Therefore, choosing the right manager with the right strategy is the single most important decision when investing in a mortgage pool fund (or any fund really) instead of individual trust deeds. The character, integrity, capacity, experience and track record of the manager is far more important for the investor when investing in a pool than when doing individual trust deeds (although it is important there too).
The bottom line is that they both have their positives and negatives. Neither is right for everyone and each is better suited for certain types of investors. I have seen some investors do spectacularly well with individual trust deeds and others who have gotten badly burned. I have seen well run funds produce great results over long periods of time and others that totally imploded. It really is not an either-or proposition. Both can work and both can produce a bad outcome. My best advice to investors is to understand your own preferences and profile first to know which is generally better suited for you. Then, do your homework, do your homework, do your homework – whether that is on the individual deals you are funding with some originator or on the fund manager to whom you are entrusting your money.
Matt Burk is founder and CEO of Fairway America, LLC, the nation’s premier consulting, advisory, and investment firm focused on the Small Balance Real Estate (SBRE) space. Fairway provides strategic business planning services to select private money lenders and other SBRE dealmakers around the United States. These services include advice relating to structuring, administering, and raising capital for these 506 Regulation D pooled investment funds. Matt has led Fairway’s capital raising efforts through seven proprietary Fairway managed funds as well as individual trust deed investors, resulting in more than $250,000,000 in capital raised from accredited investors over nearly 1,000 deals. He is also the Chief Investment Officer and Manager of the Fairway’s two current, nationwide SBRE funds, Fairway America Fund VI, LLC, and Fairway America Fund VII LP, which invests in other SBRE funds, including many that Fairway helped to structure, create, and administer.