Creating a debt fund for owner finance strategy
Investor · San Antonio, TX · Member since 2009 · 106 posts · 50 votes
Creating a debt fund for owner finance strategy
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Don KonipolBusiness Member
Investor · The Woodlands TX / Avon, CT · Member since 2009 · 6k+ posts · 10k+ votesQuote from @Ram Gonzales:
I've done a lot of wraps and subtos and highly prefer the seller-finance strategy for a lot of reasons, including offering the opportunity of homeownership to those otherwise rejected by traditional banks. I want to create a fund that will allow me to purchase distressed homes, fix them up, and sell with owner financing (possibly including a 5 year balloon so as to be able to recapitalize periodically and give investors a shorter horizon). I've had a long career in community development and have a lot of bank contacts that would likely be interested in investing, but I'd need to prove the concept first with an initial fund (there are also a lot of other community development tools that could be leveraged to maximize and scale this). Here's my question. If I create a debt fund that offers 9% interest on first lien notes with a 5-7 year payout, would that be attractive to high net worth investors? My target for the first fund would be $5-10 million and I have a few HNW investors in my network but certainly not enough. Anyone have experience putting these kinds of opportunities in front of investors?
That being said, raising capital for a blind pool fund is much more difficult than raising capital for a syndication where the property is already identified and the potential investors know exactly where there money is being invested. It’s doable, just more difficult, time consuming, with a lot more “contacts” needed for each “sale”.
I see a conflict of interest in your role as fund manager and principal in the “operating” company. As fund manager you owe your investors a fiduciary responsibility which I can foresee as a basis for lawsuits should the fund not perform as anticipated. I would check this out with a seasoned securities attorney for their opinion/guidance.
Most likely raising funds from passive investors would utilize a Reg D 506 b or c safe harbor exemption from registration. Typical cost for the setup would be in the $15,000 range which would include production of the Private Placement Memorandum, Subscription Agreement, and Operating Agreement, Investor Qualification Forms, as well as filing Form D with the SEC, and state “Blue Sky” filings in those states where your investors reside.
There are other ways to legally raise capital, however, they have some inherent disadvantages making them considerably less desirable for what you’re trying to do.
29 Replies
- Investor · San Antonio, TX · Member since 2009 · 106 posts · 50 votes1y
Quote from @Chris Seveney:
Quote from @Don Konipol:
I don’t know what the costs would be to “scale” from the volume you do now to a volume you’re targeting, but it’s probably a reasonable investment. Certainly from a capital raise perspective, $5 -10 million is a reasonable amount.Quote from @Ram Gonzales:
I've done a lot of wraps and subtos and highly prefer the seller-finance strategy for a lot of reasons, including offering the opportunity of homeownership to those otherwise rejected by traditional banks. I want to create a fund that will allow me to purchase distressed homes, fix them up, and sell with owner financing (possibly including a 5 year balloon so as to be able to recapitalize periodically and give investors a shorter horizon). I've had a long career in community development and have a lot of bank contacts that would likely be interested in investing, but I'd need to prove the concept first with an initial fund (there are also a lot of other community development tools that could be leveraged to maximize and scale this). Here's my question. If I create a debt fund that offers 9% interest on first lien notes with a 5-7 year payout, would that be attractive to high net worth investors? My target for the first fund would be $5-10 million and I have a few HNW investors in my network but certainly not enough. Anyone have experience putting these kinds of opportunities in front of investors?
That being said, raising capital for a blind pool fund is much more difficult than raising capital for a syndication where the property is already identified and the potential investors know exactly where there money is being invested. It’s doable, just more difficult, time consuming, with a lot more “contacts” needed for each “sale”.
I see a conflict of interest in your role as fund manager and principal in the “operating” company. As fund manager you owe your investors a fiduciary responsibility which I can foresee as a basis for lawsuits should the fund not perform as anticipated. I would check this out with a seasoned securities attorney for their opinion/guidance.
Most likely raising funds from passive investors would utilize a Reg D 506 b or c safe harbor exemption from registration. Typical cost for the setup would be in the $15,000 range which would include production of the Private Placement Memorandum, Subscription Agreement, and Operating Agreement, Investor Qualification Forms, as well as filing Form D with the SEC, and state “Blue Sky” filings in those states where your investors reside.
There are other ways to legally raise capital, however, they have some inherent disadvantages making them considerably less desirable for what you’re trying to do.I think in this instance it would be better to do one investor per deal rather than doing it as a fund and hypothecate each deal as it comes along.
Numbers always look good on paper but between holding costs when acquiring and renovating property, closing costs on can also add up.
I am not saying it cannot be done, as I did it with about 75 loans in a very similar fashion (except I was buying NPL's and got them reperforming). Its just hard and if there is any softening of the market.
For the original investor:
1. I would include servicing costs of the loan and licensing costs. If you are originating more than 3 licenses in most states you need to be licensed. servicing will run you abour $35-$50/mo per loan. That is not something you typically can charge an owner on an owner finance deal.
2. Do not forget about holding costs. I assume you would use your own $ to put property under agreement and get investor to close around same time, but if not you will have 1-2 months of holding costs plus time to renovate and time to sell the property. I would calculate this as a 6 month period of interest to investor to be safe.
3. Closing costs - you will have to pay taxes/stamps etc. typically as a seller.
4. Company overhead - you will need to spend $5-$10k per year on taxes and company overhead.
5. Default rate - as you scale you will have a 10% default rate on loans. How do you plan on handling that situation
6. Raising capital - It will be difficult to tell an investor their $ is tied up for 30 years and you are only banking on the borrower selling or refinancing. An investor is going to want to have a specific date they can get their money out of the deal.
Thank you @Chris Seveney. Great points. I've done the one on one thing for a while now but for a lot of reasons (timing, paperwork, reliability, etc.), it's not ideal. It might be the way I have to keep going but it's why I'm exploring this fund option as an alternative.
1. Servicing Costs - Yes, servicing is included in the proforma.
2. Holding Costs - My experience with owner financing is that I can buy and sell a property in a month or less since the rehab is minimal and I'm providing the financing. Keep in mind that I am selling them as affordable fixer uppers and usually only address any health, safety, and functionality issues. In some cases, I've had a buyer lined up by the time I close. I usually end up with a list of buyers with down payments but I don't have any more inventory for lack of inventory (capital). All that being said, the proforma includes a 90 day turnaround between purchase and cashflow.
3. Closing Costs - Yes, closing costs are in the proforma. In Texas we do not have real estate sales taxes but property taxes are high and also included in the proforma based on the 90 day holding period.
4. Company Overhead - Agreed.
5. Default Rate - Yes, I realize that there will be a certain amount of default. I have that worked into the proforma as a vacancy line item. I believe I also used 10%. Defaults result in foreclosure. I then recoup any losses in the resale and down payment forfeiture. Only other wild card is if they destroy the house on the way out. This is why I prefer the cash-for-keys approach. I've only had to do it once but it worked out well enough.
6. Raising Capital - Investor capital would only be tied up for 5-7 years. Whether the balloon or the adjusted rate approach, the borrower is incentivized to refinance. We would also be working with them to prepare them for refinance from Day 1. Worst case scenario, we sell the seasoned, performing note at a discount. This would affect the LLC payout but not the Fund investor, assuming the note is sold for more than the underlying loan of course.I appreciate your thoughtful analysis. Gives me more to consider as I develop the PPM.
- Investor · San Antonio, TX · Member since 2009 · 106 posts · 50 votes1y
Thanks @Don Konipol. Yes, the target raise would be $3-5 million for the first round. As to structure and conflict of interest, I was initially planning to structure it as an equity fund but was told it might be more attractive to investors as a first lien debt fund and to use it as a bank for the LLCs deals. The SEC attorney I've been working with advised that I would just need to disclose in the PPM that 100% of the capital would be used by my LLC.
- Lender · Nationwide · Member since 2018 · 571 posts · 310 votes1y
Ram, this is an established model in Texas and land oriented states that I have direct experience with. Let me know if you would like to connect and discuss further.
- Investor · San Antonio, TX · Member since 2009 · 106 posts · 50 votes1y
@Shafi Noss Yes, I'd love to hear more. I'll DM you. Thanks!
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