Notes funds for individual investors. What are the best players?

35 Replies

Hello everybody,

I am strongly considering part of my SDIRA to be in Notes funds. I am looking for high quality players in the industry with great historical record.
Let's talk about good and "not so good" funds!
I would appreciate any leads/opinions.
I am new to the Notes and my impression is - the notes funds are very difficult to understand in terms of historical risks, their transparency. there is no much of the SEC regulation/reporting requirements like, say, in mutual funds.

Are there any financial analysis stats out there, rankings et cetera? Are these funds legit, here to stay???

Or is this Notes fund market is short- lived hype created by recent mortgage crisis and huge inventory?

I have several investments in PPRs fund.  They invest in non-performing seconds and get them re-performing.  12% yield (1% of your investment every month) and then after 3 years, your capital investment is returned.  I have not been in these 3 years yet but I can tell you that they have NEVER missed a payment thus far.  You need to be an accredited investor to invest in most of these I believe. 

I invested in PPR because they have an entry minimum of $10,000.  I think that National Note Group and other funds may have a higher ($50,000) entry point.

There are several note investors here on BP that have funds or will be starting funds soon.  I hope they chime in and tell us about their funds as I would like to know what funds are out there and what the minimum investment is.

@Demjan Van Der Kach @Sandy Uhlmann Sandy is right, there are lots of funds out there and most of them are legit. PPR is a great company and my experience with Dave Van Horne is that he's an honest and trustworthy guy. 

Every fund is set up slightly differently, I know of another fund that recently started up (not mine) and I am very impressed by their policies on payout and how they handle the funds. Things like they don't take any extra fees for the privilege of being in the fund! PM me if you want to know more.

Personally I would be cautious about investing in 2nds, WHEN we have the next recession we will know how well these hold up in a tough market.  Think of it this way, if there is little or no equity left after the first then any second is likely to get wiped out during a foreclosure (FC sales are at a discount), once we have been through that cycle we will know how seconds do.

I prefer fist liens because you capital is better secured and if you do have to FC then you can take the property back and resell with owner financing with a high probability of being paid in full.

Hi @Demjan Van Der Kach , I think it is a relatively short lived cycle. Our fund is closed ended and a 5 year term. I recently attended the IMN note conference last month and a panel of fairly large fund managers agreed that there is at least 5 and probably 10 years of distressed debt liquidation in store for us investors, so my partners and I are taking advantage of the opportunity while this window is open. We only acquire first position debt with owner occupied properties with the goal of keeping them in their home and earning a solid cash flow stream. Seems to be working well so far.

@Bob Malecki :  Yes, you are correct.  You have to be an accredited investor for PPR's fund.  You mentioned you have a fund.  Please share with us how your fund works.  Are all funds similar to PPR's in that they pay out a flat percentage and capital is returned at the end of a set number of months/years or are there some funds that pay out based on how the pool of notes did? I know there are others out there that have funds and others out them that have invested in these funds.  Please chime in and educate us all!  Off the top of my head, Sherman Arnowitz I believe has a fund, as does Fuquan Bilal of National Note Group as does SMR. @Joshua Andrews is your fund up and running?  If not can you tell us when we can expect it to be up and running and how it works?

I know that most of the funds that I mentioned were investing in seconds.  What funds are out there that invest in firsts?

Hi @Sandy Uhlmann , funds can vary in term and how the investors are paid. Some like PPR's pays a flat return, usually what is called a "preferred return" which means that the investors get paid that stated return before the fund manager gets paid, but the manager then gets all of the remaining profit. Realize that the preferred return is NOT guaranteed. If the fund earns only 4% after expenses then the investor gets that 4% and the manager gets nothing. If the fund earns 20%, then the investors get their pref and the manager gets the rest. 

Also many funds are designed to pay the manager an annual management fee ranging from .5 to 2% of the value of the assets under management. This can erode the net profit and the manager would still get a paycheck from the management fee even if the fund's return was not favorable or even negative. This is why hedge fund managers make a great living even if their fund does not perform well. Go figure. 

Other funds are designed to pay a lower preferred return (anywhere from 6-10% on average) but also provides a split on the profits earned after expenses and the pref payments to the investors.

In that design the investors get the first X% via their preferred return, plus a portion of the additional profits. So if the fund performs beyond the min. preferred return requirements, the members in the fund essentially get a "bump" when the profit splits are paid. As you can imagine, reworking distressed debt purchased at a substantial discount can to into double digit returns when a successful outcome is completed. This is where the annualized return to the investor is more dependent upon the performance of the fund and expertise of the managers running it. 

Our fund invests in first position, borrower occupied distressed debt, and it's a closed-ended 5 year fund with a wind-down in 2021. I can't provide any specifics on returns since as a Reg D 506(b) we cannot advertise. Under this exemption, though, we are allowed to have up to 35 non-accredited, sophisticated investors. We did this so that we can accommodate the smaller self directed investor who is looking to park some money at what we think will be a good return from our performance as fund mangers in this investment space. 

We selected a 5 year term so that in years 1-2 we are in acquisition and modification mode, then assuming successful outcomes, years 3 thru 5 are cashflow income on the loan payments. During this term we expect that the notes also appreciate in value as the markets in which the homes are located appreciate (since we are purchasing the paper at a discount to BPO and the UPB is typically higher than that current BPO value, the notes "equity" grows in sync with market appreciation). The goal in year five is to liquidate the performing assets at a much higher value than we acquired them providing very good profit split for our members and us a managers while having that cash flow income along the journey.  We are basically buying and renovating paper rather than homes

Other funds are "open ended" or "evergreen" where there is no set exit term and investors can come in and out during the active term of the fund. This is more flexible but also adds more complexity since the value of the shares will fluctuate over time and that needs to be monitored and calculated every time an investor joins or leaves the fund. 

Most of the funds you reference are, I believe equity only funds, which mean that investors are trading cash for an equity position along side the other investor/members in the fund. Some funds use a hybrid approach, offering both equity and a debt component. So an investor can either trade cash for equity and that preferred return + profit split, or essentially act as a lender to the fund for a fixed interest rate over a specific term. Again the hybrid model adds more complexity and requires more overhead for accounting and tax reporting. 

We designed ours as equity only, with a 5 year term primarily to keep things simple while we build our platform, finalize relationships and increase our knowledge base. Both myslelf and my partners, Ben & Kevin feel that this will provide us a good foundation to start subsequent funds based on a solid track record and the efficiencies we developed while operating Fund I. 

As you can see there are a lot of ways to design a fund to capitalize one's note investing goals. Sorry for the long-winded response, and I hope this fairly verbose response answers your question! 

Bob Malecki

Great info. Thank you Bob.
I always would like to understand how leveraged the funds are.
What is the industry standards regarding leverage? What are the ways to get the leverage - my questions is more specific for the note funds.
The other question I have where the funds keep their cash and how much cash? Is the cash somehow insured? In what securities?
I am not a financial person - sorry if my questions don't quite make sense to some...
say the fund keeps cash in bank and bank collapses... in this case I would be much comfortable if the "cash" would be in short-term treasuries.
Can the risk of note funds could be measured? Are there any benchmarks?

Hi @Demjan Van Der Kach , there are no industry standards on leverage in a note fund, the leverage is determined based on the fund manager's business plan and offering. There are companies that will loan on a note portfolio, typically with a 3-5 year term and some parameters on min loan amount and min note value. 

As far as cash, most funds will deploy the cash into assets to get it working for their investors. The only idle cash that we intend to keep is a reserve for potential foreclosure expenses and holding costs on non performing assets, such as monthly servicing fees, force placed insurance, etc. 

The risk in a note fund is note done by any empirical measuring methods (other than performance history), its the business plan for the fund (PPM) and the manager's experience in being able to deploy the investors cash into profitable assets, along with the industry trends for the fund's asset class of investment that would determine risk. 

I concur with others. On the risk associated with Second position notes when there is any issues in the collateral those get wiped out as quick as they were created.. there are simply to many good first TD's that return 12% to even consider risking investing in that kind of deal... the risk reward simply is not there in IMHO.... you can align with a great HML in your market and make 12% every day of the week all first position etc etc... for the life of me I can't understand how people would take a risk in second positions only to make 12%.. regardless of the stature of the company.. @Sandy Uhlmann   do you feel any risk when you can be wiped out without a major cash call ?

@Bob Malecki I think its great timing right now for well position and located firsts.. although there is the assumption that there will be equity on top of the discount time will tell there.. so as long as your profitable on your rate of return today anything above is icing on the cake.. kind of like buy and hold investors think of appreciation as a bonus..  Question I would imagine these discounted notes are bringing in a nice yield currently why exit.. you probably won't be able to recreate the great deals your getting today... is there a mechanism to have the current members just buy the notes individually if they wish to keep their cash flow coming in... As you know I deal in ONE note One investor and my Note buyers cry when they get payoffs  LOL...

@Sandy Uhlmann thanks for the mention. We are laying the groundwork for our fund and expect to have more details soon. There has been good information from many of the posters here. I agree risk and expectations vary from individual to individual, and it's going to depend on the investors comfort level. I see both 1st's and 2nd liens being profitable. We have experience in 2nd's and have been happy with the results. That being said, there are model's like @Bob Malecki which utilize 1st liens that make a lot of sense and are profitable for all parties.

Josh

@Jay Hinrichs  PPR has been around for quite a while and they have loads of experience behind them.  They mitigate the risk associated with seconds as they are well aware of what the risks are.  They follow the status of the first and intervene whenever necessary. 

 If you have ever looked at a re-performer that they offer every week you would know that their re-performers sell for way above the asking price because of PPRs reputation.  PPR also guarantees your capital investment if you purchase a re-performer and it misses payments.  That is part of the reason their reputation is so good.   In many instances, I am sure just the arrears that PPR collects may pay for the entire price that they bought the notes for. Likewise, when they do offer non-performing note sfor sale, I am sure that the non-performing notes are also going for higher than market values.  

If the "thank you" gifts are any indication of how the company is doing, I can't tell you how many "thank you" gifts that I have received from PPR.  I think they are making well over the 12% that they are paying their investors. This is not to say that things may change but afterall, it is an investment and any investment is not without risks.

I also have some first trust deeds also and they are pretty sweet deals.  I think people that want totally passive investments prefer funds over individual notes.  With funds, you don't really have to understand the ins and outs of notes, you just have to hope the fund manager in knows what they are doing.

@Sandy Uhlmann   I am absolutely positive the notes they buy are near worthless its the only way they can bring in new money and pay on notes that don't perform.. its all good when its good.

its just so much cleaner in first position.. I have been doing this about 40 years so I understand the ups and downs... :)  I prefer single note single investor firsts least amount of risk in my mind.

there were many many Note funds that cratered in 08 to 2011 and took all their investors with them.. not saying anyone today that could happen to.. but its a fact.. when you have a run on the bank it gets ugly... good choice to buy first though..

Great discussion. Thank you all. It helps me in my decision making.
Regarding leverage- what are the ways for the funds - my guess performing notes funds and NPN funds are different - to leverage themselves?
What are the regulatory restrictions on leverage?

The second issue- how are these funds tax-efficient? Any long term capital gains besides the interest. How are these funds taxed internally? Any tax loopholes for the funds to use? I know - it's probably a big topic by itself....

@Sandy Uhlmann sounds like PPR does nice things: principal guaranty and "gifts"... my impression that there is something about them you love... :) however my gut feeling - without complete understanding of their risks, structure, leverage, performance in a bad market it is quite a gamble for NPN... I will definitely try to carefully read their guaranty.

To the best of my knowledge, there are no regulatory restrictions on leverage in a fund and using leverage, as mentioned previously would be part of the design/operating plan for the fun and be described in the fund's PPM.

The tax consequences on an unleveraged fund would be basically as a distribution of interest income to the fund members. Note that if you are using your SDIRA to fund your membership and the fund uses leverage, then your SDIRA is subject to UDFI on your prorated portion of profits from the fund. See http://www.sdiraservices.com/blog/understanding-un... for more info on this. 

Still looking for more suggestion on a note fund that invest in firsts and offers a monthly or quarterly return from day 1 for a sophisticated investor. Thanks Again

Originally posted by @Rick Meloni :

Still looking for more suggestion on a note fund that invest in firsts and offers a monthly or quarterly return from day 1 for a sophisticated investor. Thanks Again

Did you contact David Van Horn Re: The PPR Fund? If so, what was the outcome?

I did and his fund is for accredited investors only.

@Demjan Van Der Kach

Hey there, I'm with you. I'm pretty new to this note fund investment myself too. With all the reviews and recommendation other investors input in BP, I gave PPR a try.  I think PPR really tries everything they can to win the investor's trust. To be on the safe side, I always diversify as much as I can.... so I have reached out to different online investment platforms like PoL, Yieldstreet etc... PPR has the best customer service that either you prefer phone convo or email they do it the way you prefer. Very reasonable reply time and they answered my questions well. I received a nice gift from PPR too for the holiday. I'm waiting on my first interest payment 1/1/2017 but from all other PPR investors' input I'm pretty at ease that I'll get the payment on time. So far so good.... the website has given me most info I needed, pretty transparent about what they do and after watching a couple youtube video Dave Van Horn explaining about note investments, I sorta starting to understand how PPR can sustain paying investor 12%.... and yea.. I really like the 12% passive return.. i think I will add more capital to PPR later.. but again,,, always diversify IMO...  My thinking is... if I'm investing 100k ... if I put 20k into each platform,, and for platforms like PoL that I can do 5k per project... this will greatly diversity the investment to minimize possible loss. Well ,, just my 2cents. = )     I do think you should try PPR though.   

After being almost three years in a PPR fund I was just redeemed a few weeks ago.  And I can tell you I am extremely happy I am out and paid back in full.  Was in a fund that only paid 8% (but never received a holiday gift over the years, LOL)

All I can say is make sure you understand syndications and what you are doing here.  You are basically sending your risk capital to run their business and they have ZERO skin in the game (basing this on the fund I was in.)  Is 12% enough to take on that risk?  Up to you to decide, but most important thing to remember is you are betting PPR and the fund you are in stays in business to not only pay you a return but also return your capital.  Do you know the financials of PPR itself?  Doubt it as I am sure it is tightly held info.  What would happen IF PPR went bankrupt or the principals took their equity and left the company?  What is the backup plan?  I know many of the crowdfunding portals are providing backstops but unsure if PPR does the same.  They warranty their notes, but if the sh*t hits the fan what would that do to the fund itself?  This question has been asked on BP before but I don't recall if they ever answered it.

This is not to badmouth PPR but to guide anyone reading this in proper due diligence.  When I entered the fund, I was misled into believing what was in the fund itself, but this info did not come directly from PPR, so that was my fault in not digging further.  Thankfully, that wasn't an expensive lesson!

For me to take that risk again, I would want some share in the upside along with a preferred return -- especially since it is basically equity you are giving them.  Just my opinion, but the risk here in my mind is huge.  I am very glad to hear communication is better at PPR.  Two years ago, I sent emails and even made calls that often went unanswered or had very little to no info I was requesting.  This year, however, I did notice that my emails were answered timely.

@Henry Li

@Sandy Uhlmann   

did you happen to read the PPA and use of proceeds section? Just curious what is their fee percentage. I am all about everyone making money in any deals, but the fund I was in was heavily weighted towards the officers -- 20%+ fee (13% was just the fee to pay the officers!) Maybe I should complain I didn't get a holiday gift!!

Dave and the folks at PPR do an awesome job, that's for sure. As I posted here earlier on this discussion, a private equity fund can be created in many, many different ways, with just a preferred return like PPR, or a pref + profit split, some have a debt component along with an equity component. Mostly though a Reg D fund pretty much will have a PPM that states that the investor is risking to lose all capital, so it is up to you to look at the business model of the fund and the manager's experience and expertise in executing that model. 

We as fund managers do not plan to lose anyone's capital, but we must state all known risks in our operating documents so that our investors are fully aware of what they are investing in. 

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