WSJ story: Private mortgage lending

[csgraff]

I recently read this story in the WSJ about private mortgage investing:

Asking a Rich Stranger for a Home Loan | Jumbo Jungle - WSJ.com

The idea intrigued me, I ultimately contacted Rama Capital, mentioned in the article.

I received a reply from Mr. Alim Kassam, the CEO. (landed in my Spam folder) He attached some brochures about performance, etc with the email, mentioned he was leaving the country for several days, but offered to answer questions. We emailed back and forth a few times over 2 days.

Their minimum to invest is $100k, more than I would be interested in. I was impressed with Mr. Kassam, who was polite and professional in his attempts to help in any way possible.

I still like the idea of a similar investment, and am going to try and do some research on the topic. Other than GNMA funds and REITs, does anyone have any experience with something of this nature?

 

[SumDay]

I get personalized offers in the mail several times a week. My father did this on a more personal level: he flipped houses and financed the mortgage when he sold it. It worked well for him, this was his retirement plan and also served as a wonderful outlet for him. He visited those poor people several times a week, so when the payment due date came, they felt like they were jilting grandpa. It worked well for him. He was a softy and had no problem if they were 1, 2, 3 months behind....

Then he died. And I inherited all eight houses and the families in them. This was in 2007, right when the real estate collapse began. I have a full time job and don't have time to develop a personal bond with these people. Let me just say, if you love your children, you won't leave them real estate. I've foreclosed on three of them, and sold those outright for pennies on the dollar. I'm glad to be rid of those three headaches. The other five aren't bad, and I'm hoping they stay put and keep paying as it is a nice income stream when they pay.

I'd like to know what kind of guarantee you get on your investment. Remember, these are individuals who don't qualify for conventional financing, and there's a reason for that: their credit score is in the sewer. So let's say 30% of Mr. Kassam's individuals don't pay one month. Can he pay 100% of your promised payout? How's that work?

Personally, I hate real estate, and an REIT is about as close as I want to get to this whole mortgage situation. It's not for the faint of heart. Of course, YMMV.

I'll be interested to hear what others have to say.

 

[csgraff]

I get personalized offers in the mail several times a week. My father did this on a more personal level: he flipped houses and financed the mortgage when he sold it. It worked well for him, this was his retirement plan and also served as a wonderful outlet for him. He visited those poor people several times a week, so when the payment due date came, they felt like they were jilting grandpa. It worked well for him. He was a softy and had no problem if they were 1, 2, 3 months behind....

Then he died. And I inherited all eight houses and the families in them. This was in 2007, right when the real estate collapse began. I have a full time job and don't have time to develop a personal bond with these people. Let me just say, if you love your children, you won't leave them real estate. I've foreclosed on three of them, and sold those outright for pennies on the dollar. I'm glad to be rid of those three headaches. The other five aren't bad, and I'm hoping they stay put and keep paying as it is a nice income stream when they pay.

I'd like to know what kind of guarantee you get on your investment. Remember, these are individuals who don't qualify for conventional financing, and there's a reason for that: their credit score is in the sewer. So let's say 30% of Mr. Kassam's individuals don't pay one month. Can he pay 100% of your promised payout? How's that work?

Personally, I hate real estate, and an REIT is about as close as I want to get to this whole mortgage situation. It's not for the faint of heart. Of course, YMMV.

I'll be interested to hear what others have to say.

As you'd expect, there are no guarantees on returns, which makes finding the right fund very important. The Rama Fund has existed 4 years, averaging 10.18% per year. They have had no negative years or quarters. That kind of consistency during some tough times was important to me.

Their literature explains their philosophy as targeting buyers that need immediate access cash, and don't want to wait on banks, or buyers with good credit buying distressed properties. They require significant equity in the property prior to lending.
Currently 95% of their loans are current.

Like one of the investors mentioned in that WSJ article, the low yield environment is pushing me toward this. Its probably not something I would have considered otherwise. Risk is always present, but at some point sitting on cash for years on end will just eat away at you.

 

[CoolChange]

...

I'll be interested to hear what others have to say.

+1

I am actually surprised this thread has not generated more activity and am genuinely interested in this group's opinions on this subject since I have been considering something similar to the OP for a variety of reasons: Further diversification of my portfolio, lowish point in real estate cycle (obviously debatable and just my thoughts on this), etc.

I had fancifully considered something along the lines of what MelBay's father did but quickly decided that it would require more (and more regular) effort than I wanted expend.

 

[samclem]

I'd like to know what kind of guarantee you get on your investment. Remember, these are individuals who don't qualify for conventional financing, and there's a reason for that: their credit score is in the sewer.

I sold a house once to an individual with bad credit (a recent divorce, but he had a steady job) and I did owner financing. I asked for a considerable down payment (I think it was about 20%) and he paid it. Everything worked fine, he always paid on time and after a few years I suggested he look into getting (cheaper) conventional financing. He did, and paid me off.
This might not be a typical outcome. But there are folks out there with poor credit but are able to put down some money, so that would take some of the risk out of these adventures.

 

[azphx1972]

From the article:

Many of these loans are targeted at a small group of high-net-worth borrowers who look risky to traditional lenders because they prefer not to provide income documentation or because they're self-employed and recently had a down year. In other cases, they might need temporary funding until an expected bonus or other payout comes through or might want the loan faster than a bank can provide it.

These borrowers still seem like a relatively low-risk proposition to individual investors. In most cases, they are required to have high credit scores and to make large down payments, typically at least 30% to 40%. With significant equity in the home, experts say borrowers will be less willing to walk away from it if, say, its value were to drop. Also, if borrowers stop paying their mortgage, lenders can sell the home and use the proceeds from the sale to return investors' money.

I wonder what kind of "high-net-worth" borrower would be willing to pay the sky high interest rates on these loans. While I do think the traditional lending system is biased against the self-employed and unemployed wealthy, I think only the desperate would agree to such high interest rate loans, and therefore are the riskiest to loan money to.

 

[Meadbh]

Mortgage Investment Corporations (MICs)

There are several of these funds in Canada and some of them have been churning out good returns for decades, eg. Romspen. I went to a presentation by Romspen a few years ago. Their returns had been 10% annually, until the recession, when they decreased to 8-9%. During the 2008 crash, some of their investors got cold feet and wanted to cash in their investments. Therefore, to maintain stability, the fund shut down redemptions temporarily. They also had no hesitation in foreclosing on those who defaulted on their loans, then completing and selling the projects.

At the presentation I met several long term investors who were grateful to have the stability of regular income during good and bad times.

The bottom line is that carefully chosen, this type of investment can be a rational part of a diversified portfolio, but it should be considered high risk and illiquid. It is not for the faint hearted.

BTW, I did not invest.

 

[Bestwifeever]

+1

I am actually surprised this thread has not generated more activity and am genuinely interested in this group's opinions on this subject since I have been considering something similar to the OP for a variety of reasons: Further diversification of my portfolio, lowish point in real estate cycle (obviously debatable and just my thoughts on this), etc.

I had fancifully considered something along the lines of what MelBay's father did but quickly decided that it would require more (and more regular) effort than I wanted expend.

Here is a similar thread about peer to peer lending that might have some insights for you: http://www.early-retirement.org/forums/f28/peer-to-peer-lending-63294.html

 

[Nords]

I am actually surprised this thread has not generated more activity and am genuinely interested in this group's opinions on this subject since I have been considering something similar to the OP for a variety of reasons: Further diversification of my portfolio, lowish point in real estate cycle (obviously debatable and just my thoughts on this), etc.

Over the last decade (ouch!) this forum has given air time to a lot of niche investments. The vast majority of them involve outsize risk for their return, and they're definitely more due diligence than the hourly rates we used to earn during our working years. There's a good reason for all the insider jokes about triple inverse leveraged beever-cheeze futures.

Even if 10% lasts long enough to be historical instead of random, how much of your portfolio would you invest in it? Would that allocation move the needle on your overall returns? If not, then why bother?

After seeing all the analysis on these niche investments, the general conclusion is that a diversified portfolio does not require asset classes other than stocks, bonds, & cash. Maybe not even real estate. If you're going to invest in the "other" asset classes, then it's probably wise to do it with your testosterone-poisoned entertainment funds.

Rick Ferri has done some thinking about asset allocation:
Basics of Asset Allocation (Part 2 of 2)

And so has Larry Swedroe in his "alternative investments" book.

 

[deserat]

Over the last decade (ouch!) this forum has given air time to a lot of niche investments. The vast majority of them involve outsize risk for their return, and they're definitely more due diligence than the hourly rates we used to earn during our working years. There's a good reason for all the insider jokes about triple inverse leveraged beever-cheeze futures.

Even if 10% lasts long enough to be historical instead of random, how much of your portfolio would you invest in it? Would that allocation move the needle on your overall returns? If not, then why bother?

After seeing all the analysis on these niche investments, the general conclusion is that a diversified portfolio does not require asset classes other than stocks, bonds, & cash. Maybe not even real estate. If you're going to invest in the "other" asset classes, then it's probably wise to do it with your testosterone-poisoned entertainment funds.

Rick Ferri has done some thinking about asset allocation:
Basics of Asset Allocation (Part 2 of 2)

And so has Larry Swedroe in his "alternative investments" book.

OK - my eyes glazed over by the second paragraph at the link..I skimmed to the bottom and thought, hmmmm, based on your post and a percentage I like, I could be wisely allocated - additionally, I think Bernstein did a better job of explaining this stuff. Thanks for the link, though - reaffirmed why I'm a set it and forget it person.....except for once a year or so to possibly (not usually) rebalance.

 

[Huston55]

.

Even if 10% lasts long enough to be historical instead of random, how much of your portfolio would you invest in it? Would that allocation move the needle on your overall returns? If not, then why bother?

.

That's really the main point eh.

 

[CoolChange]

...
The bottom line is that carefully chosen, this type of investment can be a rational part of a diversified portfolio, but it should be considered high risk and illiquid. It is not for the faint hearted.
...

This was my initial reaction to this type of investment.

Here is a similar thread about peer to peer lending that might have some insights for you: http://www.early-retirement.org/forums/f28/peer-to-peer-lending-63294.html

For some reason, probably not intelectual, I put this in a different mental category than the peer-to-peer lending discussed in this thread. I guess like many in the middle of the USA, there is something in my DNA that says I should own real estate.

Over the last decade (ouch!) this forum has given air time to a lot of niche investments. The vast majority of them involve outsize risk for their return, and they're definitely more due diligence than the hourly rates we used to earn during our working years. There's a good reason for all the insider jokes about triple inverse leveraged beever-cheeze futures.

Even if 10% lasts long enough to be historical instead of random, how much of your portfolio would you invest in it? Would that allocation move the needle on your overall returns? If not, then why bother?
....

In the end, this is probably the right answer for me and most others.



Thanks to all; maybe I will quit wasting my time thinking about such things eventually.

 

[csgraff]

Even if 10% lasts long enough to be historical instead of random, how much of your portfolio would you invest in it? Would that allocation move the needle on your overall returns? If not, then why bother?

This seems to be the bit that caught everyone's attention. For me, I'd considered investing a portion of my current cash portfolio, which we all know is returning basically 0%.
More risk than cash, sure. More risk than an S&P Index fund, or Dividend Appreciation fund? Who knows at this moment in time? After researching the Rama Fund, I felt it was a risk I would be comfortable taking, had it been easier to enter. The CEO is a former Lehman investment banker. The President has over 30 years of experience in mortgage banking.

 

[Nords]

For me, I'd considered investing a portion of my current cash portfolio, which we all know is returning basically 0%.
More risk than cash, sure. More risk than an S&P Index fund, or Dividend Appreciation fund? Who knows at this moment in time? After researching the Rama Fund, I felt it was a risk I would be comfortable taking, had it been easier to enter. The CEO is a former Lehman investment banker. The President has over 30 years of experience in mortgage banking.

I'm not sure I understand your thinking. Are you saying that you're changing your asset allocation to add more of a risky asset (for which you may or not be compensated), or are you expecting to be able to pull your cash out of this mortgage fund just like it was a money market account?

I'm not sure which part of your research was so reassuring-- the asset class or the personalities. I'm pretty sure that a mediocre exec in a great business will outperform a great exec in a mediocre business every time. I'm not so sure that "30 years of experience in mortgage banking" is something that anyone would want to add to their resume until at least 2040. And everybody from Lehman is a "former" now. But if these guys had at least 50% of their net worth (and at least 50% of their compensation) tied to this fund's performance then I'd be more inclined to believe that their interests are aligned with yours. Otherwise their interests are aligned with yours to the extent that a farmer's interested in keeping his cows & hogs well fed.

You've decided that your cash is earning effectively zero, and you've decided that the future returns of this mortgage fund will be (at least) 10% APY. Yet what many overlook during the exercise of "chasing yield" is that cash is an asset class which can sit for months earning nothing, and then can purchase another asset class at a significant discount.

Rather than try to "put your dry powder to work", perhaps it'd be better to wait for a component of your existing asset allocation to need rebalancing. I'm sure some mainstream market asset will go on sale for at least a 10% discount during 2013 and recover during 2014. I'm not so sure that you can reasonably expect a private mortgage fund to return 10% during that same period. You simply lack the credible historical data to make that projection.

 

[csgraff]

I'm not sure I understand your thinking. Are you saying that you're changing your asset allocation to add more of a risky asset (for which you may or not be compensated), or are you expecting to be able to pull your cash out of this mortgage fund just like it was a money market account?

I'm not sure which part of your research was so reassuring-- the asset class or the personalities. I'm pretty sure that a mediocre exec in a great business will outperform a great exec in a mediocre business every time. I'm not so sure that "30 years of experience in mortgage banking" is something that anyone would want to add to their resume until at least 2040. And everybody from Lehman is a "former" now. But if these guys had at least 50% of their net worth (and at least 50% of their compensation) tied to this fund's performance then I'd be more inclined to believe that their interests are aligned with yours. Otherwise their interests are aligned with yours to the extent that a farmer's interested in keeping his cows & hogs well fed.

You've decided that your cash is earning effectively zero, and you've decided that the future returns of this mortgage fund will be (at least) 10% APY. Yet what many overlook during the exercise of "chasing yield" is that cash is an asset class which can sit for months earning nothing, and then can purchase another asset class at a significant discount.

Rather than try to "put your dry powder to work", perhaps it'd be better to wait for a component of your existing asset allocation to need rebalancing. I'm sure some mainstream market asset will go on sale for at least a 10% discount during 2013 and recover during 2014. I'm not so sure that you can reasonably expect a private mortgage fund to return 10% during that same period. You simply lack the credible historical data to make that projection.

I doubt I will be able to make you see my viewpoint, as you seem to have concluded that this investment vehicle has no merit, while I believe it does. I never concluded or stated any expected return on this, I only gave the rate of return over the past 4 years. I did state there was no guarantee of return.

Currently I have all the exposure I desire in both stocks and bonds. I also feel that both those classes may face headwinds in the near term. My familiarity with the my investment tolerances tells me that I currently have more funds in cash than optimum, so I am searching for other areas that seem to offer the promise of a higher return, with some evidence to back it up.

I am familiar with the idea of keeping cash on hand, ready to pick up bargains. If the market corrected, I would likely buy in, yet still have cash leftover. Unlike you, I don't feel so certain than in the next several months I would be able to identify the proper time and asset to buy.

It is my decision that I would prefer to put some of that cash into such an investment as discussed. This is cash that I would not need access to, yet for my personal choices do not wish to place into more stocks or bonds. I would still maintain what I feel is a reasonable amount of cash to "pick up bargains".

There are many trusted methods for allocating funds, and I follow them well. Still, none are a one size fits all.

 

[Nords]

I doubt I will be able to make you see my viewpoint, as you seem to have concluded that this investment vehicle has no merit, while I believe it does. I never concluded or stated any expected return on this, I only gave the rate of return over the past 4 years. I did state there was no guarantee of return.
There are many trusted methods for allocating funds, and I follow them well. Still, none are a one size fits all.

I'm more interested in the process by which you appear to be arriving at your viewpoint, including the possible susceptibilities to several investor behavioral psychology pitfalls.

Your rationale for this investment appears to be based on social proof, inadequate data to compare to other asset classes, artificial scarcity/urgency, and affinity marketing.

You also seem to be seeking higher return without necessarily appreciating that it comes with a much higher risk. In other words, it's hard to tell that you've addressed the problem of being inadequately compensated for (the prospect of) higher returns.

And then there's the issue of the expenses you're paying for this opportunity. I wonder how that compares to the average REIT or GNMA fund, and whether you're rewarded for the cost.

What did you conclude from reading Swedroe's book?

 

[brewer12345]

Would not touch this stuff with the 10 foot pole of your choice. There may well be money to be made by doing the hard money thing, but it also involves hoping that the people doing the lending of your money are both ethical and prudent and remain so for the long term. No thanks. Rather own junk bonds. At least that way I can do the credit work myself and conclude whether the risk is worth taking.

 

[csgraff]

I'm more interested in the process by which you appear to be arriving at your viewpoint, including the possible susceptibilities to several investor behavioral psychology pitfalls.

Your rationale for this investment appears to be based on social proof, inadequate data to compare to other asset classes, artificial scarcity/urgency, and affinity marketing.

You also seem to be seeking higher return without necessarily appreciating that it comes with a much higher risk. In other words, it's hard to tell that you've addressed the problem of being inadequately compensated for (the prospect of) higher returns.

And then there's the issue of the expenses you're paying for this opportunity. I wonder how that compares to the average REIT or GNMA fund, and whether you're rewarded for the cost.

What did you conclude from reading Swedroe's book?

I'm sure any discussion of behavioral psychology is unnecessary, though quite a lot is on display. I acknowledge you feel this type of investment is ill advised and your disdain for its consideration, and will keep in mind these reservations. I noted the risk involved my posts.

 

[Nords]

I'm sure any discussion of behavioral psychology is unnecessary, though quite a lot is on display.

Considering the numbers of investments that are sold instead of bought, I'd say a working knowledge of investor behavioral psychology is essential to one's net worth.

So... what'd you think of Swedroe's book?

 

[gerntz]

We've had to put 25% down to get mortgages on four different duplex rentals to net us 8-9% return/yr starting out with splitting the annual take 50/50 with someone, BIL, who does the renting, collecting & upkeep. The return gets better every year with mortgage pay down & rent increases.

Having the capital to put down is the issue. So when we go to sell 10-15 years down the road, who are we going to find with the capital to make these nice returns? I'm sure many will see the nice income, but not many will have the cash. Net, I'm thinking what we could need to do is provide the mortgages ourselves but settle for 15-20% down. I figure with that skin in the game a) they'll work hard to save it & b) we'll have ourselves covered in any foreclosure.

 

[photoguy]

As you'd expect, there are no guarantees on returns, which makes finding the right fund very important. The Rama Fund has existed 4 years, averaging 10.18% per year. They have had no negative years or quarters. That kind of consistency during some tough times was important to me.

Is this considered a good return for this asset class? Over the last four years vanguard's REIT index achieved something like a 20+% return. Of course it's not exactly the same asset class and the 5-year return is not so good. How did similar funds with longer histories fare (i.e. those that started before the market bottom)?

For me, I'd considered investing a portion of my current cash portfolio, which we all know is returning basically 0%.

If I thought I'd need to take on more risk to meet my investment goals, I would gradually reduce my cash/bonds (or redirect new money) and rebalance into my lowest performing equity sub-class (foreign small and value stocks at this point).

Currently I have all the exposure I desire in both stocks and bonds. I also feel that both those classes may face headwinds in the near term. My familiarity with the my investment tolerances tells me that I currently have more funds in cash than optimum, so I am searching for other areas that seem to offer the promise of a higher return, with some evidence to back it up.

Do you feel that the potential "headwinds" wouldn't hurt a private mortgage fund as well? If the US goes back into recession and the stock market tanks would not the private mortgage fund do poorly as well?

Are these mortgage funds really a unique asset class? or would they behave somewhat similarly to a combination of REITS, GNMAs, junk bonds, etc? (This isn't a rhetorical question, I simply don't know). If they are a unique asset class that zigs when other's zag I might be tempted to include a portion in my AA if (1) expense ratio's were low, (2) liquidity was not a problem, (3) passive index approaches existed to remove manager risk, and (4) I could handle the tax consequences of distributions.

And then there's the issue of the expenses you're paying for this opportunity. I wonder how that compares to the average REIT or GNMA fund, and whether you're rewarded for the cost.

The WSJ article suggests that the expenses are at least 1-1.5%. Compared with Vanguard's REIT index at 0.1% that's a pretty steep headwind.

 

[csgraff]

Considering the numbers of investments that are sold instead of bought, I'd say a working knowledge of investor behavioral psychology is essential to one's net worth.

So... what'd you think of Swedroe's book?

I agree completely. The "loss aversion" topic and the often inverse relationship between investor sentiment and market performance are areas that have really captured my attention over the last several years; have seen some great material on it. That's why I feel there's no need to delve further into it.

Have not read that particular Swedroe book, but I'm aware of his thoughts on TIPS, annuities, stable value funds, commodities, etc. Used to follow him on Seeking Alpha. I like the index investing pattern that he recommends, though I prefer ETFs now. The latest portfolio I can find for him is 60% stocks/40% TIPS. Personally, I'd rather have less in stocks at this moment. Peter Bernstein's book on risk is also interesting.

My outlook was shaped a great deal by James B. Stewart formerly of the WSJ/Smart Money. In 2007, he went out on a limb and suggested maybe for once it might be wise to "time" the market, and pull back on stocks some. His points seemed valid, and I did pull back. That action may have saved my planned retirement in 2009. Coincidentally, I believe it was Stewart that advised ramping up on stocks again in August 2010. Granted, strict attention to rebalancing may have seen you through as well, but that offers no guarantees for the future.

At any rate, I've decided I want to keep my eyes open for things that make sense to me, outside of stocks/bonds. I invested in some rural land 13 years ago, that has turned out well. I know from personal experience that some banks currently do a very poor job in lending. In 2009, I built a new house. I had enough cash on hand to cover most of the cost. Its not a big house, and I was half the workforce. I didn't want to have to liquidate stock funds in taxable accounts, so I applied for a HELOC on my then-home. This was from my long time, oldest and largest bank in the state; and was denied.

Puzzled, I tried to find out why. The house was mortgage free, and I had plenty of other funds in various accounts, great credit score. After several days and several phone calls, lots of voice mails, no one could tell me why. Your typical corporate boondoggle. Finally, a few weeks later I got a call asking why I had cancelled my HELOC application.

In summary, I felt this type of an investment could have a place in today's environment, acknowledging that it departs from the code of conduct of some thinkers.

 

[csgraff]

Are these mortgage funds really a unique asset class? or would they behave somewhat similarly to a combination of REITS, GNMAs, junk bonds, etc? (This isn't a rhetorical question, I simply don't know). If they are a unique asset class that zigs when other's zag I might be tempted to include a portion in my AA if (1) expense ratio's were low, (2) liquidity was not a problem, (3) passive index approaches existed to remove manager risk, and (4) I could handle the tax consequences of distributions.


.

I know you had a lot more questions in there, but it just seemed too much to copy/paste.
I do already have a position in VGSIX, which I have been gradually decreasing in favor of Federal Realty Investment Trust.(FRT) For a few reasons, I now prefer ETFs.

Yes, VGSIX has had a great run, better return than RAMA, but with much more volatility. VGSIX being invested in the stocks of US companies, is still a stock fund, publicly traded. GNMAs are bond funds, subject to falling if interest rates rise.

In the example given, the company is the lender, and originates the mortgages themselves. Their investor pool is 50/50 institutional/individual, and their mortgages are very diversified among residential, retail, industrial, office, etc. Their average Loan to Value ratio is 47%; they require 30% equity before consideration.

The tax situation would be like owning a dividend stock, dividends can be paid monthly or reinvested.

Still, its a different direction than owning REITs or stocks. Not for everyone, maybe I should do more to distance it from those types of investments. Nothing to put Junior's college money in. Definitely nothing I am trying to persuade anyone to invest in. I was more curious if others had any experience in the area.

It's just an idea to explore.

 

[brewer12345]

There is a huge amount of new regulations layered on mortgage lending these days, with more added all the time. At the very least, this would add a lot of overhead to this type of fund. I would also want to be really, really sure that the structure insulates investors from personal liability when the people lending out your money run afoul of some regs (and they will).

 

[calmloki]

Just checked and it looks like we have right at 20% of our net worth loaned out on property - mostly hard money short term loans. Our biggest and only unsecured loss was when we invested with a group of suits to loan out the money for us. Bad plan. We've taken some property back; should be closed on the sale of one of those next week and will carry the paper for ten years at 7%.

Lots less work than the rentals, which represent the bulk of our assets. We loan to flippers and property investors pretty exclusively. Makes more sense to me than the rumor and whim driven stock market values.