There are two ways to invest in first trust deeds. You can either invest directly in a loan, or you can invest in a hard money mortgage fund. Hard money mortgage funds sound great. Your investment is backed by a diversified pool of first mortgages, almost like a mutual fund. Great, right?
But there’s a problem. For the past forty years, real estate has crashed by about 45% every ten to twelve years. Examples include the S&L Crisis, the Dot-Com Meltdown, and the Great Recession. It’s been twelve years since the Great Recession.
Almost all hard money mortgage funds fail during these crashes, leaving the fund with no sponsor to make collection calls, to place forced-order fire insurance, to make sure the taxes get paid, to file foreclosure, to get the borrowers out of bankruptcy, to re-key and alarm the property, to renovate the property (almost all foreclosed property needs renovation before they can be sold), and to hire a reliable real estate broker to sell the property. If you are invested in a hard money mortgage fund when the sponsor goes bankrupt (almost all of them DO fail), you may only recover fifty cents (thirty cents?) on the dollar.
But why do the sponsors of these mortgage funds almost always go bankrupt? Answer: They never charge enough for loan servicing and property management to make their payroll and to pay their rent. During good times, they pay their expenses and earn a profit from the loan fees they earn when they make new loans. When the real estate crash hits, however, new money stops coming into their funds. Their existing investors line up to withdraw their funds, and these withdrawals eat up any liquidity from loan payoffs. Since he has no money with which to make new loans and earn loan fees, the sponsor goes bankrupt.
