State of the Market of Mortgage Funds in 2023

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Private lending has faced significant ups and downs since 2020, due in part to the economic impacts of COVID-19. As a result, many private lenders have turned to the classic and age-old formula of standing up a fund to mitigate some of this volatility. In this article, we’ll take a look at the current state of mortgage funds in 2023 and discuss some of the trends that have emerged in recent years.

One trend that has continued to be popular among mortgage fund managers is the use of the Reg D LP/GP model, which follows a 2 and 20 structure. Under this model, funds are typically structured as LPs or LLCs, and their distribution models for investors include asset management fees, preferred returns, and some form of profit participation by the manager. This model has been reinforced by the increase in lender finance options, as it provides lenders with a sense of certainty, transparency, and a senior secure position.

However, there are also some nuances to this trend that are worth noting. For example, REITs (real estate investment trusts) have become increasingly common for mortgage funds since 2018. This is because REITs provide a 20% tax savings to investors (though this benefit is set to sunset in 2025). Additionally, we’re seeing more lender-friendly terms being offered to investors, such as lower fees, first loss protection, concentration limits, and simpler liquidity and redemption plans.

On the other hand, there are some trends that have not taken off in the mortgage fund space. For example, note offerings and crowdfunding have not been as popular as some may have expected. This is because note offerings can be difficult to obtain leverage for, and lenders and banks often prefer to be the only debt securing mortgages. Meanwhile, crowdfunding strategies such as Reg A or Reg CF have gained less momentum over the past year because private lending and mortgages typically require larger investment amounts to adequately fund the mortgages in a timely manner. Further, fund managers have expressed rising concerns with working with non-accredited investors from both an investor relations perspective and a risk perspective.

Other trends to consider in the mortgage fund space include the use of leverage and offshore investor strategies. Leverage, or the use of borrowed capital to increase the potential return on an investment, can be a useful tool for fund managers, but it also comes with its own set of risks. Not all leverage is created equal.  It is important to ensure you truly evaluate those risks with counsel. Similarly, offshore investor strategies can offer some benefits, such as tax advantages and greater flexibility, but they also require careful consideration and planning. Typically, multiple investment vehicles and offshore tax experts and offshore counsel will be needed on top of US legal and tax.

Finally, trends in capital formation are worth considering when it comes to mortgage funds. Fixed income investors continue to seek yield, and the market for privately offered debt funds has grown significantly. As a result, success in raising capital often comes down to a fund’s track record, audited financials, and whether the manager has aligned their economic interests with those of the investors. Funds with a three-year track record or longer, as well as those with audited financials, tend to be more successful in attracting capital.

Overall, the current state of mortgage funds in 2023 is marked by a mix of tried-and-true strategies and new trends. While the classic Reg D LP/GP model remains popular, nuances such as the use of REITs and investor-friendly terms are also worth considering. Meanwhile, leverage and offshore investor strategies can offer their own set of benefits and challenges. In terms of capital formation, a strong track record, audited financials, and aligned economic interests are key to success in attracting investors.

Geraci LLP is your best resource for fund formation. Contact us today to set up a consultation.

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