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Fundamentals of a Mortgage Fund Yield: A Guide for the Real Estate Investor

Fundamentals of a Mortgage Fund Yield:  A Guide for the Real Estate Investor


Fidelis Limited Partners and Prospective Limited Partners:

An introduction to how the yield is calculated specifically for real estate mortgage funds and factors affecting yield in this particular investment arena.​

For generations, real estate has been a go-to investment avenue, offering both tangible assets and the potential for steady returns. While purchasing property directly is a well-understood strategy, another realm within real estate worth diving into is real estate mortgage funds. These funds invest in loans or mortgages secured by real estate, which allows the investor to passively invest in real estate without all the headaches of property ownership. To evaluate the potential income from such an investment, one needs to understand the fundamentals of Mortgage Fund Yield.

How is Yield Calculated for Real Estate Mortgage Funds?

Yield, in the context of real estate mortgage funds, represents the income generated by the fund over a year, expressed as a percentage of the fund’s current value or total invested capital by investors. The basic formula for calculating yield is:

For real estate mortgage funds, “Annual Income Generated by the Fund” would primarily come from interest payments and fees from the underlying real estate loans.

Several factors can influence the yield of real estate mortgage funds:

Interest Rates: The sensitivity of mortgage funds to interest rate changes can vary significantly based on the types of loans they invest in. For funds that focus on short-term bridge loans, like Fidelis Private Fund, yields adjust to current market conditions because as market interest rates rise, the yields on the loan portfolio better adjust to reflect the current market interest rates, leading to higher income for the fund. This eliminates the volatility in the fund’s value because of the timely rollover of the short-term loans, conversely, when rates fall, the yields on these loans may decrease but reflect the market, and thus, the value of the fund remains at par, eliminating the volatility in the fund’s value.

On the other hand, mortgage funds that invest in long-term fixed-rate mortgages, unlike Fidelis, lock in their interest rates at the time of the loan origination. As a result, the value of these funds is impacted by changes in market interest rates. When market interest rates rise, the fixed yields on these long-term loans become less attractive, decreasing the fund’s market value if the loans were sold. However, when market rates fall, these fixed-rate loans outperform new loans issued at lower current rates, potentially leading to a higher market value for the fund if immediately liquidated. Mortgage funds that invest in long-term fixed-rate loans are sensitive to interest rate changes and thus generate more risk to investors than mortgage funds that invest in short-term loans.

Credit Quality of Borrowers: The fund’s yield is directly tied to the borrowers’ capability to make their mortgage payments. A fund with riskier borrowers might offer a higher potential yield, but this comes with increased default risks. It’s important to note Fidelis’s delinquency ratio is less than .1%, which is well below the average delinquency rate for comparable mortgage funds in California, demonstrating Fidelis’s excellent credit quality.

Economic Conditions: Economic downturns pose a risk of increasing default rates, which could subsequently affect the fund’s yield. To mitigate this market risk, some mortgage funds maintain a loan loss reserve. This financial cushion is in place to absorb potential unforeseen losses, providing investors with an additional layer of security. It’s noteworthy to mention Fidelis Private Fund has over 2% of total assets as a loan loss reserve compared to many mortgage funds in California that don’t even have a loan loss reserve as a precautionary measure. When comparing different mortgage funds as an investment, it is something to consider.

Liquidity: Funds that invest in long-term fixed-rate mortgages tend to be less liquid. These loans’ extended duration and fixed interest rates make them less adaptable to changing market conditions, potentially making them harder to sell quickly without incurring a loss, especially if interest rates have risen since the loan originated. On the other hand, mortgage funds like Fidelis Private Fund that focus on short-term bridge loans, where their interest rates better reflect the market and offer greater liquidity. The yields on these loans adjust with market conditions, making them more attractive to buyers if ever the loans were sold, even as interest rates change, and their shorter terms mean they are regularly maturing and being repaid, providing the fund with more frequent opportunities to re-invest in new, higher-yielding opportunities or to return capital to investors.

Fees and Expenses: While high management and service fees can significantly reduce the net yield delivered to investors, Fidelis operates with a distinct approach to its fee structure that is more closely aligned with the investors’ best interests. Unlike the common practice in the mortgage fund industry, where management fees are calculated as a percentage of total assets, Fidelis’s management fees are based on a percentage of net income. This structure ensures that Fidelis’s interests are directly tied to the fund’s profitability. When investors do well, Fidelis does well. This creates a strong incentive for Fidelis to optimize fund performance and net income, ultimately benefiting the investors and prioritizing their returns.

Diversification: A well-diversified mortgage fund helps minimize risks by distributing its investments among a variety of borrowers and different types of properties. This strategy aims to balance out the potential impacts of any single investment’s poor performance, leading to more stable yields over time. By exemplifying this approach, Fidelis manages a diverse loan portfolio encompassing over 100 loans, ensuring a broad spread of exposure and an additional layer of risk mitigation.

In Conclusion

Real estate mortgage funds present a unique way to engage with the real estate sector without the need for direct property ownership. Grasping the intricacies of Mortgage Fund Yield and the factors that influence it is pivotal for making astute investment decisions.

With more than 16 years of experience as a fund manager and a proven track record of successfully steering a mortgage fund through the most severe recession in U.S. history without any capital losses to investors, knowing and understanding the fundamentals of a mortgage fund yield is vital for its success. Our extensive experience and expertise in this area underscores our commitment to safeguarding investor capital and ensuring the fund’s resilience, even in challenging economic climates.

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