Real estate development fund

[kmartdude]

Hey guys would love some input on this one.  I recently received an invitation to participate in a real estate investment fund for a subdivision that is being built near me.  It is a Note, which is unsecured, but it sounds like I would be behind the banks in line, but ahead of any equity owners also involved if things went bad.  I would put up $100,000.  The annual return is 12% per year, for five years, at which point you'd get your $100,000 back.  I feel confident in the area, I think it's a reasonable place to put a new subdivision and my gestalt is that it will do well.  That said, it seems like an incredible rate of return, so clearly it is more at risk than I'm thinking, along with the old adage of 'Don't invest in something you don't understand.'

Is this a scam?

Are these reasonable investment vehicles for those that are less risk-averse?

Would appreciate everyone's thoughts!

[Hank]

If this is such a great deal, why are they cold soliciting you instead of just getting funding from the bank or the developer using his own money for this?

Run, don’t walk, away.

[The White Coat Investor]

12% is too low to not be in first lien position in my opinion.

[Zaphod]

Agree with WCI. For what is going to be considered ordinary income and taxed as such, the return is not very good especially with your position in the capital structure, aka, you likely wont get anything if it goes bust. There will be no more scraps after the banks clean up.

[Complete_newbie]

Yet that is the "highest" you'll get on these crowdfunding websites. I bet if one looks it'll be 11% for second lien debt.

[The White Coat Investor]

Complete_newbie wrote:

Yet that is the “highest” you’ll get on these crowdfunding websites. I bet if one looks it’ll be 11% for second lien debt.

Click to expand...

What are talking about? Very little second lien debt there. Mostly 8-9% for first lien these days.

[Complete_newbie]

I am talking about checking various crowdfunding websites and quoting me their 2nd lien rate it'll be around 10.5-11% so this fund offering 12% is probably beating them.

And sure it's less out there but those deals come by

I know this because I do this. FWIW, my rates are much higher for commiserate risk.

[kmartdude]

Thanks guys really appreciate the thoughts and info.  I ended up meeting with the developer to get more information.  From talking to another local advisor he counseled that with these kind of real estate notes it's key to know the developer and the specifics of what the investment entails.  This is more attractive as it's a housing development in an area (Madison, WI) that is in need of further housing (I know, don't worry I have considered the next bubble but this market has quite a bit more stability than other communities given it's employment situation).  I'll keep you guys posted, haven't committed yet but it doesn't seem as fool-hardy as I was initially suspecting.  I understand that if the thing goes belly up my second lien will be worth nothing.  I guess in the end it's about assessing that likelihood.  Thanks guys.  Kmart

[White.Beard.Doc]

Is the developer putting her/his personal assets at risk to back this loan? If not, they are taking a lot of risk with OPM (other people’s money).

[ajm184]

Is this an unsecured note or 2nd lien debt?  Depending upon the overall capital structure, this maybe an important distinction.   I would do alot of due diligence upon both the developer (reputations/quality construction/development of similar size/similar home size, other development priorities not competing, pricing etc.) and their financial commitment to this development.  I would also tend to try and structure this loan similar to how the bank would despite it being a second lien by committing only a percentage of total funds based on phase of development.

Though I agree generally that Madison is more economically stable with the university there, another consideration beside employment will be interest rates (directly impacts homeowner affordability) and inflation.  Though neither has been a factor for the better part of 8 years, you are seriously exposed on 5 year risk to these factors.

Would love to visit Camp Randall one of these days and walk with the 2nd, 6th, and 7th VIR.