How Do Private Lenders Raise Capital?

In this article we outline how private lenders typically raise capital to fund the loans they originate.

In the usual banking relationship, the investor deposit funds with the bank and the borrower obtains finance from the bank. The investor is paid a conservative rate of return and has no knowledge of the particular loans that their deposit is funding.

Private lending is commonly referred to as “the oldest form of mortgage lending.” It is a type of financial intermediation where the borrower and the investors have a more direct relationship than usually applies with a bank or similar financial institutions.

With privately funded loans investors provide the capital required for specific transactions. In its simplest form, there may be one investor providing capital to one borrower. Or the structure may involve multiple investors (or even multiple lenders under a syndication).

The opportunity to become a private lender is open to most people. Private loans are typically funded by a number of entities including:

1. Family Offices
2. Corporates
3. High Net Worth Investors
4. Managed Investment Schemes (MIS)
5. Institutional Warehouse Providers

1. Family Offices

Family Offices capture generational wealth and corporatise the families financial affairs. This structure can represent a single-family office or multi-family offices.

2. Corporates

This is typically a corporate with surplus cash flows that can be invested (for a return) in the short term.

3. High Net Worth Investors 

This is an increasing pool of investors seeking diversification and regular income stream from an investment secured by real estate.

4. Managed Investment Schemes (MIS)

To operate a Managed Investment Scheme (MIS), the lender must hold an Australian Financial Services Licence and be regulated by ASIC.

There are two types of mortgage funds – Contributory Mortgage Fund and Pooled Mortgage Fund

Contributory Mortgage Fund

A contributory mortgage fund pools money from multiple investors to advance funds for a specific transaction.

Pros

• Higher returns. In a contributory mortgage fund, the returns are generally higher compared to a pooled fund.
• Regular Income source. As interest is paid by the borrower, the investors will receive a coupon. 
• Visibility. Investors decide which loans they invest in after reviewing a transaction specific Information Memorandum.

Cons

• Higher risk. An investment in a single loan is aligned to the performance of that transaction. Should turbulence be encountered there may be a risk of loss of coupon or principal.
• Additional contributions. A further investment may be required to fund variations, overruns or contingency (construction loans).
• Poor liquidity. Generally investors are unable to redeem their capital until loan is repaid by the borrower.

Pooled Mortgage Fund

Pooled mortgage funds are linked to a larger basket of funds that are used to invest in loans. Funds are managed by a professional fund manager who handles where to put the monies.

Unlike contributory mortgage funds that focus on the performance of a specific loan, pooled funds base their returns on a wide range of loans in the portfolio.

Pros

• Professionally managed. Pooled mortgage funds are managed by a specialist investment manager with experience and a track record in the asset class.  
• Diversification. Funds are invested across a portfolio of loans. This mitigates the risk of a loss in single asset transactions (contributory).
• Superior liquidity. Generally pool mortgage funds offer more flexibility around redemption and are not linked to maturity of one particular loan.

Cons

Lower returns. The offset of diversification and liquidity is a lower return profile.

5. Institutional Warehouse Providers

As the private debt markets mature and prosper, the opportunity has emerged for trading and investment banks to provide funding to select loan managers.  

Whilst providing additional liquidity, institutional funding can be restrictive with policy covenants.

There are multiple ways in which private lenders can raise capital. A well-positioned private lender would have a diverse funding pool along with capital and liquidity to fund transactions as required.

For assistance

We would love the opportunity to chat to you regarding any scenarios or questions you might have for any of your clients seeking funding. Please contact the Business Development team at Vado Private to discuss any opportunities on the details below, or you can submit a scenario online via our website.