Mortgages are an enormous market, worth $9.4 trillion in 2013, but investing directly in them can be a challenge for homeowners and renters alike.
Residential mortgage-backed securities (RMBS) have some similar characteristics, but their structure and risk-reward profiles differ from whole mortgages, which are comprised of single residential or commercial mortgages issued by a lender but not securitized.
Another key difference between RMBS and whole mortgages is that a specific asset—a property—backs whole mortgages, says Bayard Closser, president of Vertical Capital Asset Management Group, in Irvine, Calif.
In addition, a lender can identify the borrower of a specific mortgage—it’s not an anonymous pooling arrangement. That’s important information for investors, Closser says.
“You have the ability to do very specific underwriting and analysis as to how good is the credit of the asset or of the borrower, how good is the collateral, in other words the value of the property,” he explained in an interview with ThinkAdvisor. “Then you can look at it and also do an evaluation of how much equity is in it based on what they owe and the value of the property.”
In other words, an investor can evaluate each property and borrower individually before deciding to buy a whole-mortgage note from the lender that made the original loan.
It’s a labor-intensive process, Closser notes. His firm, for instance does not have dozens of general analysts on staff, but it does have plenty of credit, underwriting and due diligence specialists. Vertical Capital Asset Management Group operates in 43 states, he adds, and uses local experts to evaluate specific properties.
Another complicating factor in whole-mortgage investing, he point out, is that mortgages are classified by payment status:
- performing (currently being paid with no missed payments);
- sub-performing (a 30-, 60- or 90-day late payment in the last 12 months);
- non-performing (120 days or more of non-payment); and
- foreclosure (note in default/action being taken).
The level of analysis and amount of capital required to build a diversified portfolio of whole mortgages can keep even wealthy investors out of the market.
Recognizing these hurdles as an opportunity, the firm launched its Vertical Capital Income Fund (VCAPX), about two years ago, to acquire whole-mortgage notes.
The fund invests primarily in performing notes and had roughly $58 million of assets at year-end 2013. It is structured as a closed-end interval fund.