If the fund never owns the building, what does my money actually buy?

Question

I've been going through a debt fund's offering documents and I'm stuck on something basic. The fund's schedule of investments lists 41 loans with addresses next to them, and my first thought was that it owns 41 buildings. It doesn't, obviously, the summary says it's a lender. But then what is the asset that my units represent? A stack of paper? And a friend told me debt funds are safer than equity funds because "you're first in line," which sounds like something people repeat without checking. First in line to what, exactly, if nobody defaults?

Rena Guide · Accepted Answer

Your units represent a share of the loans, and a loan is two documents. There's the promissory note, which is the borrower's written promise to repay a set amount at a set rate, and there's the mortgage or deed of trust, which pledges the building as security for that promise. The fund owns those. The addresses on the schedule are the collateral behind each loan, not property the fund holds title to.

While everything performs, the fund collects interest and passes most of it through to you as distributions. That's the whole engine. "First in line" means position in the capital stack. A senior or first-lien loan gets repaid before mezzanine debt, and both get repaid before the owner's equity sees a dollar. So if a property that secured a $6 million first-lien loan sells for $7 million, the loan gets paid in full and the equity keeps the rest. If it sells for $5 million, the lender takes the loss the equity can't absorb.

That gap between the loan amount and the property value is the collateral cushion, usually described as loan-to-value. A 65% LTV loan means the property can fall 35% before the lender is underwater on paper. It's the single number worth understanding before any of the rest.

One thing that trips people up later: some of these funds are open-end, meaning you can request redemption on a schedule, and some are closed-end, meaning your money is locked for the fund's life. The documents will say which, and it changes the position entirely.

raj_mehta14 · Answer

So is this different from just buying a note off a note seller? I've been reading about people buying individual mortgages at a discount and I can't tell if a debt fund is that same thing with forty of them, or something else structurally.

stephen_ok9 · Answer

vellum, the count is the difference that matters to me. One note and the borrower's health is your whole outcome. Forty-one notes and a single bad one costs you maybe two percent of the book. Though I'd want to know how those 41 are distributed, because if six of them are to the same sponsor it's really 36 credits, not 41. canton, does that schedule show borrower names or just addresses?

wendy_park48 · Answer

The schedule is the friendly part. Go to the investment guidelines section and read what the manager is actually permitted to do, not what the current book looks like. I've seen documents where the strategy summary says senior secured bridge lending and the guidelines permit up to 25% in mezzanine and preferred equity, plus fund-level borrowing up to half of net asset value. Both can be fine. But the book you diligence today is not the book you're bound to, and the guidelines are the real constraint.

chriswalton8 · Answer

The reason there are so many of these to look at now is that banks stepped back from a lot of property lending and private capital moved into the space. That's the tailwind everyone cites. What I haven't figured out is whether the loans the banks stopped making were the ones they didn't want, or the ones they weren't allowed to hold.

bmoreno23 · Answer

If a borrower stops paying, who does the foreclosing, the fund or me?

If the fund never owns the building, what does my money actually buy?

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