How to think about a fund pitching a 9 percent preferred on tax certificates that clear at 5

Three questions for the documents, none of which will be answered by the deck. Is the preferred accruing or is it payable, and if it accrues, does unpaid pref compound. What is the manager's discretion language on the quarterly redemption window, because on a book full of properties working through foreclosure that discretion will get used. And what's the valuation policy for a parcel the fund has taken title to and hasn't sold, because that number feeds the reported return and possibly the manager's fee. A 9% pref that accrues on paper against assets marked by the manager is a very different instrument from one that pays cash.

The deed sale side is where the digging matters most. In deed auctions generally, the lots that go cheap tend to go cheap for reasons visible in the zoning file, no legal access, a split easement, a parcel that can't be permitted for a septic. Two exits at 40 and 60 percent of intrinsic value tell an investor nothing without knowing who set intrinsic value and how many parcels are still sitting unsold.

Ask who manages the houses between title and sale. A vacant house in a distressed neighborhood with no boots on it gets stripped, and that cost lands in the fund with no line item on page four. If the answer is a local realtor checks on them, that is not management.

Still getting a footing here. A certificate is a claim for unpaid taxes that pays a rate set by statute, and a deed purchase is buying the house at auction. Those are two completely different businesses in one fund. Is the read on sable's post right that the marketing calls the whole thing the first one?

@raj_mehta14 yes, and that's the substance of the complaint. Certificate books are slow and predictable, deed books are lumpy and depend on selling actual dirt. Blending them isn't wrong. Describing the blend with a smooth 9% number is where sable's discomfort is coming from.

The thing that would decide it for me is vintage detail. $14m target, so what did the last fund raise and where does it stand. If fund one is four years in and still holding half its deed parcels, the 9% pref on fund two is being paid partly out of fund two's own capital, which is legal and disclosed usually and still not what most people think they're buying.

Two exits at those multiples out of how many acquired? Ask for the full list of parcels acquired by vintage with disposition and hold time, not the highlights. A small sample of good outcomes in a deck is exactly the risk to underwrite around.

@chriswalton8 your alternative sounds smaller and more knowable. $30k of your own certificates at rates you can see, with results you can check against the county file next year. I'd rather learn on that than write $50k into a five state foreclosure calendar I can't observe.

The line about the lumpy part carrying the smooth part is the one I keep coming back to. Does that mean the preferred gets paid only when a house sells? If nothing sells for six quarters, what actually happens?

@kevin_lombard depends entirely on whether the pref is cash pay or accrual, which is @dmitri_248's first question and the reason he asked it first.

For an investor seeking income without a second job, this thread is doing a good job of explaining why the products marketed hardest at that goal are often the ones with the most moving parts underneath. Nine percent with a twelve month lockup and manager discretion after that is not income, it is a hope with a schedule attached.

Sponsors who answer the awkward question in one line are usually fine. The ones who reframe it usually are not. Sable, you asked where the 9 percent comes from and he answered with two success stories. That's a reframe.

Pull the fee waterfall and read the order of operations, because that's where these deals differ from each other and it never appears in the deck. A common structure: management fee off the top of gross receipts, then servicing and legal costs of the certificate book, then pref, then split. If foreclosure legal costs sit above the pref in that stack, a busy foreclosure year is a year the pref accrues and doesn't pay while the manager still collects 2% on committed. That's not misconduct, it's just the deal, and it's a completely different risk than the deck's return profile suggests. Also check whether the 2% is on committed or on net asset value, and whether deed parcels are carried at cost or at the manager's mark. If it's on committed capital during a slow deployment period, the fee drag on deployed dollars is much higher than 2% in years one and two, and that number should be run before getting to anything about the pref. Ask for it as a dollar figure per year on a $50k position under a slow deployment scenario. If they won't model a slow case, that's an answer.

The lesson that applies here is that a vacant house held through a legal process costs money every single month with nothing coming in. Nine houses in foreclosure across five states means nine sets of taxes, insurance and mowing, running on court calendars nobody controls.

@wendy_park48's question about modeling the slow case is the one I'd send first. It's the same instinct as asking a tenant applicant something they can't have prepared for.

Sable, reconstructing his auction results from public files before the meeting is the reason those questions land at all. Do the same for the deed side, most of those counties publish sale results too, and the parcel count will be known before he ever says it.