Regarding Potential Risks
Chances are remote that an investor would lose his or her entire investment. First, each investor will have funds invested in a diversified portfolio of first mortgages and deeds of trust. For someone to lose their entire investment, many things would have to go wrong simultaneously. For example, all of the mortgages within the portfolio would have to quickly go into default, the Fund would have to obtain all of its properties at foreclosure transactions without any third-parties overbidding the Fund, and a situation would have to arise where there would not be a single buyer for any of the properties, regardless of price. The likelihood of all of these happening at once is practically impossible.
Like many investments, there is the possibility of losing a portion of your invested principal. In the event a loan within the Fund portfolio defaults, a foreclosure may occur. When that happens, there is a chance that the foreclosed property might sell for less than the amount of the loan, causing a loss. Further, if the value of the property underlying an equity investment drops below the breakeven point for the investment, a loss would occur. Such losses, however, should be minimal.
For example: The Fund makes a second loan of $200,000 behind a first loan of $700,000 to a borrower purchasing property for $1,200,000, which combined represents $900,000 in loans or 75% of the property's value (also known as a 75% Combined Loan-to-Value or 75% LTV). After default and foreclosure, the Fund sells the property for $800,000, which results in a $100,000 loss for the Fund. Let's say the fund has $10,000,000 in portfolio investments and a member/investor's participation is $500,000 or 0.10% of the fund. The investor's pro rata share of the loss would be $10,000. Conversely, based on the Fund's anticipated annualized return of 12%, the loss would reduce the net annualized return from 12% to 11.8% (for all investors in the Fund) and the investor's principal would be protected. This example is for illustrative purposes only and if a loss occurs the actual results may vary.
In order to help mitigate the costs and potential losses in the Fund's portfolio, the Fund seeks to diversify its investments across borrowers and sponsors, property types, investment structures (debt versus equity), duration, and other attributes. Further, each investment is underwritten to determine the merits of the loan or investment, the return potential, factors that may impact returns and ways to help mitigate downside risk. While diversification and underwriting will not eliminate the potential for loss in all investments, it should assist in buffering the impact of losses in the portfolio should they occur.
Any money invested in real estate, whether through a partnership or a REIT, will be subject to some risk because those investments may involve direct investment in real estate with no buffer against changes in property values or other factors, may involve debt or other leverage which may be senior to the investor's capital, may have greater exposure to market and interest rate changes, and would be subject to all the risks attendant to the management and operation of one or more properties. If, for example, there is a shortage in cash flow and a partnership isn't able to make the payments on the debt or pay insurance and property taxes, a lender can choose to foreclose the property causing investors to lose their principal investment.
As compared to the WFP Income Fund, which is a more conservative fund investing in first mortgages and deeds of trust secured by real estate at lower loan-to-value ratios, the WFP Opportunity Fund's investment objective is to seek higher risk-adjusted returns through investments in loans secured by real estate at higher loan-to-value ratios and direct equity investments. Therefore, WFP Opportunity Fund should be considered for investment by parties are willing to accept a higher degree of investment risk in exchange for higher potential returns.
As compared to other funds, partnerships and REITs, the WFP Opportunity Fund is designed to have portfolio investments with a shorter investment horizon, creating greater potential liquidity within the fund. Further, while the value of exchange-traded funds, partnerships, REITs and other real estate-backed securities such as can fluctuate due to changes in interest rates or the markets in which they trade, the Fund's portfolio investments are short-term in nature and generally held to maturity. Therefore, the Fund's portfolio is potentially less susceptible to market and interest rate fluctuations.
As seasoned investors already know, the principal invested in stocks, bonds, mutual funds and REITs may rise or fall, be increased or lost due to fluctuations in respective markets in which those securities trade. Such losses may be completely unrelated to the fundamentals of the underlying business or investment quality. They may be due to factors such as investor sentiment or action by the Board of Governors of the Federal Reserve. Conversely, the Fund is comprised of a diversified pool of real estate secured loans (i.e. mortgages and deeds of trust) that are not correlated to the stock market, the bond market, interest rate changes and other factors which affect many other investments. Further, the Fund makes direct equity investments in real estate which have a shorter investment horizon. This does not mean that real estate values underlying these loans and investments are immune from fluctuation or change. Real estate values have changed in the past and will change in the future.
The Fund strives to mitigate or reduce the risk that declines in real estate values will impact the Fund's principal investments. Among other things, the Fund invests in short-term loans and investments. By investing in loans with terms of approximately 1 to 3 years and holding those loans to maturity, the Fund is better able to react to changes in real estate values and interest rates as compared to being locked into 30 year mortgages. Shorter-term investments in real estate (either directly, through participating loans and other facilities) also give the Fund the opportunity to better gauge potential future market conditions over a 1 to 2 year time horizon as opposed to projecting market conditions 7 or 10 years into the future.
The Fund also strives for diversification across a number of segments, including the number of loans and investments, geography, property types, borrowers, sponsors, maturities, interest rates, loan-to-values and other factors. As compared to an investment consisting of a pool of homogeneous loans that react in a similar way (e.g. a mortgage backed security consisting of 30 year fixed rate loans secured against single-family homes), the diversification helps to mitigate the risk of the entire pool of loans and investments negatively reacting in a similar fashion at the same time.
The actions taken will depend on the facts, nature, and circumstances of the default. Potential actions may include permitting additional cure periods, restructuring the loan, appointing a receiver to collect rents and manage the property, selling the loan, or foreclosing on the property. In the event the Manager elects to sell the loan, likely buyers may include junior lien holders or other investors interested in owning the property. The point is that there are a number of potential actions that may be taken by the Manager in an effort to protect and preserve the principal investment in the loan. That said, the Manager has the ability to act quickly and aggressively in the event of default.
Depending on the structure of the investment, the Fund may have various remedies available to it. Potential actions may include restructuring the investment, taking over and managing the property, selling the investment, or foreclosing on the property. Like a loan default, there are a number of potential actions that may be taken by the Manager in an effort to protect and preserve the principal investment in the property. That said, the Manager has the ability to act quickly and aggressively in the event a project is not performing.
Declines in real estate values, longer marketing periods, lower absorption rates and other factors in a declining market may have an effect on the Fund's portfolio. Specifically, if the value of the property underlying an investment (whether a debt or equity investment) drops below the breakeven point for the investment, a loss would occur.
As an active market participant that has weathered several real estate cycles, the Manager's principals have in-depth knowledge, expertise and experience managing such risks. In anticipation of potential market changes the current underwriting philosophy employed by the Manager results in the use of third party valuations (e.g. appraisals), market analysis, stress testing of cash flows, capitalization rates, and project projections, deal structure and other factors to help mitigate downside risk. While there are no assurances that the Manager will be successful with all investments, in a waning market the Manager has the ability to review and revise its underwriting approach and stress testing as necessary to employ a more conservative approach to further address changing market conditions.
The Fund has a targeted annualized return of 12%, net of all expenses, costs and management and profit participation fees payable by the Fund. If members of the Fund receive a quarterly return of 3% (for an annualized rate of 12%), any net profits remaining after the members have received their quarterly return of 3% will be split 80% in favor of the members and 20% in favor of the Manager as a quarterly profit participation fee.
In order to achieve the net target return, the Fund will strive to achieve an annualized yield on the loans in its portfolio in the range of approximately 12% to 16% and annualized returns on its equity investments of approximately 18% or greater, but these target yields and returns may change based on various factors, including changes in market interest rates, the economy, competition, individual investment criteria and other factors.
Although the Fund plans to target these overall annualized net target returns for its members, there is no guarantee that the Fund will be able to provide its members with these or any specific levels of returns in any given year or at all, and neither the Manager nor the Fund represents or warrants (whether expressly or by implication) that such returns will be achieved, whether in any segment of the Fund's portfolio or on average. However, while we believe those returns are realistic, they are not guaranteed.
Yes, future returns may be lower than returns paid in prior periods.
Once the gains on any investments are realized, there is no guarantee that the Fund will find comparable quality investments at the same or a higher return to replace them. Specifically, in
order to stay competitive and maintain a portfolio of higher-quality investments, the Manager carefully monitors the market and adjusts its required rate of return on its investments as needed.
The Fund will also experience periods of time when committed capital is not fully invested in targeted real estate-related loans and equity interests. Those periods will include the initial capital-raising and investment periods ("Ramp-Up Periods"), the periods during which capital is committed to fund acquisitions, loans and project-specific allocated capital prior to deployment of the capital, committed funds immediately prior to the funding of a specific investment, funds returned immediately following a liquidity event, and other similar events. At such times, the Fund will seek to employ such under-invested capital in short-term, interest-bearing investments to temporarily generate additional income for the Fund. However, overall returns in the Fund will be affected by the under-deployment of capital.
It is unlikely that the rate of return earned by the Fund's members will be inferior to the rates offered by banks, credit unions or other insured financial institutions on checking accounts, savings accounts, money market accounts and certificates of deposit. The explanation is relatively simple: the financial models of those institutions differ from the Fund.
Banks and other insured financial institutions have an incentive to reduce their cost of funds (a large portion of which is based on the rate they pay on deposits) to ensure a healthy Net Interest Margin (NIM). Essentially, the Net Interest Margin is the spread between a bank's cost of funds and the rates they charge on loans. All other things being equal, the greater the NIM or spread, the more potential profit the bank receives. In a low interest rate environment like the one we have experienced over the last several years, the deposit rates offered by some banks may be under 1%. Therefore, while the banker may have the same objective of protecting their depositor's principal, the banker's incentive is to maximize returns for their shareholders and themselves and not necessarily their depositors.
However, the Fund has an incentive to maximize investor returns. Unlike depositors in a bank, Fund investors receive all distributable cash earned by the Fund. The distributable cash in the Fund is primarily the interest received on the loan portfolio and returns on the other investments made through the Fund, less the costs of operating the fund, working capital and loan loss reserves. As a result, the Fund has a targeted net annualized return to its investors of 12%.
Generally, the distributions would be treated as ordinary income. However, investments through IRA, 401K, pension and other qualified plans may receive more favorable tax treatment, such as the deferral of income taxes. We do not provide legal, tax or accounting advice and therefore, recommend that you consult with your tax advisor about your particular tax situation.
The operating agreement of the Fund allows you to withdraw all or a portion of the investment after an initial 24 month period has passed. After that period, you may withdraw up to the lesser of 25% of your investment or $100,000 every consecutive 3 months, although additional restrictions on withdrawals may apply. Further, in certain circumstances, the Manager may permit an accelerated or full withdrawal of invested funds. Earnings will accrue on your investment to the date of the withdrawal and there are no penalties for withdrawals.
There are two cash sources available for withdrawals, with the main source being loan payoffs. The Fund's portfolio consists of loans with different maturity dates, creating a laddering effect where loans payoff at different times creating liquidity in the Fund to pay withdrawal requests.
The second source is cash entering the Fund through new subscriptions. Effectively, cash from a new subscription to purchase Units in the Fund may be used to pay an outgoing investors, request for a withdrawal.
Generally, less than 1 month but it could be as long as 3 months depending on how far in advance of the first day of the calendar quarter you invest.
Once the Subscription Documents are completed by the investor and investment funds are deposited into the Fund's subscription account, the Manager must promptly accept or reject the Subscription Documents. If the Subscription Documents are rejected, the investor's funds will be promptly refunded to that investor from the subscription account. If the Subscription Documents are accepted, the investor's funds will be moved into the Fund's general account on the first day of the calendar quarter following the acceptance of the subscription and the investor will become a member of the Fund on that date.
Subject to the Subscription Documents being accepted by the Manager, an investor's funds may be borrowed from the Subscription Account at a rate of 4% per annum prior to the investor being admitted as a member of the Fund on the first day of the following quarter. Therefore, depending on when an investor invests with the fund (i.e. early in the quarter or later in the quarter), if accepted by the Manager, funds may be held in the subscription account from a few days to several weeks.
Many of the Fund's borrowers are professional real estate investors. As such, they need an efficient lending source when capitalizing on market opportunities - and they are willing to pay a premium in the interest rate and fees on the loan in exchange for speed and efficiency. It becomes a business expense of the transaction. Therefore, because the Manager and the Fund have a funding platform that can deliver the speed and efficiency desired by those borrowers, they can command higher interest rates and fees than banks and other institutional lenders. This results in higher yielding loans in the Fund's portfolio and higher risk-adjusted returns for the Fund's investors.
The Fund has engaged the services of Armanino, LLP ("Armanino") to perform an annual audit. Further, Armanino assists with a review of the Fund's monthly reconciliations and member distributions.
Armanino is one of the largest California based Certified Public Accounting firms and one of the top 50 accounting firms in the United States. They have been providing accounting and consulting services for over 50 years. Armanino provides services to more California mortgage pools and funds than any other firm in the state and are rapidly becoming a national leader in this industry. Armanino is subject to review by the Public Company Accounting Oversight Board ("PCAOB"), a private-sector, nonprofit corporation created by the Sarbanes-Oxley Act of 2002 to oversee the audits of public companies and other issuers in order to protect the interests of investors and further the public interest in the preparation of informative, accurate and independent audit reports. Further, Armanino is a member of Moore Stephens, one of the world's major accounting and consulting networks and provides access to over 300 independent accounting firms in 100 countries.
As described above, the Fund "bridges" the gap in timing or financing borrowers often experience when they need speed and efficiency to capitalize on a market opportunity, or before they can position their property for more traditional institutional financing or a sale.
Shorter and medium-term loans and investments allow the Fund to manage its portfolio in several important ways. By keeping the terms of the loans short, the Fund has the ability to require existing borrowers to pay off or remargin (i.e. pay down the principal balance) their loans at maturity. This helps to reduce the risk of having a legacy portfolio of loans with longer maturities made at a time when property values were much higher. This is also true of the Fund's equity investments. By keeping the investment horizon short the Fund is in a better position to assess the market conditions over a shorter-term horizon. In addition, as loans and investments pay off, the Fund can make new loans and investments at the then current market values.
In a waning market, as opposed to being locked into the terms and conditions on longer-term loans and investments, the Manager has the ability to review and revise its underwriting approach and stress testing as necessary to adjust to changing market conditions and mitigate overall portfolio risk as new loans and investments are made.
Lastly, shorter and medium-term loans and investments create liquidity in the Fund's portfolio to address withdrawal requests by the Fund's members.
Investment Type: The WFP Opportunity Fund is a professionally managed fund investing in shorter term loans and investments secured by real estate; predominantly in California. It should be measured against other moderately aggressive to aggressive short-term, fixed income investments in your portfolio.
Investment Objective: Higher Return on Shorter Term Portfolio Investments. The WFP Opportunity Fund will strive to provide "smart, value-added capital" through strategic partnerships, joint ventures, co-investments, participating loans, higher yielding subordinate financing and joint ventures and other debt and equity investments. Therefore, the Fund will strive to obtain above average returns on a risk-adjusted basis which seeking to mitigate certain risks involved in real estate investments and real estate loans.
Investment Strategy Justification: The WFP Opportunity Fund is a short-term, fixed income investment alternative that provides the following benefits:
- Professionally managed, pooled investment
- Low/little correlation to stock or bond market, or interest rates
- No Load
- Secured by hard asset - Real Estate
- Portfolio Diversifier