For many Australian investors, the current financial landscape presents a dilemma. Traditional options, such as cash-based investments and high-interest savings accounts, often fail to provide returns that keep pace with inflation, thereby eroding purchasing power over time. On the other hand, the share market offers growth potential, but comes with significant volatility that not all investors are comfortable with.
First mortgage investments occupy a compelling middle ground. They offer a unique opportunity to gain exposure to Australian real estate debt markets while seeking to preserve capital. By stepping into the shoes of the lender, investors can access targeted income distributions secured by tangible assets.
This guide to first mortgage investments explores the mechanics of first mortgage investment funds in Australia, the associated risks and benefits, and why they are becoming an attractive option for many Australian investors.
What Are First Mortgage Funds?
At its core, a first mortgage investment is a loan provided to a borrower that is secured by a registered first mortgage over a specific property—generally known as the security property.
The defining feature of this asset class is the ‘first’ ranking. In this case, ‘first’ refers to the priority of repayment. If a borrower defaults and the property must be sold to recover the debt, the holder of the first registered mortgage has the legal right to be paid out before any other creditors. This includes second mortgage holders, unsecured creditors, and the property owner themselves.
This legal priority makes first mortgage investments a highly advantageous position in the real estate debt capital stack. You are not betting on the property’s value skyrocketing; rather, you are aiming to receive a targeted return from the interest payments made by the borrower, which are underpinned by the value of the real estate.
How First Mortgage Investment Funds Work
While sophisticated investors or wholesale investors might have the capital to fund a single asset investment (lending the full amount to one borrower), this approach carries significant concentration risk. If that loan defaults, the investor’s entire capital is at risk.
First mortgage investment funds can help address this problem. That’s because first mortgage investment funds are managed investment schemes that pool capital from multiple loans and investors. An experienced fund manager oversees the portfolio, conducting due diligence on borrowers and managing the loan term and repayment process.
For investors, the process is typically streamlined:
- Invest: You deposit your capital into a mortgage fund for a selected term.
- Lend: The fund lends this capital to borrowers for commercial real estate or residential projects.
- Income Distribution: The borrowers pay interest, which is passed back to investors as targeted income distributions, typically on a monthly basis.
Benefits for Investors Seeking Targeted Returns
So, now that we understand what first mortgage investment funds are, the question becomes, why are investors seeking out this asset class? Largely, it’s because first mortgage funds offer a range of distinct advantages over other investment vehicles, including:
Defensive Characteristics
The primary benefit is the registered first mortgage over the property. Because the loan is backed by collateral (the property), there is a tangible asset from which to recover funds in a worst-case scenario. This focus on capital preservation is often achieved by strictly enforcing a maximum loan-to-value ratio (LVR). A lower LVR ensures that a substantial equity buffer exists between the loan amount and the property value.
Targeted Income Potential
First mortgage investments typically offer attractive targeted returns for investors willing to accept a proportionately higher level of risk compared to traditional cash-style assets. Non-bank lenders can charge borrowers higher interest rates because they offer speed and flexibility that traditional banks cannot match. In turn, these interest rates can translate into attractive yields for the investor.
First Mortgage Investment Opportunities: Understanding the Risks
All investments carry risks, and first mortgage investments are no exception. It is vital to understand these risks before making an investment decision. Specific risks may include:
- Borrower Defaults: There is a risk that a borrower fails to meet their interest payments or repay the principal. First mortgage funds mitigate this risk by holding the security property and maintaining conservative LVRs, though this does not eliminate the risk entirely.
- Market Fluctuations: Australian real estate values can change. If the property market drops significantly, it could impact the recoverability of the loan upon sale.
- Liquidity Risk: Mortgage investments are generally illiquid for the duration of the loan term. Unlike shares, which can be sold instantly, the underlying loans are tied up in property. Redemption rights are subject to liquidity and may be delayed or suspended.
First Mortgage vs Second Mortgage Investments
It is important to distinguish between first and second mortgages.
A second mortgage investment sits behind the first mortgage in priority. If the property is sold, the first mortgage is paid in full before the second mortgage receives a cent. Because of this increased risk, second mortgages generally attract higher interest rates to compensate the investor.
While a second mortgage investment can boost the overall yield of a portfolio, it should only be undertaken by those who understand the associated risks. A diversified portfolio might include a small allocation to second mortgages for yield enhancement, but first mortgage investments can form the foundation for portfolio resilience.
Pooled Funds vs Contributory Funds
When it comes to first mortgage loans, investors essentially have two structural choices:
- Contributory Fund: You select specific underlying loans to fund. If that loan performs, you get paid. If it defaults, your capital is at risk.
- Pooled Mortgage Fund: Your investment is spread across a diverse range of loans.
At ASCF, we champion the pooled mortgage fund model. By spreading investor capital across a broad portfolio of loans, we aim to reduce the impact of any single borrower default on the overall fund. This diversification can provide smoother returns for investors seeking to mitigate the impact of individual borrower defaults.
Mortgage Investment Options to Match Your Needs
Australian Secure Capital Fund (ASCF) is a leading provider of mortgage investment opportunities. We operate three distinct funds, each tailored to different financial requirements and risk appetites. These are:
ASCF Premium Capital Fund
This fund is a first mortgage investment opportunity designed for conservative investors with a lower risk profile. It invests in a registered first mortgage pool over Australian property.
- Target: Capital preservation.
- Asset Class: First mortgages only.
- LVR: Conservative limitations to ensure a strong equity buffer.
- Returns: Target Distribution Rates ranging from 6.35% to 7.00%* p.a.
ASCF Select Income Fund
This fund targets a balance of income and yield, investing in first mortgage funds with slightly different parameters to generate a higher return.
- Target: Monthly distributions.
- Asset Class: Registered first mortgages.
- Returns: Target Distribution Rates ranging from 6.50% to 7.25%* p.a.
ASCF High Yield Fund
For those willing to take on slightly more risk for higher potential returns, this fund allows for a prudent selection of second mortgages to be added to the pool.
- Target: Maximising yield.
- Asset Class: First and second mortgage investment mix.
- Returns: Target Distribution Rates ranging from 6.75% to 7.75%* p.a.
* Distribution rates are an investment objective and not a forecast.
Why Choose ASCF’s First Mortgage Investment Funds?
While past performance is not a reliable indicator of future performance, a strong track record can speak volumes about a manager’s due diligence and capabilities.
Since ASCF was launched in 2016:
- All investors have received their distributions every month.
- All investors have had their requests to redeem funds paid on time.
- The value of the initial unit price has been maintained at $1.00.
Our directors have over 80 combined years of banking and property experience. Unlike peer-to-peer lenders, where you take the risk on a single borrower, your investment in ASCF is spread across the entire pool, mitigating risk. We also strictly avoid lending to property developers for construction based on “on-completion” values, ensuring our collateral is based on “as-is” real asset value.
Conclusion: Understanding First Mortgage Investments
First mortgage investments provide a strategic avenue to broaden your portfolio and access the real estate sector through the potential for regular targeted income distributions. For those seeking to generate returns across varying economic environments or looking to balance the price fluctuations of the share market, mortgage funds can provide a robust portfolio solution.
By choosing a pooled fund structure with an experienced manager like ASCF, you can benefit from professional due diligence, diversification, and the additional protections associated with a registered first mortgage.
Interested in finding out how first mortgage investment funds can work for you? Check out our return calculator tool, learn more about how to invest (including our Product Disclosure Statement) and discover more useful resources to guide your decision.
This article provides general financial product advice only. It is always recommended that you seek personal advice from a licensed financial adviser. They can assess your financial situation and objectives. Before making any further investment decisions, you must read the relevant Product Disclosure Statements (PDS) and Target Market Determination (TMD) documents in full.
