Monday, January 26, 2015

"Earn 8%+ Fixed Interest" - Fortress Real Capital Syndicated Mortgage Review

Given today's interest rates, 8%+ sounds perfect, eh? 

Is Fortress Real Capital a fraud, scam or a Ponzi scheme? I am unable to say such things without looking at their books (they are a private company). Is this a good investment product? NO. Could you actually make 8%+ per year? Maybe, but I personally wouldn't put one cent into this product. I feel the marketing of the product is very misleading. Note the terms that brokers push such as 'security of principal', making the product seem like it has very low downside risk.

In reality, this is an extremely risky product, more economically similar to an equity investment than a safe fixed income product and is distributed through inappropriate sales channels. 

Here are 5 reasons (in my opinion) that Fortress Real Capital's syndicated mortgages are one of the worst investments in all of Canada. 

5) Conflict of interest: Brokers of the product receive a massive upfront fee for selling the product, total sales and commission fees for one disclosed project were 10.35% as per a December 2013 report. There may be a temptation by the broker to simply get the client to sign on the dotted line and not explain the investment risks. And of course, Fortress also receives an upfront fee from day one, regardless of your returns.

The company's own craigslist ad specified that "you will be in the field and closing sales in less than 7 days" and you should expect to earn a minimum of "$125,000 in your first year." These kind of investment products give good hardworking mortgage brokers a bad name. It is important to remember Fortress is using, in what is my opinion, a legal loophole that allows it to classify its investment product as a 'mortgage' which allows distribution via mortgage brokers.

4) Weak position in the capital structure: Very little of an investor's money ends up going towards the hard costs of the project itself, hence this is more similar to an equity investment than a mortgage. Your investment sits behind other lenders in the capital structure. In a potential downside scenario where the soft costs have been spent and not enough units sold, Fortress investors will be the least likely to see any principal returned in a liquidation scenario. With quarterly payments and no new revenue, your 8% 'interest rate' may turn out to in fact have been a return of capital instead of a return on capital. 

A number of projects are already behind schedule.  With the collapse in oil prices and condos in Alberta there may be additional projects delayed as well.
*Update another Fortress linked project is facing serious concerns.
**Update another Fortress project falls behind schedule.
*** Note these projects have been bailed out by the parent company, preventing (delaying?) a loss to investors (this is the key to their marketing story of no losses). How long Fortress can keep covering up these losses to maintain its 'perfect record' is anybody's guess.

3) The property valuation firm: The company responsible for valuing the specific development I was looking at is called Legacy Global Mercantile Partners. The office phone number on their website goes directly to the one guy that is also the only person listed on LinkedIn for the company. This may be a 1 person shop responsible for the majority of Fortress's 'independent' valuation assessments. For a small company with no long standing reputation and a presumably high customer concentration risk, there is a huge conflict of interest when issuing the valuation assessment.

2) The loan to value ratio: The loan to value ratio is a way an investor can figure out how leveraged the development will be, so determining this value is important. Unfortunately this calculation is performed by Legacy Global Mercantile Partners. You might think that if a given project is valued at $10m than the low '63% loan to value' (such as the one I was looking at), would be quite secure. But the $10m valuation may not be as precise as you believe.

After talking with Legacy Global, the person disclosed that this value is not based on comparable transactions but rather a 'residual valuation' method which is based on projected sales. In other words, the development is not currently worth $10m today, but instead is 'projected' to be worth $10m due to the planned development. That's all well and good but if the deal doesn't go through then the investor may have to value this on an 'as is' market basis which could be dramatically lower than the previously assessed figured.

Note; the manipulated loan to value ratio may jeopardize the claimed 'RRSP eligibility'.

1) Prior history with regulators: In 2011, the President and CEO of Fortress Real Developments as well as the COO were banned by the OSC for 15 years and paid $3 million in a settlement. This also follows a 2005 lifetime ban from the Mutual Fund Dealers Association, for the President and CEO. The settlement with OSC 'does not indicate guilt or wrong doing' but I strongly recommend reading the OSC file for yourself and coming to your own conclusion. Note, according to the company's own website the COO is currently responsible for due diligence evaluating transactions to be marketed by Fortress.

As always do your own homework, but unfortunately I wouldn't be surprised if there were some very unhappy investors one day. How this is able to be sold in its present form without regulators acting is beyond me. Unfortunately, these stories only seem to get media and government attention after the losses hit. At least you have been warned.

"Only when the tide goes out do you discover who's been swimming naked." - Warren Buffett

Macleans 2016 article

FSCO: Before investing in a syndicated mortgage

(I'm very happy the FSCO put this out, it's not enough, but it's a start)

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