Private lending has navigated a turbulent environment since 2020, with rising interest rates, market volatility, and shifting capital flows reshaping how lenders structure and deploy capital. For many private lenders, the response to this volatility has been a time-tested one: standing up a fund.
Mortgage funds pool capital from multiple investors and deploy it across a diversified loan portfolio, providing lenders with more stable capital, operational scale, and the ability to weather individual loan defaults without threatening the entire business. This article reviews the key trends and structural considerations that defined the mortgage fund market in 2023.
The Continued Dominance of the Reg D LP/GP Model
The most prevalent structure for private mortgage funds continues to be the Regulation D limited partnership or LLC organized on a two-and-twenty basis. Under this model, a fund manager charges investors an asset management fee — typically around 2% annually — and participates in a percentage of profits above a preferred return threshold, often structured as a carried interest or profits interest.
This structure has proven durable for several reasons. The Reg D exemption from SEC registration remains accessible for funds raising capital from accredited investors, the LP/GP framework clearly delineates management authority from investor economics, and the preferred return structure aligns the manager’s incentive with investor performance.
The availability of lender finance — credit facilities and warehouse lines extended to mortgage funds by banks and specialty finance companies — has reinforced the LP/GP model’s appeal. Institutional lenders extending leverage to funds often prefer the structural transparency and defined economics that the LP/GP model provides.
The REIT and SubREIT Trend
Since approximately 2018, mortgage REITs (real estate investment trusts) have become a significant structural consideration for private mortgage fund managers. The driver is primarily tax efficiency: REIT dividends are eligible for the 20% qualified business income deduction (QBID) available under the Tax Cuts and Jobs Act, providing meaningful tax savings to eligible investors.
Two implementation strategies have emerged:
The SubREIT has become the preferred approach for most managers because it provides the tax benefit without requiring structural changes to the fund’s existing economics, and without triggering a vote of investors.
It is important to note that the QBID benefit was scheduled to sunset after 2025 under the original Tax Cuts and Jobs Act. Managers considering a REIT or SubREIT strategy should consult tax counsel regarding current law and any legislative developments affecting this benefit.
What Has Not Gained Traction
Not every structure that generated early enthusiasm in the private mortgage fund space has delivered on its promise.
Note offerings — in which a fund issues notes to investors rather than equity interests — have seen limited adoption. The primary obstacle is leverage: note offerings are structured as debt instruments, and lenders and banks providing warehouse financing to mortgage funds typically require that their position represent the senior debt in the capital structure. A fund that has already issued notes to investors may find it difficult or impossible to obtain the leverage necessary to scale.
Crowdfunding strategies, including offerings under Regulation A and Regulation Crowdfunding, have also underperformed expectations in the mortgage fund context. Private lending transactions generally require larger individual investment amounts than crowdfunding platforms are designed to accommodate, and the overhead of managing a large pool of non-accredited investors — from both an investor relations and a regulatory compliance perspective — has deterred most managers.
Leverage and Offshore Capital
Two more sophisticated capital formation strategies — leverage and offshore investor participation — have become increasingly relevant for established mortgage funds, though both require careful planning.
Leverage allows a fund to amplify its deployment capacity by borrowing against its existing loan portfolio. A fund with $10 million in equity might access a $10 million credit facility, deploying $20 million in loans. The additional income generated by the leveraged capital flows to investors and the manager. The risks of leverage are real and should be evaluated with counsel and with a clear stress-test analysis. Not all leverage arrangements are equal, and the terms of the credit facility — including covenants, margin requirements, and event of default provisions — deserve thorough review.
Offshore investor strategies involve accepting capital from non-U.S. investors through parallel funds or feeder vehicles designed to address their specific tax and regulatory concerns. These arrangements typically require multiple entities, coordination among U.S. counsel, tax advisors, and offshore counsel, and ongoing compliance with FATCA and applicable treaty provisions. For the right fund manager with established institutional relationships, offshore capital can provide a meaningful expansion of the investor base.
Capital Formation: What Separates Successful Funds
Across the market, the factors that consistently predict success in raising capital for a private mortgage fund are:
Track record. Managers with three or more years of audited performance history have a meaningful advantage in capital formation conversations with institutional investors, family offices, and registered investment advisors.
Audited financials. Annual audits, prepared by a qualified public accounting firm, signal operational maturity and provide investors with confidence in the accuracy of reported returns.
Aligned economics. Investors evaluating a fund manager want to see that the manager’s financial interests are aligned with their own. A manager who co-invests in the fund, who earns the majority of their compensation from carried interest rather than fees, and who has built a long-term track record in the strategy is better positioned to raise capital than one who relies primarily on management fees.
Transparency. Clear disclosure of investment strategy, underwriting criteria, concentration limits, liquidity terms, and fee structures reduces investor friction and builds trust.
Looking Ahead
The private mortgage fund market in 2023 reflects both the resilience of proven structures and the selective adoption of new approaches where the economics are compelling. The core LP/GP model remains the foundation for most funds, while REIT and SubREIT strategies provide meaningful tax planning opportunities for the right manager. Capital formation remains competitive, and managers who invest in track record, audit quality, and structural sophistication are best positioned for growth.
Contact Geraci LLP
Geraci LLP has over 15 years of experience advising private mortgage fund managers on fund formation, securities compliance, capital structure, and investor relations. If you are evaluating a new fund launch, a REIT conversion, or a refinement of your existing structure, contact us today.
Geraci LLP 90 Discovery, Irvine, CA 92618 (949) 403-3488
