Thoughts on IMH
I get the sense that the Wall Street Journal is looking for scandal in real estate securities. A few weeks ago it picked on Grubb & Ellis, trying weakly to link it to other known problem sponsors, and today it targeted IMH. The WSJ needs to look a little harder (heck, contact me and I'll point you in the right direction). I have been writing about IMH for several years and re-read my previous posts this evening. The WSJ article mocked IMH's moto of "Rule 1: Don't lose money. Rule 2: Don't lose money. Rule 3: Don't forget Rule 1 and Rule 2." I noted this silly moto, too, nearly two years ago.
I missed that the SEC was investigating IMH related to transactions and relationships with the broker / dealers that sold the units in the IMH Secured Loan Fund. I have no idea of what will come of the investigation, but I always thought, from a fee standpoint, IMH was not egregious. If I remember correctly, IMH Secured Loan Fund's initial costs were much lower than non-traded REITs, and the points paid to IMH were paid by borrowers not the Secured Loan Fund (which, if you look at enough deals, you'll find this not common). The consolidation of IMH Secured Loan Fund and the IMH management company made sense, because without it investors would have likely lost everything, and of course there is still a chance all could be lost. The amount paid to IMH as part of the consolidation was $14 million in restricted stock, which is now the subject of a class lawsuit. If IMH is not successful in working out its SEC issues and is unable to list its shares, get additional capital, and figure how to grow the business, the $14 million won't be realized. As it now stands, investors have at least a chance of getting some return of their original investment.
My issue with IMH was its refusal, at least in its filings, to fully address the underlying problems in its portfolio. Everything seemed rosy until it wasn't. Even today, I would question the value of IMH's remaining assets.
The WSJ article focuses on the unfortunate investment losses of small investors. Many investors put their money thinking it was a safe, income investment. But to IMH's defense, it never obscured or hid its business plan, and the business plan had substantial risk. IMH Secured Income Fund made pre-development loans to developers. Developers went to IHM for pre-development loans because they couldn't yet qualify for development and construction loans from traditional lenders. Put another way, the loans IMH Secured Income Fund were making were considered too risky for banks. This is not saying the loans weren't sound and not made in good faith, just that banks did not make this kind of loan.
The loans were made to developers in many of the "hot" residential real estate markets, like Arizona and Nevada that have imploded on themselves. Like the WSJ article noted, many of the loans were made on land parcels without any zoning or entitlements (one reason why banks don't make these loans). No matter the market environment, pre-development loans carry high-risk, even with the collateral. Throw in the worst housing crisis since the depression and the risk is compounded exponentially. I am not saying the strategy was flawed, but that it carried significant risk.
IMH Secured Loan Fund paid high distributions, typically north of 10%, and repurchased shares from investors that requested liquidity. The high yield was what attracted investors. Investors need to question their brokers, especially on opportunities that offer out-sized returns, like the IHM Secured Loan Fund. High returns NEVER come without high risk, and risk is a two-way street, both up and down. This may sound snarky, but if someone figured out how to give high returns with low risk, Wall Street and institutional investors would have moved in and small investors would have been excluded.
The WSJ article was not as bad as its title implied. It probably could have been worse for IMH. The story of IMH is not over. I will be paying attention to the SEC investigation and any potential outcome. Then IMH needs to tap the capital markets, which will be the real challenge. This will also be the real test of IMH's valuation assumptions. The market is unforgiving and if the IMH's asset values are overstated it will be apparent quickly. I am not sure of positive alternatives to IMH if an IPO is not marketable.