Private credit funds use investor capital to provide commercial borrowers with short-term loans to finance real estate projects.
When someone invests in a private credit fund, they become a limited partner (LP). As borrowers make monthly interest payments, investors receive distributions in proportion to their allocation in the fund.
Through private credit funds, non-institutional investors can access the benefits of real estate debt, such as backing by the underlying property and stable returns, without having to originate loans themselves.
However, direct lending credit funds no longer deliver the returns they once did. Most funds borrow additional capital to increase their lending capacity, known as leverage, but borrowing costs continue to rise, and lending rates (the interest funds charge borrowers) remain the same.
Funds currently borrow at around 9% interest and can only lend at 10% to 14%, meaning their spread is 1% to 4%, which is relatively thin compared to historical norms.
Consequently, Constitution Lending has shifted focus from direct lending to purchasing and resolving distressed private debt, also known as non-performing loans (NPLs), to achieve higher returns.
The Constitution Lending NPL fund generated 57.60% annualized returns in 2024, while most direct lending funds averaged around 7% to 14%.
This guide discusses the investment strategy behind how Constitution Lending’s NPL fund generates high annualized returns and prioritizes capital preservation at the same time. However, if you’re interested in traditional, direct lending funds, skip to this section.
To date, Constitution Lending’s NPL fund has purchased and resolved over $40MM in distressed private debt. Schedule a call with a fund manager to learn more about our investment strategy.
What Are Non-Performing Loans (NPLs)
Non-performing loans (NPLs) are real estate-backed loans in which borrowers have stopped making payments. Traditional banks aim to get these loans off their balance sheet as quickly as possible because:
- They are no longer generating monthly cash flow: The bank must find a way to resolve the debt; however, this falls outside its business model. Banks are lenders, not debt resolution experts. So, they’d rather sell the loan at a loss and free up capital to originate more loans instead of pouring further resources into debt resolution.
- Regulatory requirements limit the number of NPLs banks can hold on their balance sheets: Too many NPLs increase a bank’s risk profile, negatively impacting its credit rating and ability to raise funds at low interest rates.
As a result, banks sell NPLs to debt resolution experts like NPL funds, who have the systems, knowledge, and experience to resolve debt quickly.
NPL funds purchase distressed debt from banks at a discount to the borrower’s outstanding balance, then use their expertise to recover the full amount. The spread between the purchase price and the balance owed is one way this asset class can achieve high returns.
Constitution Lending’s NPL Investment Strategy
Constitution Lending’s investment strategy has two target objectives:
- Generate higher yields than performing debt or fixed-income investments
- Protect investors’ private capital through significant downside protection
Here’s how we achieve those target objectives.
How the Constitution Lending NPL Fund Generated a 57.60% Return in 2024
Constitution Lending Typically Purchases NPLs at Substantial Discounts
As we alluded, the Constitution Lending NPL fund purchases senior-secured NPLs for less than the unpaid loan balance. We can do this because:
- We’ve built relationships with banks, insurance carriers, and credit unions throughout the U.S., giving us direct access to NPLs before they reach open capital markets.
- We use proprietary sourcing software to pull data from hundreds of foreclosure sales in the U.S. and automatically email the court asking about the starting bid. You can learn more about our sourcing tech here.
Once we’ve purchased an NPL, we use our debt resolution expertise to accelerate the loan, a contract provision that kicks in when default occurs, forcing the borrower to sell the property within 10 to 30 days and use the proceeds to pay the entire loan balance.
For example, we recently acquired an NPL through a relationship with a bank for $6MM, while the borrower owed $10MM in total. If the borrower sells and pays the balance within the next year — which is very likely — we’ll earn a 66% annualized return.
In most cases, the borrower will sell the property within the 10 to 30-day notice period to avoid a foreclosure sale, a court-ordered liquidation in which the property is sold at a significantly discounted price. Borrowers typically short-sell within 10 to 30 days to get a fairer price.
Constitution Lending Purchases NPLs with High Default Interest Rates
In addition to the discount paid when purchasing the NPL, we use the default interest rate to achieve strong returns.
The default interest rate is a penalty rate applied to a loan once the borrower defaults, exceeding the normal or floating rate on a performing loan. For example, most of the NPLs in the Constitution Lending fund have a default interest rate between 18% to 24%.
However, unlike performing loans where the borrower makes interest payments every month, the borrower already defaulted on the loan, so they don’t pay this default interest month to month. Instead, we add it to their unpaid loan balance.
Fund managers and investors receive payment for the default interest rate when the property is sold, and disbursements are used to settle the unpaid loan balance.
How the Constitution Lending NPL Fund Protects Investors’ Capital
Many investors' first question when they hear about NPLs is regarding safety. Because the borrower has defaulted, is it riskier than a performing loan?
Not necessarily. In fact, high-quality, investment-grade NPLs can provide greater levels of capital preservation than performing loans and equity investments like private companies. To understand how this is possible, we must quickly define LTV.
LTV stands for loan-to-value and is a measure of how much collateral backs a loan. For example, if the unpaid loan balance is $600K and the collateral is worth $1MM, the LTV is 60%.
Low LTV loans offer two advantages:
- More protection against market downturns: The substantial equity cushion safeguards against fluctuations, providing a significant buffer before investor capital is at risk. With a 60% LTV loan, for example, the property could lose 40% of its value and investors’ capital would still be safe. This makes low LTV loans inherently safer than equity investments such as private equity.
- More time to accrue default interest: Because the loan balance is well below the property’s value, default interest and fees can build during foreclosure or restructuring, allowing the fund to recover the full amount upon resolution.
Credit funds that originate performing loans typically lend at 70%–80% LTV, leaving little equity cushion against default or market risk.
With high-quality NPLs, however, you’re in a stronger position: the loans have had principal paid down over several years, while the property’s value has likely appreciated since origination. By the time the borrower encounters trouble near the end of the loan term, the remaining balance is often well below the property’s current value.
NPLs in Constitution Lending’s Fund Have an Average LTV Below 60%
Constitution Lending purchases NPLs with an LTV of less than 60%, giving investors a 40% borrower equity cushion to help mitigate market volatility.
Additionally, because the loan balance is well below the property’s value, we can safely accrue default interest and loan fees.
Additional Fund Information
Minimum Private Credit Investment Amount
Constitution Lending has a minimum investment amount of $20K.
This is far less than most NPL funds and private credit funds, which typically require a $1MM–$2MM investment.
If individual investors want to purchase NPLs directly from banks and resolve the debt themselves, they typically need over $2MM — and sometimes $5MM to $10MM — which is impractical for non-institutional investors.
Lock-Up Periods
A lock-up period is the timeframe after an investor deposits capital during which withdrawals are not allowed. These provisions give fund managers the stability to acquire high-quality NPLs and resolve the debt, rather than selling on secondary markets to meet redemption requests.
In short, lock-up periods protect investors by ensuring managers have the time to fully execute their private credit investment strategy, since NPLs are an illiquid asset class.
With Constitution Lending, as with most NPL credit funds, lock-up periods are 18 months.
Distributions
NPL funds cannot distribute monthly earnings like traditional private credit funds focused on direct lending. This is because they don’t receive monthly borrower interest payments, they generate returns by resolving the debt, and debt resolution timelines vary significantly. As a result, NPL funds distribute earnings quarterly or bi-annually.
Constitution Lending’s NPL fund distributes earnings to investors quarterly after the 18-month lock-up period.
Auditing
EFSI administers the Constitution Lending NPL fund, with audits conducted by Fundviews Capital and Akram.
EFSI ensures that the Constitution Lending NPL fund operates with rigorous financial controls and proper risk management. Meanwhile, regular audits by Fundviews Capital and Akram provide an independent review of the fund’s financials.
How to Invest in Constitution Lending’s NPL Fund
Here’s how to invest in the Constitution Lending NPL fund:
- Schedule an introductory call with one of our asset managers to learn more about our non-performing credit strategies.
- You’ll need to provide income verification, tax returns, or net worth evidence to verify that you are a credited investor.
- If you decide to invest, we’ll send you a partnership and LLC operating agreement, which details all the information surrounding our NPL fund, including investor rights, the terms of your investment, fees, and fund rules.
Although direct lending funds typically generate lower returns than NPL funds, they may still be a good investment vehicle for some investors due to the following benefits:
- Regular distributions
- Significant downside protection
- Short investment horizon
- More accessible
In addition to the Constitution Lending NPL fund, investors can purchase fractions of the loans we originate, starting with $1,000. Sign up for an investor account to explore our investment opportunities.
Regular Distributions
Because traditional private credit funds lend money to commercial issuers who make monthly interest payments, fund investors receive more frequent distributions than NPL funds.
Most private credit funds pay investors a monthly coupon. This makes them a more attractive option for conservative investors who aren’t necessarily looking for the highest returns, but want regular interest payments.
You can invest in the loans that Constitution Lending issued, and we pay you monthly. We also offer a payment guarantee, which means we pay you out of pocket even if the issuer misses a payment. You can learn more about investing in our performing loans here.
Significant Downside Protection
Investing in a high-quality private credit fund gives you access to low LTV commercial loans.
Investors have significant downside protection because if the property loses value or the borrower stops paying, fund managers have a borrower equity buffer before the loan becomes underwater.
At Constitution Lending, we exclusively originate loans with an LTV below 75%, providing investors with substantial borrower equity to protect against risks in the private credit market.
Since we lend to creditworthy borrowers with extensive real estate experience and strong repayment histories, defaults are rare. Thanks to our rigorous underwriting, fewer than 2% of loans default.
More Accessible
Although most private credit funds have minimum investment amounts around $50K, this is still significantly less than the private capital required to originate loans. For example, originating a 70% LTV loan on a $400K property would require $280K.
Constitution Lending makes investing in performing loans even more accessible because investors can get started with just $1,000, allowing for easy investment portfolio diversification.
Capitalize on High Yields and Substantial Downside Protection by Investing in Constitution Lending’s NPL Fund
You can learn more about our investment strategy and financial services by booking a call with one of our portfolio managers.
