The information provided here is intended to supplement the slide deck and video that you should have received.
It’s most useful for seasoned fund investors, wealth managers, and those who generally prefer detailed information.
Most Popular
Category 1
You are welcome to view the fund’s legal paperwork by clicking on the links below:
Private Placement Memorandum (PPM): This document explains the fund to prospective investors in great detail. Those who review PPMs on a regular basis will find the language to be much softer and more pro-investor than is customary.
Company Agreement: This is known as a partnership agreement for some funds. Again, the language is much more pro-investor than is customary.
Subscription Agreement: Investors must review and sign this agreement as part of the investment process. There is no need to print and sign this version of the document, as you’ll be able to DocuSign a customized version of this document as you invest.
Credit Agreement: This agreement provides great detail on the loans between the fund and its borrowers.
The fund has 18 benefits that we have been able to identify. Click here for an explanation of each one.
Various entities work together to carry out the business of the fund and the land business. These are as follows:
Hawthorne Income Fund, LLC is the fund. It is owned by fund investors as is managed by Hawthorne Income Fund Manager, LLC, which is an entity that Doug Smith owns.
Hawthorne Land, LLC is Doug’s entity that purchases and holds title to land. We subdivide, improve and sell the land, so its land ownership is temporary. It borrows from the fund against the land it owns.
Hawthorne Interests, LLC is Doug’s entity that purchases real estate notes, often from Hawthorne Land, and holds them long term. It borrows from the fund against the notes it holds.
Hawthorne Management, LLC and Hawthorne Property Services, LLC are Doug’s entities that cover most of our general overhead and employ many of our team members.
The fund lends to Hawthorne Land at a maximum of 65% of the projected aggregate sales price of the ranchettes for a relevant property. That is widely considered to be a low loan-to-value (LTV), which is important for reducing risk. Each loan is at 10%, interest only.
For each note that Hawthorne Interests buys and holds, the fund lends to it at a maximum amount whereby the monthly payment to the fund will be at least 10% less than the incoming monthly payment to Hawthorne Interests. This means that if the fund had to foreclose on a loan, it would become the owner of a note that provides more monthly income than the original loan. Each loan is at 10%, amortized.
All of this is covered in Section II of the Private Placement Memorandum (PPM) and on Schedule 1 of the Credit Agreement.
Hawthorne Land (HL) seeks out a new property and places it under contract. In this case, it’s 100 acres of land outside of Houston. The purchase price is $1M, which comes out to $10K per acre.
HL’s plan is to subdivide the property into ten 10-acre ranchettes and sell each one for $250K. That’s a cumulative projected sales price of $2.5M.
Because the total projected sales price is $2.5M, Hawthorne Income Fund (the fund, HIF) will lend the lesser of 65% of that amount or the purchase price. The lesser is the purchase price, so it lends $1M to HL upon purchase, secured by a first lien against the property.
Over the coming weeks and months, HL makes improvements to the ranchettes, and HIF issues additional loan funds, also secured by a first lien against the property.
Eventually, HL makes a total of $250K in improvements, and HIF will have loaned an additional $250K against the property, thus taking the total loan amount up to $1.25M. This comes out to a $125K loan against each ranchette.
HL sells each ranchette on owner financing. Each time it does, it collects a down payment of approximately $20K and takes back a note for about $230K at 10.9% over 20 years.
Upon selling the land and generating the note, HL sells the note to Hawthorne Interests (HI). HL pays off its $125K loan to HIF, and HIF lends just shy of $220K to HI with the $230K note as collateral.
In this scenario, the ranchette buyer/borrower pays HI $2,358.40 per month, and HI pays HIF $2,122.56 per month, which is 10% less than the incoming payment. This provides HI with a positive cash flow of $235.84 per month.
HL and HI receive a capital infusion equal to the difference between the $125K loan payoff and the new $220K loan, plus the $235.84 per month in positive cash flow over 20 years.
HIF earns interest income from various sources throughout this process. At first, it earns it from a 10% interest-only loan to HL. Later, it earns it from a 10% amortized loan to HI. In addition, it earns interest income on any capital that it has taken on but has not loaned out.
Combined, these three sources of interest income provide HIF with the income it needs to provide a 10% monthly preferred return to its investors.
This was covered in the video but not the slide deck (PDF).
Investors are receiving $833.33 per month, which is $10,000 per year, on each $100,000 invested. Those who have chosen to automatically reinvest their monthly returns are benefiting from compounding over time. This helps raise their internal rate of return (IRR) to 10.47%.
An investment of $100,000 is projected to be worth $150,000 after 5 years if you choose to take your distributions and leave them in a checking account. That same investment is projected to be worth $164,531 after 5 years if you chose to have your returns automatically reinvested.
A $100,000 investment is projected to be worth $300,000 after 20 years if you take your distributions and leave them in a checking account. That increases substantially to $732,807 if you chose to have them automatically reinvested.
As you can see, reinvesting can lead to vastly improved outcomes over time. This is why Albert Einstein referred to it as the “miracle of compound interest.”
This is a Reg D Rule 506(b) offering and must comply with associated SEC requirements. As a result, all investors must be accredited.
Per the SEC, an individual must meet one of the following two criteria to invest:
“Net worth over $1 million, excluding primary residence (individually or with spouse or partner).”
“Income over $200,000 (individually) or $300,000 (with spouse or partner) in each of the prior two years, and reasonably expects the same for the current year.”
Find more details on the SEC’s Accredited Investor page.
Because this is a Rule 506(b) offering instead of Rule 506(c), you’re able to self-identify as accredited during the investment process. We do not ask you to provide us with any documentation or other proof.
You are able to request and receive a return of part or all of your investment should you desire. You can find a detailed explanation of this process in section 4.04 of the Company Agreement.
Below is a simple illustration that shows how this works:
You have $300K invested in the fund, and you provide a written request that we return $250K of it.
We have 120 days to return $100K. We must return another $100K 60 days later (on day 180). Then we must return the final $50K 60 days after that (on day 240).
We are to pay you fees of $100 per month per $100K requested should we be unable to return your capital according to the schedule outlined in the Company Agreement and illustrated above.
Should the fund be accruing or paying fees to any investor for more than two years, the fund is legally obligated to stop lending on land deals and to return capital to all investors as it becomes available.
Our goal is to return as much of your requested capital as possible within a few days of your request. Our ability to do so depends on the amount you request and the fund’s current liquidity. If needed, we can generate additional liquidity through the means shown in the following FAQ.
There are several options:
1. The fund typically has a few million dollars that it has taken on but has not yet loaned out. It resides in the fund’s checking account and can be quickly distributed from there. You will find the most recently documented amount at the top of page 2 in this Capital Allocation Report.
2. Hawthorne Land or Hawthorne Interests can pay down a fund loan, thus providing liquidity in the fund’s checking account, which can be distributed. There are usually a few hundred thousand dollars in those accounts or accounts associated with them.
3. Hawthorne Interests can sell one or more notes and pay off the fund in the process, thus providing liquidity.
4. Hawthorne Interests can borrow from a bank against some of its notes. In doing so, the fund’s loans against those notes will be paid off, thus providing liquidity for the fund.
5. Hawthorne Land can sell some of its land for cash or conventionally (not on owner financing) and use those proceeds to pay down a fund loan.
6. The fund can increase its cash position by taking on additional capital from a new or existing investor, just as it does on a regular basis.
7. Doug or another investor can buy out an investor for the amount that’s due to them.
Many investors find it important that the sponsor, Doug Smith in this case, have a vested financial interest in the fund. This “skin in the game,” is being provided in various ways:
Doug is currently paying over $125K per month in interest to the fund via his entities that borrow from it.
He is spending about $100K per month on payroll and general overhead (office, equipment, advertising, etc.) through his entities that buy, improve and sell the land.
He fronts the money for improvements. Invoices can add up to over $100K at times.
He has invested up to $1.4M in the first two funds, and much of his net worth is allocated to land deals.
He was the sole investor for the first 2+ years of the business.
His business reputation is tied to Hawthorne Capital. He protects that and his investors above all else.
The SEC regulates private equity funds and has the right to investigate and prosecute any sponsors who represent returns as being “guaranteed.” Based on the fund’s structure and lending criteria, we do not see a feasible way for our investors to lose their investment or fail to receive the projected returns. However, it is up to each investor to assess the risk/reward profile of a prospective investment.
We strive for full transparency and are happy to provide this Capital Allocation Report. You will find asset values, collateral values, links to filed documents, property maps, and more.
Other Important FAQs
Category 2
Sales have been strong, and we expect this to be another record-setting year. You can view historical ranchette sales by going here. Refer to recent email updates for pictures and more.
The following paperwork is common and required each time we buy land or sell a ranchette. Many of these documents protect the fund’s position as a lender:
RMLO Package for a Ranchette Sale: This contains all information related to qualifying and approving a borrower. It is assembled by Texas Pride Lending in Dallas.
Title Package for a Ranchette Sale: This is the documentation that is presented and signed by all parties during the sale of a ranchette at a title company.
Sample Deed of Trust for a Loan Against Land: This document secures the fund’s loan with a first lien against the land. It is filed at the courthouse where the property is located.
Sample Promissory Note for a Loan Against Land: This document details the terms of the fund’s land loan.
Sample Collateral Transfer of Note and Lien: This document secures the fund’s loan with a first lien against a note. It is filed at the courthouse where the property is located.
Sample Promissory Note against a Land Note: This document details the terms of the fund’s loan against a note.
These are not bank loans, but Doug still thinks it’s important that investors know about his character and credit worthiness. With that in mind, here are those reports:
Background Check: Ehlert Law, PC investigated Doug’s background and compiled this report. It shows no criminal activity.
Credit Check: This credit check from Identity Guard shows no late payments and a credit score of 810.
Please click here to see list of some of our investors. Names are excluded to maintain their privacy. It’s an impressive group, and we try to provide networking opportunities as much as we’re able.
Some investors are not comfortable with having someone else manage their assets, regardless of the level of transparency. For that reason, we do offer other means of investing. These include buying notes from us and lending against our notes directly. Please contact us if you’re interested in learning about the pros and cons of these other opportunities.
The S&P 500 tends to generate a return of about 9-11% per year, but that varies wildly.
We do not claim to be stock market experts but encourage you to look at the indicators found on this popular website. You can click into each one for more details. The Buffett Indicator is of particular interest.
Both the slide deck and video reference a study by Dalbar, Inc., which shows that people often start their investment journey when they are excited about the market’s upward trend and sell after the market stalls and reverses course. If they hold, it can sometimes take decades for their portfolio to recover.
Investments in multifamily syndications or private equity funds are very common and can be very lucrative. They can also be seen as risky by more conservative investors.
This isn’t covered in the slide deck, but the video discusses one risk of these types of investments. Let’s say a group of investors purchases an asset for $10M using $2M of investor capital and $8M of debt. If the value drops to $8M after two years, the lender can recuperate the majority of its capital, but the equity investors stand to lose their $2M.
In spite of the risk, many multifamily properties have generated exceptional returns for their investors over the last few years. This is largely due to a phenomenon known as “cap rate compression” whereby multifamily buyers have been paying increasingly large amounts for the same amount of cash flow. This has allowed investors who are selling to reap large profits.
Seasoned investors tend to have the same concerns about multifamily properties: 1) This “cap rate compression” phenomenon is generally seen as being largely unable to continue and thus hurts projected IRRs. 2) These properties appear to be highly overvalued after seeing a huge runup over the last few years, 3) There’s an extremely large amount of “dumb money” chasing very few real deals, 4) and multifamily operators have the money, staff and fee structure in place and are therefore incentivized to keep doing deals, even if they are weak or risky.
Boding well for these types of investments, however, are rising rents and underlying land values that are largely being driven by inflation. It’s up to each investor to decide whether the positive or negative forces will ultimately prevail and whether investing in this asset class is a wise move at this point in the market cycle.
Perceived Risks
Category 3
We entered into what’s known as the COVID-19 recession in early 2020. It was one of the deepest recessions in U.S. history, with 14.7% peak unemployment and a 19.2% drop in GDP. By comparison, the Great Recession resulted in only 10% and 5.1% respectively. (Source)
For about two months, buying activity slowed down and some borrowers didn’t make their mortgage payments due to some misinformation that had spread. These issues were quickly resolved, and we went on to sell over $10M worth of ranchettes that year. This bodes well for this business’s ability to thrive during all market cycles.
In addition, selling on owner financing and collecting on those payments is traditionally seen as a recession strategy. Doug and his colleagues saw this work extremely well during and after the Great Recession when selling houses conventionally proved difficult in many cases.
Should we experience a prolonged recession with large job losses, some or many of our borrowers will be affected. That will likely increase the default rate to some extent. Although Hawthorne Interests (HI) is to make monthly payments to the fund each month, regardless of the income it collects, a steady stream of income into HI does help in that regard.
It would be difficult for HI’s income to drop below what it pays to the fund. If that happened, we suspect it would only be temporary until HI was able to foreclose on its non-performing loans and originate new ones, many of which would be at larger amounts. During that temporary period, additional cash could be funneled into HI from Doug’s other business and personal checking accounts.
Extremely high default rates during a recession seem unlikely, as they didn’t occur during the COVID-19 recession. Moreover, borrowers are incentivized to keep a property that they have put a substantial amount of money into via mortgage payments and improvements and that they have seen increase in value over time.
This is not needed or even desired to get the fund or our business through a recession, but we have seen an extreme willingness by the U.S. government to pump large amounts of capital into the economy to prop it up. This tends to prevent massive waves of foreclosures in all areas of real estate, including rural land.
Inflation is impacting individuals, businesses and governments in various ways, both positive and negative. Below are some of the ways it can impact the business and/or fund:
Real estate values tend to rise with inflation. That includes rural land. This means that we now must pay more for land when we buy. It also means that we sell for more, so it’s not necessarily a positive or negative in this regard.
Over time, inflation leads to higher wages and higher profits in nominal dollars. Hawthorne Interests (HI) collects monthly payments from those who bought ranchettes on owner financing. These payment amounts don’t change, thus making them more affordable in comparison with our borrowers’ higher wages and/or profits over time. This helps HI keep its default rate down, which provides HI with a more reliable steam of income. That stream of income is used to pay loans from the fund and its investors by extension.
On occasion, HI must foreclose on a borrower, take possession of the underlying land and resell it. A desirable outcome is reselling the land for more than it was first sold for and generating an even larger note with a larger monthly payment coming in. This is much more likely when land values have gone up. Inflation is helping that to happen.
Some other types of investments rise with inflation. That could make them more appealing to some of our current or prospective investors, thus making it more difficult for us to attract or retain investor capital. This has not happened thus far. One reason could be that many of those types of investments appear to be overvalued and/or high-risk.
Interest rates have been rising and may continue to rise. There is no consensus as to how high they might go. Fortunately, the Federal Reserve is not incentivized to increase them beyond acceptable levels.
The United States government carries substantial debt, and higher rates would mean that it must pay out much more via regular interest payments. Significantly higher rates would also be crippling for the countless Americans who carry consumer debt. There are other incentives for keeping rates at reasonable levels that we and our advisors are happy to explore with you.
Should rates rise to a level that leads you to believe your capital would be better invested in bonds or elsewhere, you are welcome to request a return of capital. It will be carried out according to the information in the “return of capital” FAQ.
Should bond rates rise above 10%, we would consider a temporary increase in the fund’s loan rates and preferred returns to match those of bonds.
We’re seeing extremely strong demand for the ranchettes that we sell. This was also the case during the pandemic and resulting recession and even long before that period. It’s reassuring that demand for our product has far exceeded our ability to meet it across these very different market cycles.
If we ever see demand dropping off, we could certainly curtail buying activity. In the unlikely scenario where we needed to stop buying, we would finish out current projects and provide investors with preferred returns and a return of their capital over time.
It is important that we choose our buyers wisely when selling on owner financing. This provides the fund with solid collateral on its loan against such notes, and it leads to a steady stream of payments coming into Hawthorne Interests over time. Those payments provide the cash flow that service the associated loans made from the fund to Hawthorne Interests.
We heavily screen our buyers and involve a RMLO (residential mortgage loan originator) for each owner financing sale. This dramatically increases the probability of a successfully performing note. Regardless, some loans will go into default. When they do, we continue paying the fund on its loan as we foreclose on the property or have the buyer deed it back to us.
If we take ownership, the fund’s note loan converts to a land loan. It then reverts back to a note loan when we sell that land on owner financing to a new buyer.
The outcome for Hawthorne Interests can be positive or negative each time this scenario plays out. We are always able to collect a new down payment and are sometimes able to sell the land for more the second time around. This is more likely if land values have appreciated over time and/or the buyer made improvements to the property.
Doug is in excellent health, but the fund and business have structures, systems and processes in place that should remain in place if Doug passes away. Current team members are capable of rising up to fill his shoes, and a new but seasoned executive could even be hired.
If the team does well, the business will grow at the same pace or faster. If they fall short, business will slow down. In either case, existing fund loans, all of which are secured by real assets, will stay in place, and fund returns can continue being paid out.
In addition, the fund can continue lending against assets that meet its strict lending criteria.
If any investor wishes to withdraw his or her capital before or after Doug’s passing, he or she is welcome to request that as outlined in the “return of capital” section. The fund’s management is required to carry out those requests or face negative consequences.
The fund is a lender. Lenders are unlikely to get sued unless they are violating lending laws, which the fund does takes great care not to do.
In any case, the borrower would generally need to sue the lender, and Doug’s entities are the borrower. Doug has no reason to sue the fund that he and his team created to serve as a “friendly lender.” In addition, any suit would almost certainly get tossed out because his entity is managing the fund.
As with anyone or any company involved in a business undertaking, Hawthorne Land, Hawthorne Interests or Doug Smith could get sued. Innocence and/or insurance would protect us in most cases. Access to our own capital reserves would resolve the issue in other cases.
Regardless, the fund has first liens on our assets and would therefore be in a first position to get paid should assets need to be sold to resolve legal issues.
The fund lends to Doug Smith’s entities, which are primarily Hawthorne Land and Hawthorne Interests.
In the “flow of funds” FAQ, you can see that the structure of the fund provides for ample liquid capital for Hawthorne Land each time it sells a ranchette. This capital, along with capital already available in Hawthorne Land and Doug’s other personal and business checking accounts, provides substantially more resources than are needed to service the loans made to Hawthorne Land.
Hawthorne Interests should not have an issue covering loan payments either, as it receives more income each month from its borrowers on each note than it must pay to the fund each month for the associated fund loan.
In an unlikely and unforeseeable worst-case scenario, the fund has mechanisms in place for fund management or fund investors to foreclose on assets that the fund has loaned against. It could either hold or sell them at that point.
The fund does not make unsecured loans to a business but instead makes secured loans against real assets. Therefore, the pertinent question would really be, “What happens if you go out of business and quit paying on your loans?… even though the fund structure means you have significant cash flow to pay those loans.”
As was mentioned in the prior FAQ, in a far-fetched worst-case scenario, the fund has mechanisms in place for fund management or fund investors to foreclose on assets that the fund has loaned against. It could either hold or sell them at that point.
“Going out of business” has involved a bankruptcy for some companies. This has happened when their liabilities were greater than their assets. We do not see how this would be feasible with the fund structure, seeing that strict lending criteria is in place to keep loan balances within reason.
It is implausible but technically possible that Doug’s entities could take on additional unsecured debt that ultimately led the company to bankruptcy. In this case, the courts would oversee the process of selling assets, paying off the fund’s loans (which are all secured by first liens) and returning capital to investors.
Any fund manager could mismanage or squander funds. Fortunately, this is fairly rare because most managers are seasoned professionals who wish to 1) maintain a solid reputation, 2) avoid legal problems, and 3) secure repeat investors and referrals so that they can do more deals.
Mismanagement of this fund is largely prevented by this fund’s structure and strict lending criteria. The only thing that could feasibly be stolen is liquid capital, which typically represents a very small percentage of fund assets. In addition, most of the fund’s cash is only accessible to Doug and two key employees.
Fund capital is highly accounted for via our partnership with Cobalt Fund Services, which is an accounting firm that handles bookkeeping and reporting. Another accounting firm, Whitley Penn, conducts an annual audit and provides a report of its findings to our investors.
In addition, we provide regular emails and reports that show the properties and notes that the fund is lending against.
Finally, all fund investors are welcome to stop by our offices anytime during normal business hours to view the checking accounts, loan paperwork, QuickBooks reports and more.
People are making money in the vast majority of private equity investments that we have seen. There is an occasional fund or investment that that ends badly, and these are the ones that are widely discussed and/or covered in the news.
It is very rare, but a fund manager could have a business model that makes no or minimal profits, instead providing investors with “returns” by falsifying statements and/or distributing “returns” from the capital provided by other investors. This is difficult or impossible to do with third-party administration and audited financials, which are in place with this fund. This fund also makes a substantial profit each month in the form of interest income.
Equity funds that borrow against their assets, and therefore place that debt ahead of their investors in the capital stack, expose their investors to some risk. If the asset values drop or do not increase as planned, the debt can get paid back first, leaving investors with little or nothing. In contrast, this is a debt fund that does not owe any debt but instead owns it.
Many people have lost most or all of their investment simply by investing in something that was high risk. An example would be investing in startups.
The fund is managed by Hawthorne Income Fund Manager, LLC, which is owed by Doug Smith. The manager can be removed and replaced by a two-thirds vote of investors (by number) and investor interests (by investment amount). This is a lower threshold than is typically seen with private equity funds and is therefore pro-investor. This removal and replacement process is outlined in Section 7.03 of the Company Agreement.