Item 1. Business
Item 1. Business
Background
We were organized as a New York corporation in January 2016 under the name HML Capital Corp. On December 15, 2016, we changed our name to Sachem Capital Corp. Prior to February 8, 2017, our business operated as a Connecticut limited liability company under the name Sachem Capital Partners, LLC (“SCP”). On February 9, 2017, we completed our initial public offering (the “IPO”) in which we issued and sold 2.6 million common shares, $.001 par value per share. We believe that since the consummation of the IPO, we have qualified as a REIT and we elected to be taxed as a REIT beginning with our 2017 tax year. We believe that it is in the best interests of our shareholders that we continue to operate as a REIT. As a REIT, we are required to distribute at least 90% of our taxable income to our shareholders on an annual basis. To the extent we distribute less than 100% of our taxable income to our shareholders (but more than 90%) we will maintain our REIT status, but the undistributed portion will be subject to regular corporate income taxes. As a REIT, we are also subject to federal excise taxes and minimum state taxes. Finally, we intend to operate our business in a manner that will permit us to maintain our exemption from registration under the Investment Company Act.
Company Overview
We are a Connecticut-based real estate finance company that specializes in originating, underwriting, funding, servicing and managing a portfolio of short-term ( i.e., three years or less) loans secured by first mortgage liens on real property located primarily in Connecticut. Each loan is personally guaranteed by the principal(s) of the borrower, which guaranty is typically collaterally secured by a pledge of the guarantor’s interest in the borrower. Our typical borrower is a real estate investor who will use the proceeds to fund its acquisition, renovation, rehabilitation, development and/or improvement of residential or commercial properties located primarily in Connecticut and that are held for investment or sale. The mortgaged property may or may not be income producing. We do not lend to owner-occupants. Our loans are referred to in the real estate finance industry as “hard money loans” primarily because they are secured by “hard” ( i.e., real estate) assets.
Our loans typically have a maximum initial term of one to three years and bear interest at a fixed rate of 5.0% to 13.0% per year and a default rate of 18% per year. We usually receive origination fees, or “points,” ranging from 2% to 5% of the original principal amount of the loan as well as other fees relating to underwriting, funding and managing the loan, such as inspection fees. We also receive additional “points” and other loan-related fees in connection with a renewal or extension of an existing mortgage loan. Interest is always payable monthly in arrears. As a matter of policy, we do not make any loans if the loan-to value ratio exceeds 70%. In the case of construction loans, the loan-to-value ratio is based on the post-construction value of the property. We rely on readily available market data, including appraisals when available or timely, tax assessment rolls, recent sales transactions and brokers to evaluate the value of the collateral. Finally, we have adopted a policy that limits the maximum amount of any loan we fund to a single borrower or a group of affiliated borrowers to 10% of the aggregate amount of our loan portfolio, after accounting for the loan under consideration.
Our primary objective is to grow our loan portfolio while protecting and preserving capital in a manner that provides for attractive risk-adjusted returns to our shareholders over the long term through dividends. We intend to achieve this objective via a simple, yet compelling, two-prong strategy: 1) accelerate profitable growth and 2) drive operational excellence. More details behind this strategy may be found in this Item 1 under the heading “ Our Business and Growth Strategies ”. We will continue to selectively originate loans and carefully manage our loan portfolio in a manner designed to generate attractive risk-adjusted returns across a variety of market conditions, economic cycles and high-growth geographies.
Approximately 88.9% of our mortgage loan portfolio at the end of 2020 included loans having an original principal amount of $500,000 or less, compared to 93.2% at the end of 2019. We believe that the demand for relatively small real estate loans, those less than $350,000, in Connecticut and neighboring states is significant and growing and that traditional lenders, including banks and other financial institutions that usually serve this market are unable to satisfy this demand. This demand/supply imbalance has created an opportunity for “hard money” real estate lenders like us to selectively originate high-quality first mortgage loans on attractive terms and these conditions, we believe, should persist for several years. Nevertheless, the increase in the number and proportion of loans having an original principal amount exceeding $500,000 reflects our strategy to fund larger loans, secured by higher quality properties being developed by borrowers with a history of successful development.
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One target of our growth strategy is a focus on Texas and Florida, states that Forbes ranked #2 and #5, respectively, in their 2019 “Best States for Business” study. Both Texas and Florida have net migration into the state, no state income tax, a pleasant climate, a strong job market, and a positive economic forecast. According to the Forbes study mentioned above, Texas has an unemployment rate of 3.5% compared to the current national average of 6.2%; and its projected annual job growth is 1.7%. The state economy – $1.9 trillion – second only to California. In addition, Texas is headquarters to 100 of the top 1,000 public and private U.S. companies. Florida has a 3% unemployment rate and in 2019 welcomed 906 new residents per day on average. Its gross state economy is $1.1 trillion. We are initially targeting South, Southwest, Central, and Northwest Florida. Taken together, these are compelling reasons for Sachem Capital to focus on these high-growth geographies.
In summary, we built our business on a foundation of intimate knowledge of the Connecticut real estate market, our ability to respond quickly to customer needs and demands, and a disciplined underwriting and due diligence culture that focuses primarily on the value of the underlying collateral and that is designed to protect and preserve capital. As we implement our growth strategy, we will continue to apply this same rigor and discipline to selected geographies beyond Connecticut. We believe that our flexibility in terms of meeting the needs of borrowers without compromising our standards on credit risk, our in-house expertise, our intimate knowledge of real estate in the geographic markets we serve, and our focus on newly originated first mortgage loans have defined our success until now and should enable us to continue to achieve our objectives.
In light of the impact of the COVID-19 pandemic on general economic conditions and the capital markets, we immediately took various steps to reduce our risks, including the following changes to our underwriting guidelines as of April 1, 2020 applicable to new loans:
● limited new loan activity to the amount of cash generated by loan payoffs;
● reduced the loan-to-value ratio on new loans to 50%;
● loans greater than $1 million required the approval of one of our independent directors; and
● required an interest reserve with respect to loans exceeding a specified amount.
In addition, in response to the COVID-19 pandemic, in the second quarter of 2020 we instituted a forbearance program to help borrowers who were adversely impacted by the pandemic. Under this program, approximately $200,000 of interest on twenty-three loans, having an aggregate principal amount of $6.5 million at June 30, 2020, was deferred. As of December 31, 2020, all these loans have moved off forbearance and were current with respect to their interest payment obligations and no other loans were added to the forbearance program.
As conditions improved, effective July 1, 2020, we relaxed some of these measures by increasing our loan-to-value ratio back to 70% while still maintaining a cautionary perspective.
The Market Opportunity
Notwithstanding the spread of the novel corona virus known as COVID-19, which has had a severe adverse impact on general economic conditions, we continue to believe that once the spread of the virus abates there still will be a significant market opportunity for a well-capitalized “hard money” lender to originate attractively priced loans to small-scale real estate developers with strong equity positions ( i.e., good collateral), particularly in Connecticut where, traditionally, real estate values in many neighborhoods have been stable and substandard properties are improved, rehabilitated and renovated. We further believe that there will be many opportunities for us to expand our business into new markets. Starting in the fourth quarter of 2019 and during 2020, we have funded loans secured by properties in Naples, Florida, Phoenix, Arizona, Austin, Texas, Charleston, South Carolina, Littleton, Colorado and Sacramento, California. We also believe these developers will prefer to borrow from us rather than other lending sources because of our flexibility in structuring loans to suit their needs, our lending criteria, which places greater emphasis on the value of the collateral rather than the property cash flow or credit of the borrower, and our ability to close quickly. See Risk Factors — “ The outbreak and spread of the novel coronavirus disease 2019, known as COVID-19, could have a material adverse effect on our business, operations and financial condition ”; Management’s Discussion and Analysis of Financial Condition and Results of Operations — “Year in Review — 2020; Outlook for 2021” and Note 18 to our Financial Statements.
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Our Business and Growth Strategies
Our primary objective is to grow our loan portfolio while protecting and preserving capital in a manner that provides for attractive risk-adjusted returns to our shareholders over the long term principally through dividends. We intend to achieve this objective via a simple, yet compelling, two-prong strategy: 1) accelerate profitable growth; and 2) drive operational excellence. To accelerate profitable growth, we will continue to focus on selectively originating, managing and servicing a portfolio of first mortgage real estate loans designed to generate attractive risk-adjusted returns across a variety of market conditions and economic cycles. We are also targeting larger-value commercial loans with strong, experienced sponsors. To drive operational excellence, we have embarked on a broad change management initiative to review, assess, and upgrade – or transform if necessary – our existing operational processes, from workflows and employee roles/responsibilities to decision trees and data collection forms. We believe that our ability to react quickly to the needs of borrowers, our flexibility in terms of structuring loans to meet the needs of borrowers, our intimate knowledge of the Connecticut real estate market (which accounted for approximately 77% of our loan portfolio at the end of 2020), our expertise in ‘‘hard money’’ lending and our focus on newly originated first mortgage loans, should enable us to achieve our primary objective. Nevertheless, we remain flexible to take advantage of other real estate opportunities that may arise from time to time, whether they relate to the mortgage market or to direct or indirect investments in real estate.
Our strategy to achieve our objective also includes the following:
● capitalize on opportunities created by the long-term structural changes in the real estate lending market and the continuing lack of liquidity in the commercial and investment real estate markets;
● take advantage of the prevailing economic environment, current economic, political and social trends that may impact real estate lending, as well as the outlook for real estate in general and particular asset classes;
● remain flexible to capitalize on changing sets of investment opportunities that may be present in the various points of an economic cycle;
● increase the size and quality of our mortgage loans and expand our geographic footprint to reduce our exposure to adverse market conditions that have a disproportionate impact on a single asset class or geographic area; and
● continue to operate to qualify as a REIT and for an exemption from registration under the Investment Company Act of 1940, as amended, or the Investment Company Act.
Our Competitive Strengths
We believe our competitive strengths include:
● History of successful operations. We commenced operations as a limited liability company in December 2010 with three investors and limited equity capital. Since our inception through December 31, 2020, we have funded approximately 1,400 mortgage loans having an aggregate principal amount of $349.2 million. Immediately prior to the IPO, we had approximately 155 investors and $27 million of members’ equity. Since the IPO, we have raised an additional $48.7 million in equity capital and $114.2 million of debt capital. Similarly, since the IPO, our mortgage loan portfolio has grown from $33.8 million to $155.6 million at December 31, 2020. In addition, at December 31, 2020, we had $19.4 million of cash. We have reported net profits in every quarter since our IPO.
● Long-standing relationships. We have ongoing relationships with many of our borrowers. At December 31, 2020, our loan portfolio includes 128 loans having an aggregate principal balance of approximately $25 million that were extensions of prior loans. Customers are also a referral source for new borrowers. As long as these borrowers remain active real estate investors, they provide us with an advantage in securing new business and help us maintain a pipeline to attractive new opportunities that may not be available to many of our competitors or to the general market.
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● Competent workforce. Our employees are multi-skilled professionals who have a strong “team” orientation, a “continuous process improvement” mentality, and an authentic desire to learn all aspects of our business and contribute wherever and however they are needed.
● Knowledge of the market. Our intimate knowledge of the Connecticut real estate market enhances our ability to identify attractive opportunities and helps distinguish us from many of our competitors.
● Disciplined lending. We seek to maximize our risk-adjusted returns, and preserve and protect capital, through our disciplined and credit-based approach. We utilize rigorous underwriting and loan closing procedures that include numerous checks and balances to evaluate the risks and merits of each potential transaction. We seek to protect and preserve capital by carefully evaluating the condition of the property, the location of the property, the value of the property and other forms of collateral.
● Vertically integrated loan origination platform. We manage and control the loan process from origination through closing with our own personnel or independent legal counsel and, in the case of larger loans, independent appraisers, with whom we have long-standing relationships. Together, these individuals constitute a team highly experienced in credit evaluation, underwriting and loan structuring. We also believe that our procedures and experience allow us to execute opportunities quickly and efficiently.
● Structuring flexibility. As a relatively small, non-bank real estate lender, we can move quickly and have much more flexibility than traditional lenders to structure loans to suit the needs of our clients. Our ability to customize financing structures to meet borrowers’ needs is one of our key business strengths.
● No legacy issues. Unlike many of our competitors, we are not burdened by distressed legacy real estate assets. We do not have a legacy portfolio of low-yield or problem loans that could potentially dilute the attractive returns that we believe are currently available and/or that could distract and monopolize management’s time and attention. Similarly, we do not have any adverse credit exposure to, and we do not anticipate that our performance will be negatively impacted by, previously purchased assets.
Our Real Estate Lending Activities
Our real estate lending activities involve originating, underwriting, funding, servicing and managing short-term loans ( i.e., loans with an initial term of three years or less), secured by first mortgage liens on real estate property held for investment purposes located primarily in Connecticut. Generally, borrowers use the proceeds from our loans for one of three purposes: (i) to acquire and/or renovate existing residential (single-, two- or three-family) real estate properties; (ii) to acquire vacant real estate and construct residential real properties; and (iii) to purchase and hold income producing properties. Our mortgage loans are structured to fit the needs and business plans of the borrowers. Revenue is generated primarily from the interest borrowers pay on our loans and, to a lesser extent, loan fee income generated on the origination and extension of loans.
At December 31, 2020, our mortgage loan portfolio included loans ranging in size from $2,600 to $10,780,000. Approximately 71% of the mortgage loans have an original principal amount of $250,000 or less, with an average mortgage loan size of approximately $314,000 and a median mortgage loan size of approximately $157,000. The table below gives a breakdown of our mortgage loan portfolio by loan size as of December 31, 2020:
Aggregate
Number of
Principal
Amount
Loans
Amount
$100,000 or less
140
$
9,456,456
$100,001 to $250,000
210
33,790,106
$250,001 to $500,000
90
31,152,104
$500,001 to $1,000,000
28
18,137,053
Over $1,000,000
27
63,080,581
Total
495
$
155,616,300
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Most of our loans are funded in full at closing. However, where all or a portion of the loan proceeds are to be used to fund the costs of renovating or constructing improvements on the property, only a portion of the loan may be funded at closing. At December 31, 2020, our loan portfolio included 128 loans with future funding obligations, having a funded principal amount of $41,140,683 and $19,601,731 unfunded pending borrower performance. Advances under these loans are funded against requests supported by all required documentation (including lien waivers) as and when needed to pay contractors and other costs of construction.
In general, our strategy is to service and manage the loans we originate until they are paid. At December 31, 2020, approximately 86% of the loans in our portfolio (representing approximately 77% of the aggregate outstanding principal balance of our loan portfolio) were secured by properties located in Connecticut. In comparison, at the end of 2019, approximately 90% of the loans in our portfolio (representing approximately 89% of the aggregate outstanding principal balance of our loan portfolio) were secured by properties located in Connecticut. Most of the properties we finance are residential investment, or commercial. However, in all instances the properties are held only for investment by the borrowers and may or may not generate cash flow. The table below gives a breakdown of our loan portfolio by state as of December 31, 2020:
Number of
State
Loans
Amount
Percentage
Arizona
1
$
1,500,000
0.97
%
California
1
3,150,000
2.02
%
Connecticut
427
119,818,849
77.00
%
Florida
17
15,005,662
9.64
%
Massachusetts
22
4,419,553
2.84
%
Maine
1
35,384
0.02
%
New York
13
6,434,029
4.14
%
Rhode Island
8
1,933,606
1.24
%
Tennessee
1
82,500
0.05
%
Texas
4
3,236,717
2.08
%
Total
495
155,616,300
100
%
The typical terms of our loans are as follows:
Principal amount. We have a policy that will limit the amount of any loan to 10% of our total loan portfolio after accounting for the loan in question. At December 31, 2020, our loan portfolio included loans ranging in size from $2,600 to $10,780,000. Approximately 71% of the loans had an original principal amount of $250,000 or less and 89% had an original principal amount of $500,000 or less. The average loan size was approximately $314,000 and the median loan size was approximately $157,000.
Loan-to-Value Ratio. Our underwriting guidelines require that the original principal amount of a loan may not exceed 70% of the fair market value of the property securing the loan. In the case of properties undergoing renovation, the loan-to-value ratio is calculated based on the estimated fair market value of the property after the renovations have been completed.
Interest rate. Currently, a fixed rate between 5.0% to 13.0% per annum with a default rate of 18% per annum.
Origination fees. Ranges from 2% for loans of one year or less to 5% for three-year loans. In the case of three-year loans, a portion of the origination is credited back to the borrower in the event the loan balance is paid off early. In addition, if the term of the loan is extended, additional points are payable upon the extension.
Term. Generally, one to three years with early termination in the event of a sale of the property. Recently, to mitigate the risks associated with rising interest rates, whenever possible, we seek to limit the term on new loans to one year. We may agree to extend the maturity date so long as the borrower complies with all loan covenants, financial and non-financial, and the loan otherwise satisfies our then existing underwriting criteria. As a matter of policy, we will only extend the maturity for one year at a time, although there is no limit on the number of times the same loan can be extended. We treat a renewal or extension of an existing loan as a new loan.
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Prepayments. Borrower may prepay the loan at any time without premium or penalty.
Covenants. To timely pay all taxes, insurance, assessments, and similar charges with respect to the property; to maintain hazard insurance; to maintain and protect the property.
Events of default. Include: (i) failure to make payment when due; or (ii) breach of a covenant.
Payment terms. Interest only is payable monthly in arrears. Principal is due in a “balloon” payment at the maturity date.
Escrow. Generally, none required.
Reserves. Generally, none required. However, in some cases, we will require that the buyer prepay certain expenses, such as insurances, taxes and/or interest.
Security. Each loan is evidenced by a promissory note, which is secured by a first mortgage lien on real property owned by the borrower. Each loan is guaranteed by the principals of the borrower, which guaranty is usually secured by a pledge of the guarantor’s interest in the borrower or other real estate owned by the guarantor.
Fees and Expenses. Borrowers pay an application fee, an inspection fee, wire fee, bounced check fee and, in the case of construction loans, check requisition fee for each draw from the loan. Finally, as is typical in real estate finance transactions, the borrower pays all expenses relating to obtaining the loan including the cost of a property appraisal, the cost of an environmental assessment report, if any, the cost of a credit report and all title, recording fees and legal fees.
Operating Data
Our lending activities increased each year since we commenced operations and we have reported net profits in every quarter since our IPO. We believe this trend will continue for the foreseeable future.
Our Loan Portfolio
At December 31, 2020, our mortgage loan portfolio included 495 loans having an aggregate outstanding principal balance of $155.6 million. In comparison, at December 31, 2019, our loan portfolio included 438 loans having an aggregate outstanding principal balance of $94.3 million. The following tables highlight certain information regarding our real estate lending activities for the periods indicated.
Year Ended
December 31,
2019
2020
Loans originated
$
64,742,552
$
117,230,923
Loans repaid
$
43,347,362
$
54,961,570
Mortgage lending revenues
$
11,848,873
$
16,165,084
Mortgage lending expenses
$
5,041,609
$
8,050,668
Number of loans outstanding
438
495
Principal amount of loans earning interest
$
94,348,689
$
155,616,300
Average outstanding loan balance
$
215,408
$
314,376
Weighted average contractual interest rate (1)
12.42
%
11.79
%
Weighted average term to maturity (in months) (2)
10
8
(1) Does not include origination fees.
(2) Without giving effect to extensions.
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The following table details our mortgage loan portfolio as of December 31, 2020 by year of origination:
Aggregate
Number of
Principal
Year of Origination
Loans
Amount
2020
215
$
90,587,437
2019
127
34,894,813
2018
60
11,955,978
2017
49
12,120,373
2016
20
2,919,555
2015 and prior
24
3,138,144
Total
495
$
155,616,300
Historically, most of our loans are paid prior to their maturity dates. For example, of the loans that were repaid in full during 2020, approximately 82.4% were repaid prior to maturity. Similarly, for 2019, approximately 81.5% of the loans repaid during that year were paid prior to maturity. Our loan portfolio at December 31, 2020 included 93 mortgage loans of which ( i.e., approximately 19% of the loans in our portfolio) had matured in 2020 but have not been repaid in full or extended. These loans are in the process of modification and will be extended if the borrower can satisfy our underwriting criteria, including the proper loan-to-value ratio, at the time or renewal. We treat renewals and extensions of existing loans as new loans.
We monitor our loans on a day-to-day basis. We generate daily reports from our loan tracking software that provides us with detailed information on each loan in our portfolio including the maturity date of the loan, the date the last payment was received, the date the next payment is due, the amount, if any, in arrears, whether we have received any notice from the insurance carrier that a claim has been made or that coverage has been discontinued and whether we have received any notice from the taxing authority of a lien for non- payment of taxes. If there is a default, we immediately contact the borrower to determine the reasons underlying the default and what action the borrower plans to take to cure the default. Once we become aware of the default, we continue to monitor the loan closely until we are satisfied that the situation has been resolved. Generally, we do not make periodic inspections of the properties securing our loans or obtain new appraisals during the term of the loan even if there is a default. However, if the borrower desires to extend the term of the loan, since we treat that as a new loan, we undertake all our underwriting procedures, including, if necessary, a new appraisal.
As a real estate finance company, we deal with a variety of default situations, including breaches of covenants, such as the obligation of the borrower to maintain adequate liability insurance on the mortgaged property, to pay the taxes on the property and to make timely payments to us. As such, we may not be aware that a default occurred. At December 31, 2020, of the 495 mortgage loans in our portfolio, 16, or approximately 3.23%, were in the process of foreclosure. The aggregate outstanding principal balance and the accrued but unpaid interest and borrower charges on these loans as of December 31, 2020 was approximately $3.1 million, or approximately 2.0% of our mortgage loan portfolio. In the case of each of these loans, we believe the value of the collateral exceeds the outstanding balance on the loan and, accordingly, we have not reserved for any losses. In comparison, at December 31, 2019, of the 438 mortgage loans in our portfolio, nine, or approximately 2.1%, were in the process of foreclosure. The aggregate outstanding principal balance, accrued but unpaid interest and borrower charges on these loans as of December 31, 2019 was approximately $2.8 million, or approximately 3.0% of our loan portfolio. In the case of each of these loans, we believe the value of the collateral exceeds the outstanding balance on the loan and, accordingly, we have not reserved for any losses.
In addition, as our business and mortgage loan portfolio has grown, we realize that late payments could adversely impact our performance and could adversely impact our ability to comply with loan covenants under a credit facility. As a result, over the last few years we have been more aggressive in asserting our right to collect late payment fees. As a result, revenue from late payment fees increased initially. Notwithstanding our aggressive stance, we realized that certain borrowers may have difficulty staying current on their obligations. Thus, if a borrower can demonstrate true “hardship”, we will not enforce our rights immediately and give the borrower an opportunity to cure its default. We do not have any specific definitive criteria as to what constitutes hardship or the period we will forbear. Some of the factors we will consider include the nature of the default ( i.e. , whether nonpayment of amounts due or breach of a covenant or agreement), the reason or reasons for the default, our cash flow requirements, the nature and length of our relationship with the borrower, whether or not the borrower has a history of non-payment and the loan-to-value ratio at the time of the default.
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At December 31, 2020, 12 affiliated borrowers accounted for 6.0% of our loan portfolio. At December 31, 2019, 11 affiliated borrowers accounted for 6.5% of our loan portfolio.
The following tables set forth information regarding the types of properties securing our mortgage loans outstanding at December 31, 2020 and 2019 and the interest earned in each category:
At December 31,
2019
2020
Developer–Residential Mortgages
$
71,605,920
$
112,240,128
Developer–Commercial Mortgages
16,122,990
33,548,683
Land Mortgages
5,639,979
6,111,670
Mixed Use
979,800
3,715,819
Total Mortgages Receivable
$
94,348,689
$
155,616,300
For the Years Ended December 31,
2019
2020
# of Loans
Interest Earned
%
# of Loans
Interest Earned
%
Residential
351
$
7,401,076
75.9
405
$
9,969,162
72.1
Commercial
64
1,666,447
17.1
67
2,979,792
21.6
Land Mortgages
16
582,939
6.0
13
542,838
3.9
Mixed Use
7
101,271
1.0
10
330,039
2.4
Total
438
$
9,751,733
100.0
495
$
13,821,831
100.0
At December 31, 2020: 427 loans, which accounted for approximately 77.0% of the aggregate outstanding principal balance of our loan portfolio, were secured by properties located in Connecticut; 17 loans, which accounted for approximately 9.64% of the aggregate outstanding principal balance of our loan portfolio, were secured by properties located in Florida; 13 loans, which accounted for approximately 4.14% of the aggregate outstanding principal balance of our loan portfolio, were secured by properties located in New York; 22 loans, which accounted for approximately 2.84% of the aggregate outstanding principal balance of our loan portfolio, were secured by properties located in Massachusetts; four loans, which accounted for approximately 2.08% of the aggregate outstanding principal balance of our loan portfolio, were secured by properties located in Texas; one loan, which accounted for approximately 2.02% of the aggregate outstanding balance of our loan portfolio, was secured by properties located in California; eight loans, which accounted for approximately 1.24% of our loan portfolio, was secured by a property located in Rhode Island; and one loan, which accounted for approximately 0.97% of our loan portfolio, was secured by property located in Arizona; and two loans, which accounted for approximately 0.07% of the aggregate outstanding principal balance of our loan portfolio, were secured by properties located in Maine and Tennessee.
At December 31, 2019: 393 loans, which accounted for approximately 88.7% of the aggregate outstanding principal balance of our loan portfolio, were secured by properties located in Connecticut; 18 loans, which accounted for approximately 3.8% of the aggregate outstanding principal balance of our loan portfolio, were secured by properties located in Massachusetts; 14 loans, which accounted for approximately 4.0% of the aggregate outstanding principal balance of our loan portfolio, were secured by a property located in New York; 10 loans, which accounted for approximately 1.6% of the aggregate outstanding balance of our loan portfolio, were secured by properties located in Rhode Island; one loan, which accounted for approximately 1.6% of our loan portfolio, was secured by a property located in Arizona; and two loans, which accounted for approximately 0.4% of our loan portfolio, were secured by properties located in Florida.
Our Origination Process and Underwriting Criteria
Our management and underwriting team are experienced in hard money lending under various economic and market conditions. Our chief executive officer, John L. Villano, spends a significant portion of his time on business development as well as on underwriting, structuring and servicing each loan in our portfolio. A principal source of new transactions has been repeat business from existing and former customers and their referral of new business. We also receive leads for new business from banks, brokers, attorneys and web-based advertising.
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When underwriting a loan, the primary focus of our analysis is the value of a property. Prior to making a final decision on a loan application we conduct extensive due diligence of the property as well as the borrower and its principals. We rely on readily available market data, including appraisals when available or timely, tax assessment rolls, recent sales transactions and brokers to evaluate the value of the collateral.
We also order title, lien and judgment searches. In most cases, we will also make an on-site visit to evaluate not only the property but the neighborhood in which it is located. Finally, we analyze and assess selected financial and operational data provided by the borrower relating to its operation and maintenance of the property. In terms of the borrower and its principals, we usually obtain third party credit reports from one of the major credit reporting services as well as selected personal financial information provided by the borrower and its principals. We analyze all this information carefully prior to making a final determination.
Ultimately, our decision is based primarily on our conclusions regarding the value of the property, which takes into account factors such as the neighborhood in which the property is located, the current use and potential alternative use of the property, current and potential net income from the property, the local market, sales information of comparable properties, existing zoning regulations, the creditworthiness of the borrower and its principals and their experience in real estate ownership, construction, development and management. In conducting due diligence, we rely, in part, on third party professionals and experts including appraisers, engineers, title insurers and attorneys.
Before a loan commitment is issued, the loan must be reviewed and approved by our chief executive officer. Our loan commitments are generally issued subject to receipt by us of title documentation and title report, in a form satisfactory to us, for the underlying property. We also require a personal guarantee from the principal or principals of the borrower.
Our Current Financing Strategies
To continue to grow our business, we must increase the size of our loan portfolio, which requires that we raise additional capital either by selling shares of our capital stock or by incurring additional indebtedness. Our operating income in the future will depend on the amount of debt incurred and the spread between our cost of funds and the yield on our loan portfolio. Rising interest rates could have an adverse impact on our business if we cannot increase the rates on our loans to offset the increase in our cost of funds and to satisfy investor demand for yield. For example, in 2019, we sold $23,663,000 unsecured unsubordinated 5-year notes at 7.125% and $34,500,000 unsecured unsubordinated 5-year notes at 6.875%. In 2020, we sold unsecured unsubordinated 5-year notes having an aggregate original principal amount of $56,363,750 at 7.75%. The gross proceeds to us from the sale of these notes was $56,083,750. In addition, rapidly rising interest rates could have an unsettling effect on real estate values, which could compromise some of our collateral.
We do not have any formal policy limiting the amount of indebtedness we may incur. At December 31, 2020, debt capital represented approximately 64.3% of our total capital compared to 35.7% at December 31, 2019. Depending on various factors we may, in the future, decide to incur additional debt to expand our mortgage loan portfolio to increase the potential returns to our shareholders. Although we have no pre-set guidelines in terms of leverage ratio, the amount of leverage we will deploy will depend on our assessment of a variety of factors, which may include the liquidity of the real estate market in which most of our collateral is located, employment rates, general economic conditions, the cost of funds relative to the yield curve, the potential for losses and extension risk in our portfolio, the gap between the duration of our assets and liabilities, our opinion regarding the creditworthiness of our borrowers, the value of the collateral underlying our portfolio, and our outlook for interest rates and property values. However, to prudently grow the business and satisfy the tax requirement to distribute 90% of our taxable income, we expect to maintain our current level of debt and look to reduce our cost of capital. We intend to use leverage for the sole purpose of financing our portfolio and not for speculating on changes in interest rates.
As discussed above, in 2020, we raised approximately $56.1 million (after taking into account original issue discount) from the sale of unsecured unsubordinated 5-year notes. In addition, in 2020, we opened a margin loan account with Wells Fargo. At December 31, 2020, the balance on that account was $28.1 million, which we use to fund new mortgage loans and for working capital and general corporate purposes.
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The following table shows our sources of capital, including our financing arrangements, and our loan portfolio as of December 31, 2020:
Sources of Capital:
Debt:
Bonds payable, net
$
109,640,692
Line of credit
28,055,648
Mortgage payable
767,508
Total debt
138,463,848
Other liabilities
7,286,796
Total liabilities
145,750,644
Capital (equity)
80,919,540
Total sources of capital
$
226,670,184
Assets:
Cash and short-term marketable securities
$
56,701,731
Mortgages receivable
155,616,300
Other assets
14,352,153
Total assets
$
226,670,184
Management
Commencing with our IPO, our founders, Jeffrey C. Villano and John L. Villano, served as co-chief executive officers. In addition, Jeffrey C. Villano served as our president and treasurer and John L. Villano served as our chairman, chief financial officer and secretary. On November 20, 2019, Jeffrey C. Villano resigned from his positions as our co-chief executive officer, president and treasurer. On December 10, 2019, he also resigned as a member of the board of directors. Upon his resignation, the board of directors confirmed John L. Villano as our sole chief executive and appointed him as president and treasurer as well. John L. Villano then resigned as secretary and Peter Giannotti, our in-house counsel, was appointed as secretary in his place.
Pursuant to his employment agreement with us, John L. Villano is required to devote 100% of his time and efforts to our business and has discontinued all other business activities in which he might be engaged even if it does not conflict with our business.
Effective as of July 1, 2020, the board of directors appointed Peter J. Cuozzo as our executive vice president and chief operating officer. His duties include but are not limited to overseeing and supervising our expansion into other markets including, but not limited to, Florida and Texas.
Competition
The real estate finance markets in Connecticut and other geographic areas in which we operate are highly competitive. Our competitors include traditional lending institutions such as regional and local banks, savings and loan institutions, credit unions and other financial institutions as well as other market participants such as specialty finance companies, REITs, investment banks, insurance companies, hedge funds, private equity funds, family offices and high net worth individuals. In addition, we estimate that, in addition to us, there are numerous “hard money” lenders of significant size serving these markets. Many of these competitors enjoy competitive advantages over us, including greater name recognition, established lending relationships with customers, financial resources, and access to capital.
Notwithstanding intense competition and some of our competitive disadvantages, we believe we have carved a niche for ourselves among small real estate developers, owners and contractors throughout Connecticut and the rest of New England as well as in parts of New York State because we are well-capitalized, we have the flexibility to structure each loan to suit the needs of each individual borrower and we can act quickly. In addition, through our marketing efforts we are beginning to develop a brand identity in some of the other markets in which we operate. We believe we have developed a reputation among these borrowers for offering reasonable terms and providing outstanding customer service. We believe our future success will depend on our ability to maintain and capitalize on our existing relationships with borrowers and brokers and to expand our borrower base by continuing to offer attractive loan products, remain competitive in pricing and terms, and provide superior service.
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Sales and Marketing
We do not engage any third parties for sales and marketing services. Rather, we rely on our senior executive officers and our new marketing department to generate lending opportunities as well as referrals from existing or former borrowers, brokers, bankers and web-based advertising. Particularly, in Florida and Texas we rely on brokers for referrals. A principal source of new transactions has been repeat business from prior customers and their referral of new leads.
Over the past year, we have created a pipeline of originating loans via a digital marketing strategy and multiple marketing campaigns. Online marketing and advertising is a productive and cost-effective approach to generate leads. These campaigns place emphasis on digital marketing, targeting those at home or online surfing the web in need of a lender. Sachem has been able to find a new borrower segment by utilizing multiple online advertising platforms. Sachem has also joined a variety of websites to be a “listed lender,” differentiating our services from our competitors in this relatively new virtual advertising world. The objective is to connect with a new audience while creating brand awareness in every new state we enter. Given that 81% of Americans now search online to purchase a product or service, Sachem Capital can now reach this large and ever-growing market segment of potential borrowers.
Intellectual Property
Our business does not depend on exploiting or leveraging any intellectual property rights. To the extent we own any rights to intellectual property, we rely on a combination of federal, state and common law trademarks, service marks and trade names, copyrights and trade secret protection. We have not registered any trademarks, trade names, service marks or copyrights in the United States Patent and Trademark Office.
Employees
As of December 31, 2020, we had 17 employees, including our chief executive officer, of which 12 were full-time.
Regulation
Our operations are subject, in certain instances, to supervision and regulation by state and federal governmental authorities and may be subject to various laws and judicial and administrative decisions imposing various requirements and restrictions. In addition, we may rely on exemptions from various requirements of the Securities Act of 1933, as amended (the “Securities Act”), the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the Investment Company Act and ERISA. These exemptions are sometimes highly complex and may in certain circumstances depend on compliance by third parties who we do not control.
Regulatory Reform
The Dodd-Frank Act, which went into effect on July 21, 2010, is intended to make significant structural reforms to the financial services industry. For example, pursuant to the Dodd-Frank Act, various federal agencies have promulgated, or are in the process of promulgating, regulations with respect to various issues that may affect us. Certain regulations have already been adopted and others remain under consideration by various governmental agencies, in some cases past the deadlines set in the Dodd-Frank Act for adoption. We do not believe any regulations adopted under the Dodd-Frank Act apply to us. However, it is possible that regulations that will be adopted in the future will apply to us or that existing regulations will apply to us as our business evolves.
Regulation of Commercial Real Estate Lending Activities
Although most states do not regulate commercial finance, certain states impose limitations on interest rates and other charges and on certain collection practices and creditor remedies and require licensing of lenders and financiers and adequate disclosure of certain contract terms. We also are required to comply with certain provisions of, among other statutes and regulations, certain provisions of the Equal Credit Opportunity Act that are applicable to commercial loans, The USA PATRIOT Act, regulations promulgated by the Office of Foreign Asset Control and federal and state securities laws and regulations.
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Investment Company Act Exemption
Although we reserve the right to modify our business methods at any time, we are not currently required to register as an investment company under the Investment Company Act. However, we cannot assure you that our business strategy will not evolve over time in a manner that could subject us to the registration requirements of the Investment Company Act.
Section 3(a)(1)(A) of the Investment Company Act defines an investment company as any issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities. Section 3(a)(1)(C) of the Investment Company Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. Government securities and cash items) on an unconsolidated basis, which we refer to as the 40% test. Real estate mortgages are excluded from the term “investment securities.”
We rely on the exception set forth in Section 3(c)(5)(C) of the Investment Company Act which excludes from the definition of investment company “any person who is not engaged in the business of issuing redeemable securities, face-amount certificates of the installment type or periodic payment plan certificates, and who is primarily engaged in one or more of the following businesses... (C) purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.” The U.S. Securities and Exchange Commission (the “SEC”) generally requires that, for the exception provided by Section 3(c)(5)(C) to be available, at least 55% of an entity’s assets be comprised of mortgages and other liens on and interests in real estate, also known as “qualifying interests,” and at least another 25% of the entity’s assets must be comprised of additional qualifying interests or real estate-type interests (with no more than 20% of the entity’s assets comprised of miscellaneous assets). We believe we qualify for the exemption under this section and our current intention is to continue to focus on originating short term loans secured by first mortgages on real property. However, if, in the future, we do acquire non-real estate assets without the acquisition of substantial real estate assets, we may qualify as an “investment company” and be required to register as such under the Investment Company Act, which could have a material adverse effect on us.
If we were required to register as an investment company under the Investment Company Act, we would become subject to substantial regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with affiliated persons (as defined in the Investment Company Act), portfolio composition, including restrictions with respect to diversification and industry concentration, and other matters.
Qualification for exclusion from the definition of an investment company under the Investment Company Act will limit our ability to make certain investments. In addition, complying with the tests for such exclusion could restrict the time at which we can acquire and sell assets.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.