The §3(c)(5)(C) asset test requires a mortgage fund to maintain qualifying interests at or above 55% of total assets and real-estate-related assets at or above 80%, measured on each quarterly date. If either floor is breached, the fund must take corrective action before the next measurement date or risk losing its Investment Company Act exemption.

Step 1: Build the Asset Inventory

Start with a complete balance-sheet snapshot on the measurement date. For each position in the portfolio, record the instrument type, unpaid principal balance, lien position (first or subordinate), collateral classification, and the value assigned to that asset. Capture whole mortgage loans, B-notes, mezzanine positions, mortgage-backed securities, and fee interests in real property as separate line items. Cash, Treasuries, and other non-real-estate holdings form a distinct category that affects both test floors. Every asset on the balance sheet must appear on the inventory before the classification step begins.

Step 2: Classify Each Asset

Investment Company Act §3(c)(5)(C) and the SEC no-action guidance establish three classification tiers.

• Qualifying interests (Tier 1): Whole mortgage loans senior secured by real estate, fee interests in real property, and other interests the SEC has recognized as qualifying under its no-action position framework.
• Real-estate-related assets (Tier 2): All qualifying interests, plus B-notes, mezzanine loans, agency and non-agency MBS, and equity interests in real-estate-operating companies supported by SEC no-action letters.
• Other assets (Tier 3): Cash equivalents, Treasuries, and non-real-estate holdings.

Document the specific no-action authority behind each classification. The SEC expects a fund’s auditors and counsel to trace every decision back to the underlying guidance, and a contemporaneous rationale is far more defensible than one reconstructed after a question is raised.

Step 3: Run the Two-Tier Test

With every asset classified, compute two ratios against total assets on the measurement date.

• 55% qualifying-interest floor: Divide the aggregate value of Tier 1 qualifying interests by total fund assets. The result must meet or exceed 55%.
• 80% real-estate-related floor: Divide the aggregate value of Tier 1 plus Tier 2 assets by total fund assets. The result must meet or exceed 80%.

Both calculations run independently. A fund that clears the 80% threshold can still fail at 55% if its qualifying-interest concentration is insufficient. Record the ratios and the measurement date together; that pairing is what an auditor or SEC examiner verifies first.

Expert Take

The 55% floor is where most mortgage funds run into trouble, not the 80% floor. A portfolio built around B-notes and mezzanine positions can comfortably clear 80% while falling short at 55%, because those instruments count toward the broader real-estate-related category but not toward qualifying interests. Fund managers who allow B-note and mezzanine concentrations to drift upward without separately tracking the first-tier ratio often discover a compliance gap at the worst time – during an investor audit or a fund restructuring. Running both ratios monthly, not just quarterly, is the practical hedge against that risk.

Step 4: Document the Test Result

Documentation is not a formality. It is the compliance record that protects the fund if the SEC ever questions the exemption. The measurement-date file should include the full asset inventory with values, the classification rationale for every asset with the specific no-action letter or statutory authority cited, the two computed ratios showing compliance with both floors, and confirmation of review by the fund’s SEC counsel. Produce this package contemporaneously – not weeks after the measurement date – and route it through counsel before it goes into the official file.

Step 5: Conduct the Annual Review

The annual review ties together four quarters of measurement-date results under independent scrutiny. The fund’s auditor reviews the asset-classification methodology and the quarterly ratios. SEC counsel reviews the no-action position framework applied to each classification, including any borderline assets that required judgment calls during the year. If any quarter showed either floor approaching its threshold, the annual review is the time to assess whether the current asset mix poses ongoing concentration risk. If a breach occurred and was corrected, the corrective-action record – including the rebalancing steps, the subsequent measurement confirming compliance, and the legal analysis supporting the approach – belongs in the annual review file alongside the standard quarterly documentation.

Related Topics

• §3(c)(5)(C) Questions Fund Managers Ask
• §3(c)(5)(C) vs. §3(c)(1) for Mortgage Funds
• 5 Common Pitfalls in Managing a Fund as a Private Lender
• 10238 Multi-Lender vs. 25102(f) Private Offering

This article is educational and does not constitute legal advice. The §3(c)(5)(C) exemption operates under the Investment Company Act of 1940 and applies to entities primarily engaged in purchasing or acquiring mortgages and other liens on and interests in real estate. Asset classification decisions under the qualifying-interest and real-estate-related frameworks depend on the specific facts of each asset and the current state of SEC no-action guidance. Consult qualified SEC counsel before relying on any classification framework for your fund’s compliance program.

Sources

• Investment Company Act §3(c)(5)(C) – Real Estate Exception. Securities and Exchange Commission.
• SEC Division of Investment Management – No-Action Letters. Securities and Exchange Commission.
• Securities Act Regulation D – Rules 506(b) and 506(c). Securities and Exchange Commission.
• Investment Company Act §3(c)(1) and §3(c)(7). Securities and Exchange Commission.