As a trust deed investor, you take on the roll of a Bank by lending money, secured by real property, to borrowers or properties that do not meet the current restrictive Banking criteria.
These restrictive guidelines have created tremendous opportunity in the small balance real estate space. This tightening of credit has left many borrowers unable to obtain the financing needed, providing opportunity for private individuals to fill this void and earn higher returns without taking on unnecessary risks.
The main consideration of the private lender is the protective equity (the difference between the loan and the market value of the property) and a reasonable exit strategy of the borrower for repaying the loan.
Trust Deeds are similar to bonds or other fixed rate investments, here is a quick comparison of some of the similarities and key differences:
|Borrower||Real Estate Investor/
|Corporation or Government|
|Collateral||Secured by real estate||Asset of Corporation or Full Faith and Credit of the Government|
|Volatility||Low||High- subject to national and global market and economic influences/risk|
|Insurable against Loss||Yes, (fire, flood etc)||No|
|Yield||7-12%||.01% – 4.5%*|
|*Source Yahoo Finance 5/23/14. .01% 3 month Treasury – 4.5% 20 year A rated corporate bond|
Investing Options – 3 Methods
There are 3 primary methods by which an investor can take advantage of the higher yields available in trust deeds investing. Each with their own degree of investor involvement and capital requirements, the investor can select the methods they are most comfortable with or even allocate assets toward the various methods.
1. Individual or Whole Loan Trust Deed Investing
This type of trust deed investing refers to an investor that fully funds a loan on one particular property.
One risks associated with individual trust deed investing is the lack of diversification. Since the investor’s entire investment is secured by a single property, the investment holds more potential risk as opposed to an investment spread over several properties. This concentration of assets into a single property also exposes him to zero return should that single investment payoff until he can redeploy his capital, thereby diluting yields.
Another challenge to whole deed investing is limitation on available investment funds. When dealing with whole trust deed investments, a single investor must have sufficient capital to fund the entire loan request. Individual investors may have insufficient funds to act as the sole funding source for a larger loans or investing in several individual trust deeds, thus increasing diversification risks discussed above.
For these additional risks and personal involvement however, the investor usually receives a slightly higher return.
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2. Fractionalized Investing
This type of investing refers to a group of investors, each funding a percentage of the total amount of the loan request.
For example, if a borrower required a $500,000 loan, the note may be “fractionalized” up to 10 different investors, each contributing $50,000, thus each investor would own 10% of the transaction. All 10 investors would be vested on the recorded deed of trust and they would share in the profits based on percentage of initial contribution. Investor interests do not have to be equal, for example, one investor could fund $250,000 and own 50% of the trust deed from the example above.
Fractionalized investing can permit investors with smaller amounts to participate in larger investments or spread their investment capital amongst several properties, thereby minimizing diversification risks.
Fractionalized investing can present problems if there are disputes between the multiple investors concerning the disposition of the property in the event of a default. Since each investor is a vested partial owner of the note and trust deed, 51% of the group of investors must come to an agreement whenever there is a question of how to proceed.
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3. Fund Investing
This is also referred to as a “mortgage pool” or “Blind Investment”.
This method allows investors to combine their investment funds together by purchasing interests in the Fund (usually an LLC) and then the Fund invests in a variety of transactions providing the most diversification across property type, note duration and even geography. Funds work very similarly in concept to mutual funds where the Mutual Fund Manager invests in a variety of stocks across multiple industry segments on behalf of the investors of the mutual fund.
When an investor purchases shares of the fund, they obtain a proportionate interest in all of the loans in the Fund. Interest earnings from the loans in the Fund are typically passed directly to investors, who can choose to receive distribution checks or reinvest the monies back into the fund.
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For more information on Fund investing, visit Platinum Real Estate Fund l, LLC
Sources of Funding Capital
Investors can invest personal saving, corporate funds, trusts monies and from various types of self directed retirement accounts.
Cash and Savings
Investors can use personal savings or business savings to invest in trust deeds. One major consideration is liquidity. Due to the nature of real estate investing, it is not as liquid as some other investments so consideration should be given to the duration of the investment chosen relative to possible future capital needs.
Funding with Retirement Accounts
Investors can invest in trust deed through a self directed IRA. There are many IRA custodians that will allow investing in trust deeds and other alternative investments. This is an attractive option because it creates an opportunity to grow your retirement savings in a tax-sheltered environment and usually liquidity is not as big of concern.
Custodians of pension monies can also make trust deed investments.