How to Make a Profit from California Trust Deed Investments
If structured properly, California trust deed investments offer an attractive current yield with relatively low risk. Here’s how to make a profit.
First of all, a trust deed investor is a person seeking a competitive rate of return by loaning private funds on real estate. In short, you’re the bank. The loans are secured by real estate. Trust deed investors make a higher interest yield than would typically be obtained by a regular bank and is secured by the borrower’s equity in the real estate transaction
Compared to government or corporate bond issuance, individual trust deed investments are relatively small. The limited supply and high demand leads to a high yield for trust deed investors. Trust deed investors usually earn high single-digit annual returns, paid monthly. In some cases, returns above 10% are possible. These returns are very favorable relative to other investment options with similar risk profiles. The risk of losing money in a trust deed investment is mitigated by a built in “margin of safety.”
There are four main options for someone interested in California trust deed investments:
- Personally source individual loans and lend money directly to real estate investors.
- Purchase loans backed by real estate from brokers.
- Invest in a fund that invests in trust deeds.
- Identify people who are directly investing in trust deeds as a group and invest along with them.
The most important aspect of trust deed investing is the ability to distinguish the good deals from the bad ones. You will need to invest the time in learning about the different deals. Once you have these skills, trust deed investing is not time-consuming at all. The tasks involved include sourcing prospective deals, evaluating the deals on their economic merits, and conducting due diligence on the property and borrower.
Here is what you need to know about hard money lenders:
Hard money lenders are important participants in the trust deed market. A hard money lender is a non-bank lender that makes loans with more lenient lending standards than a bank. To compensate themselves for moving quickly and funding loans banks won’t fund, hard money lenders charge higher rates than banks.
Hard money lenders use private capital to fund loans secured by real property. The business model is simple: there are one or more investors on one side of the deal and a borrower on the other. The entity issuing or brokering the loan must charge the borrower enough to pay the investor(s) the return they are seeking and retain enough to cover their own overhead and desired profit margin.
How trust deed investors get paid:
California trust deed investors receive monthly payments at the agreed upon interest rate. These payments can be structured in various ways. One is partially amortized monthly payments containing interest and some principal; another is with a balloon payment balance delivered at the end of the loan term. When the borrower pays off the loan or the loan term expires, the investor receives payment for the principal investment and any remaining interest owed.
These interest payments tend to be higher when compared to other fixed income securities like government bonds. It also tends to be more predictable and substantial than stocks or equity because of the real estate collateral.
Basically, if you decide to start trust deed investing, you stand to make money when the borrower pays back the loan in full or if the borrower defaults on the loan and you foreclose on the property in order to recover your investment.
California trust deed investments are very simple to understand. Essentially, most investors will have had some experience being a borrower on a home loan. If you understand how a home loan works, the rest is simple. By owning a Deed of Trust, you are taking the place of the bank or lender. With a good equity position, borrowers who are in trouble generally sell the property and pay off the loan rather than letting it go to foreclosure and risk losing their equity.