Fractionalized trust deeds seem like the prudent way to go for beginning investors or for those who have taut resources but want to invest in trust deeds in California. There are two options. There’s the one kind that are offered by some states where you purchase the trust deed for a shorter amount of time than usual, let’s say six months instead of a year and assess it as you go. Want longer? Extend your term or buy more.
There’s another type of fractionalized trust deed where people pool their resources together and own slices of the trust deed. So, for instance, your share may be 15% while those of collaborators are 25 percent, 4 percent or whatever percent of a trust deed that is broken up into pieces. Quite a few companies offer this resource. You can also go this route by finding a friend or colleague who wants to invest with you and share resources. This type of fractionalized trust deeds is also common in the mortgage broker world – and is becoming more so as the industry progresses.
The first type of fractionalized trust deeds has comparatively few problems. It is safe.
Many investors like the second type but Peter Rosenthal president of V.I.P. Trust Deed Company warns that these fractionalized trust deeds are more dangerous than they appear.
Unity of actions and documents is key.
In a regular trust deed investment, the investor claims 100 percent of the investment and owns the promissory note, the trust deed, the title policy and fire insurance policy – each in its original form. With a fractionalized trust deed, the broker retains the documents and merely gives lenders a copy to evidence their ownership.
If problems arise in a regular trust deed investment, the lender can deal with that problem with your complete accord. You are dealing with one (or more problems) there is no one else involved. That Is the beauty of unity where you own all.
Conversely, with fractionalized trust deeds, the trust deed is broken into fractions with all investors having to agree before you are able to solve your problem. For example, two of the fractions may have their percent to advance to a senior lien holder, but some of the other fractions may refuse. The buck’s going back and forth and you emerge with far more stress than necessary (if you emerge with a profit at all!). In the worst scenario, your broker gets into financial difficulties or closes down. Your ‘fractionalized’ company’s adrift and each has to fend for herself.
Rosenthal’s story that he tends to tell when cautioning his clients perfectly shows you the dangers of this approach:
I received a call the other day from a fractionalized investor who was in such a situation and wished to sell the fraction. Fractionalized trust deeds are salable (at a higher discount than a whole trust deed), however this fractionalized investor was totally in the dark as to the true status of the investment. It appeared that the note was worthless and if so the fraction was worthless.
This caller had read some of my columns on the subject and even read my “what to do if one is in this situation” column. The first question that I asked was, “Have you had a meeting with the other fractions?” the answer stupefied me. There had been no meetings because the broker claimed that the names of the other investors was “confidential information.” Actually nothing could be further from the truth.
If you still want to go ahead with a fractionalized trust deed because you find it cheaper or for whatever reasons here are three steps you can take to protect yourself:
- Make sure you have regular meetings with each member of your group being involved. Do not end these meetings until you have a clear sense of direction and until you uniformly agree on all matters.
- Make sure your group is as small as possible. Eight or nine people the maximum.
- If possible, hire a qualified real estate attorney to advise and represent your group.
Finally and most important: Do not invest in a fractionalized trust deed unless you personally know the other fractions.