Pros and Cons of Trust Deed Investment Every Investor Should Know
When property understood, a trust deed investment can provide profitable returns. According to Scotsman Guide, “private investments in trust deeds typically have yielded investors returns of between 9 percent and 15 percent annually depending on risk tolerance. Those investments have experienced similar or larger losses as compared to investments within more-traditional equity and debt markets since the start of the recession, however.”
Before you get started, however, you should know about the risks and rewards of trust deed investing.
There are many pros to a trust deed investment and trust deed investments are one of the safest high-yield investment vehicles available. First of all, investors can choose to take an active role in structuring the investment with the help of their escrow and mortgage broker. However, if the investor wants to let the professionals take care of their investments, they can do that as well. Also, unlike other investments, trust deed lending allows investors to hand craft their investment.
Here are various pros to a trust deed investment according to The Lending Mag:
- Predictability: Payments are fixed and contractually agreed to in the note and deed of trust (the security instruments). The payment period may be monthly, quarterly, annually or even at maturity.
- Ease: Private lending is real estate related, but there are few management issues or typical landlord issues such as property upkeep and maintenance and time intense management activities such as evictions, tenant qualifications, problematic tenants, repairs and upkeep and the like.
- Semi-Liquidity: Like stocks, private notes can be sold, exchanged and even used as collateral to borrow against.
- Term: Trust deeds can be formed for periods as short as 1 month and as long as 30 years. Most borrowers prefer to use the funds for 12-36 months. Private lenders simply state how long they are comfortable keeping their capital in play and participate in transactions that fit the desired time.
- Collateral Asset: The private borrowing community is vast and diverse, as is the collateral. Private lenders can choose assets with which they are most familiar: industrial properties, land, single family residences, office buildings, condos, leaseholds, medical office buildings, fuel stations and car washes, apartments, and retail operations are just a few of the potential assets.
- Yield and Risk: Lenders are the best judge of how much they want to risk and what yield is acceptable. Traditionally, the lower the yield, the safer the investment…so investing in a first trust deed of $300,000 on a four plex in Los Angeles with $1mm of protective equity may produce a coupon of 7.000% APY while the same investment in Golden, Colorado with only $200,000 of protective equity could produce a coupon of 10.500%. There are not “set” yields or pre-determined measures of risk: each transaction and its various components offer different opportunities.
- Location: Where the asset is located is almost always an important and a deciding factor if a private money loan is made. Many private lenders are OK with lending nationally, while others may only lend where they are comfortable and where they can periodically check the collateral asset to make sure that it’s being properly cared for. In many cases investors are intimate to specific regions or areas due to where they might have attended school, where they might have worked or where they might have been raised and grew up. We cannot stress enough the importance of properly selecting the areas in which the capital is deployed.
- Being Involved: Private lending is supported by a large community of professionals that know the business and can make each transaction run smoothly. Title, escrow, loan servicers, appraisers, contractors, lawyers, real estate agents, loan brokers, loan underwriters and processors all contribute to originate, underwrite, document and make legal the loan opportunity. Once the transaction closes there are folks that service the loan month by month, year by year… Private lenders often choose to stay involved in some area of the deal: they might want to inspect the asset and kick the tires, review or meet the loan applicant or simply service their own loan and collect monthly payments.
It is important to always know both the pros and cons of any potential investment. Here are some of the cons according to The Lending Mag:
- Mortgage brokers are touting double-digit returns on trust deed investments.
- Trust deed investments are not insured by the FDIC or any other government agency.
- If a borrower files for bankruptcy, it could affect the foreclosure process and cost investors large amounts of money on resultant legal fees.
- Since a single investor doesn’t need to put up the entire loan sum in fractionalized trust deed investments, this may be the preferred method for those with less money to invest.
- Lenders in fractionalized trust deeds may not have possession of original documents, which could turn into a problem down the line.
In order to mitigate the risk of trust deed investing and to increase the quality of collateral, private first-trust-deed investments will focus on small bridge loans that amount to less than the minimums required by traditional lenders. Developing a concentrated strategy of investing in assets, private first-trust-deed investments offer investors the opportunity to make high profits on low-risk collateral while also providing borrowers with a funding source that works for them.