What is a Trust Deed Investment?
A Trust Deed investment is a loan made by an Investor, commonly referred to as the “Lender,” to a Borrower using real estate as collateral. The instrument used to secure the loan is a Deed of Trust which is recorded as a lien on the property. The Borrower makes payments to the Lender per the terms of the Promissory Note. The loan is repaid once the borrower sells or refinances the property.
Why Invest in Trust Deeds?
Trust Deeds make a good investment because they offer attractive returns (typically between 8% to 12% annually), pay consistent monthly income, and use real estate as collateral. Many investors prefer investing in trust deeds vs. owning rentals because there is no property or tenant management or property upkeep.
Tips on Investing in Trust Deeds
A good rule of thumb for investors new to trust deed investing is to focus on 1st position trust deeds secured on single family or multifamily real estate. It is also highly recommended that new investors keep their trust deeds at or below 65% to 70% of the current market value.
The term “position” refers to the priority of the trust deed. For example, a 1st trust deed has priority over subordinate trust deeds such as a 2nd or 3rd trust deeds. If the property is sold or refinanced, the funds from the transaction would first go to payoff the 1st position lien holder, with any remaining proceeds being used to pay off all subordinate lien holders. If there not sufficient proceeds to repay a subordinate lien holder after the priority lien holder repaid, the subordinate lien holder will take a loss.
It is also recommended that new trust deed investors focus on single family and multi-family real estate. These property classes are considered the most liquid of all real estate asset classes due to the higher number of buyers, the availability of financing, and its ability to produce income. The opposite is true for land where financing is more difficult and buyers for land can be scarce.
Capping trust deed investments at 65% to 70% of current market value (Loan to Value Ratio) can minimize downside risk if property value drops. In the scenario that a Lender funded a trust deed at 65% of the property value, the value would need to drop by 35% (assuming no other costs) before the Lender would take a loss.
What are Common Mistakes made by Trust Deed Investors?
If you invest in trust deeds long enough, you will be required to initiate a foreclosure action. This may occur because of nonpayment, loan maturity, unpaid property taxes / insurance, to name a few. When this occurs, it is referred to a “borrower default” and may result in a foreclosure action.
If a Lender underwrote the transaction correctly using the standard 65% to 70% LTV ratio, the proceeds from the sale of the real estate collateral should repay the loan principal, unpaid interest, and other fees / costs associated with the foreclosure. However, the prior scenario isn’t always the case and here is why:
- Investing in a trust deed at too high of a Loan to Value. If the value of the property drops below the outstanding balance of the loan, the Lender may take a loss. This may occur because the Lender funded at too high of a Loan to Value. Trust Deed investors should take a cautious approach when investing in trust deeds and cap their investments at no greater than 65% to 70% of market value. Remember, unpaid interest and foreclosure costs can accrue quickly and should be considered when examining the risk of a trust deed investment.
- The underlying real estate asset was too complicated or illiquid. When the real estate market slows and values being fall, real estate that experiences the greatest price volatility tend to be complicated assets such as commercial, industrial, hospitality, retail, and land. In poor economies, businesses are more likely to downsize which will in turn push up vacancies and drive down commercial real estate prices. On the other hand, people will always need a place to live so residential real estate may weather better and rebound faster.
- Lender waits to act on a default. Lenders need to take immediate action when a default occurs. Not acting quickly could result in unpaid interest, fees, and foreclosure costs accruing to a point where the borrower owes more than the value of the property.
Investing in Trust Deeds can be an excellent investment option for investors seeking high yields, consistent monthly income, and the security of real estate. However, investing in trust deeds can be risky. To mitigate the risk, investors should consider investing in 1st position trust deeds secured on real estate and no more than 65% to 70% of completed value.
About TaliMar Financial
TaliMar Financial is a California hard money lender located in San Diego, CA. TaliMar Financial specializes in funding Fix & Flip, Construction, and Bridge Loans for residential and commercial real estate. Investors can participate in the loans we originate as a trust deed investor. Contact TaliMar Financial today at (858) 613-0111 or visit talimarfinancial.com to learn more about our trust deed investments.