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Trust Deed investments make an excellent option for investors seeking consistent, monthly cashflow with the security of real estate. In this article, we are going to explain a trust deed investment and the top five mistakes investors make when investing.
A trust deed investment is a loan made an investor to a Borrower and secured by real estate (known as the collateral). Just like a bank, the investor (also known as the Lender) lends money using real estate the Borrower pledges as collateral for the loan. That Borrower then makes monthly payments to the Lender over an agreed period of time. The document that specifics the terms of the loan is called the “promissory note.”
The term “trust deed” comes from the security instrument that that is recorded on the property and secures your loan. Should the Borrower not perform under the terms promissory note, the Lender has the right to initiate a foreclosure action in an effort to return their principal, unpaid interest, and other unpaid costs.
Trust Deeds make an attractive investment because they offer consistent monthly cashflow. Additionally, investors can often invest in their community and unlike owning income properties, trust deeds don’t require an investor to buy or sell property, pay for property maintenance, or manage tenants.
The following are the Top 5 risks that I have identified is some risk however when investing in trust deeds.
There is a common misperception in the trust deed industry that only Borrowers with poor credit use private Lenders. The truth is, is that many strong credit real estate investors use private Lenders to fund their transactions because banks won’t.
Let’s take for example the Borrower that is buying a single family home to rehab and then sell for a profit. There are very few banks that will lend money on this type of transaction. Banks are not interested in lending money a property that is in poor condition and to a Borrower that intends to repay the money in less than 12 months. The only option this Borrower has is to use a private Lender for the loan.
Another example is the Borrower that needs to close quickly. This often happens when a bank pre approves the loan request but because of delays in their underwriting, cannot fund the loan quick enough. Again, these Borrowers are often have strong credit and may already have a good banking relationship with their bank, but the bank cannot process loans quick enough for the Borrower. In this instance, the Borrower is then again forced to Borrower from a private Lender.
The scenario I highly recommend staying away from is the Borrower that has poor credit, a bankruptcy, or a mortgage history with a pattern of late payments. First, Borrowers rarely change their habits and if they have a history of late payments, that history will roll over into your loan.
Your investment in a trust deed is secured by the underlying collateral. That collateral could be a single family home, multi-family property, commercial asset, or some other type of property. The most safe and liquid asset is a single family home because, in most cases, you can easily rent the property for best Cash Flow Investments in San Diego, there are plenty of buyers if you need to sell it, and financing is readily available. This compares with raw land which often provides no cash flow, the buyer pool for land is limited, and financing land is difficult.
When considering an investment in trust deed, always make sure you are comfortable owning that property that secures the loan. IF you are not comfortable managing a mixed use commercial / residential property, then don’t invest in a trust deed that is secured on that type of property.
One of the biggest mistakes that investors in trust deeds make is funding construction or land development loans because they offer higher returns. The biggest issue with these types of loans is that their value isn’t fully recognized until they are completed.
Consider, when you lend on the construction of the single family home, your collateral is partially built house until it’s complete. If you are forced to foreclose on a partially built house, it will be up to you complete the construction. The same is true on land development.
Identifying, underwriting, and funding a trust deed investment is only fifty percent of the investment. The other fifty percent is managing the loan, also known as servicing the loan. Servicing a loan entails collecting the payments, providing the Borrower with monthly statements and year end tax statements, and foreclosing if the Borrower fails to perform on the loan.
It is imperative that a trust deed investor take immediate action if the Borrower stops performing on a loan. By not taking action on a Borrower that is late on the payments, that has allowed the loan to mature, has failed to keep the property tax or property insurance payments current could result in problems when you initiate a foreclosure action.
The common reason why a investor won’t take immediate action is either they are not paying attention, they don’t know how to take action, or they are uncomfortable contacting the Borrower. These are all reasons why I suggest using a third party loan servicing company to manage the loan. It will become there responsibility to contact the Borrower.
Investing in Deeds of trust in San Diego can be an attractive option for investors who are seeking a steady stream of monthly cash flow and the added security of investing in real estate. However, it is important for investors to exercise caution and take steps to manage risks associated with these investments. By carefully evaluating and selecting such investments and being aware of red flags, investors can reap the benefits of trust deed investing while minimizing their exposure to risk. Ultimately, it is crucial for investors to thoroughly research and understand the unique features and risks of trust deed investments before making any investment decisions.
Brock VandenBerg is the President of TaliMar Financial and the Fund Manager of TaliMar Income Fund I. Since establishing TaliMar Financial in 2008, Brock has funded over 850 loans totaling over $350 million. He currently services a loan portfolio of over 50 loans totaling over $55 million. Presently, Brock pools investor capital in TaliMar Income Fund I, a mortgage fund, which focuses on funding short term residential and commercial bridge loans throughout California. Prior to establishing TaliMar Financial, Mr. VandenBerg spent two years with the Federal Deposit Insurance Corporation and 5 years with KeyBank’s Private Equity Group.
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