Trust Deed Investing - The Basics
What is a Trust Deed Investment?
Trust deed investments are specialized high-yield loans secured by real estate that are provided from the private sector. They are not real estate investment trusts (REITs). They are also not mortgage-backed securities - the repackaged loan bundles under significant scrutiny for the past few years.
Trust Deed Investing in a Nutshell
Trust deed investing is essentially loaning money that is secured by real estate as collateral. In the simplest terms, it is a privately funded mortgage. The trust deed investor loans money to the borrower, and the loan is secured by the real estate of the property. In many cases, such as the trust deeds managed by ICCG, the loan is also secured by the borrower's personal guarantee.
What is a Trust Deed?
The "deed of trust" or "trust deed" is the document used to secure the loan against the property. It acts like a mortgage and is used as security for repayment of the loan. In a trust deed investment there are three parties - the beneficiary (the lender), the trustor (borrower), and the trustee (who is often the county public trustee or in some states, a private trust company). The trustee is a third party selected by the lender. The trustee has the legal power to act on the lender's behalf and hold title until the note has been paid. If the borrower defaults, the lender can take possession of the property.
Trust Deed Returns
A trust deed generally secures a note with a set interest rate (typically 12%-18%). Loan programs vary from traditional amortized loans, interest-only loans and balloon loans. Based on the particular loan type, the investor may receive regular periodic payments or payment in full at maturity.
Real Property as Collateral
In many ways, trust deeds offer less risk than many other investments. If a borrower defaults on a loan, the property secured by the trust deed can be sold as a foreclosure in order to recoup part, or all of the outstanding balance.
Obviously, the value of the property securing a trust deed investment is of critical importance. Trust deed investors are careful to consider the value of the property securing the loan compared to the amount of the loan (referred to as "Loan to Value" ratio or "LTV"). For example, a trust deed investor may choose to limit lending to a maximum of 70% of the value of the collateral property. This would ensure a minimum equity of 30% in the property to act as safety padding in the event of default.
Trust Deed Investment Vehicles/Programs
There a several different ways to invest in trust deeds to meet the investor's needs and goals. These include individual trust deed investing, fractionalized trust deeds and fund investing.
Individual Trust Deed Investing: This type of trust deed investing refers to an investor that fully funds a loan on one particular property. As the note is paid, the investor receives the return at the interest rate in the note.
Fractionalized Trust Deed Investing: This type of investing refers to a group of investors, each funding a percentage of the total amount. For example, if a borrower required a $1 million loan, the note may be fractionalized into 10 different investors, each contributing $100,000. Thus, each investor would own 10% of the transaction. All 10 investors would be vested on the recorded security document and they would share in the profits based on percentage of initial contribution.
Fund Investing: This is also referred to as "mortgage pool". This method allows investors to combine their investment funds together to invest in multiple transactions, similar to mutual funds that invest in a variety of stocks.
For further details about the investment vehicles, and pros and cons of each, see Options in Investing.