A Beginner’s Guide to Trust Deed Investing
Property investing comes in many shapes and sizes. Most investors stick to purchasing properties either to rent to tenants or to fix and flip to sell for a profit. However, these are not the only potentially beneficial options available for those who want to diversify their real estate portfolio.
Trust deed investing is an alternative to standard investing that can offer extensive advantages to investors. This avenue is not widely utilized and is unknown even to many seasoned property investment experts. While not the right fit for everyone, those interested in taking the next step may find trust deed investing to be a natural fit. Here is what you need to know about getting started in trust deed investing.
What Is Trust Deed Investing?
Trust deed investing is the process of investing in lending opportunities secured by real estate.
In standard investing, there are two parties in a mortgage loan: the lender and the borrower. Trust deed investing has a borrower, investor (also the lender) and a servicer (for example, Westpark Loans). The investor in essence takes on a loan secured by a lien on the purchased property, which serves as collateral in case something goes wrong in the repayment process.
Trust deed investing is a compelling opportunity as it does not require the purchase of actual property. For investors who want the benefits of returns on an investment without the labor that goes into preparing a property for sale or tenants, trust deed investing provides the ability to get involved in real estate with less complications. While returns are not always as high as what a fix and flip can yield, for example, interest collected from the borrower can offer a regular passive income stream for a period of years with guaranteed returns, provided a borrower does not default.
The Role of Trust Deed Investing
For those new to the concept of trust deed investing, it is not uncommon to wonder why this is an option. In general, the borrower and lender relationship does not require a third-party investor, so determining the role of trust deed investing is not always clear.
In general, trust deed investing exists to fill gaps in a normal lending structure. Intended primarily for professional real estate investors, like developers, those purchasing homes to fix and flip or consumers looking to fund a business, trust deed investing can provide resources unavailable anywhere else. In many cases, these kinds of projects either are not seen favorably by a bank or are not positioned well to seek a traditional loan. For example, a loan may be too large for a small lending institution but not sizable enough for a large institutional lender to consider.
Further, not all banks are comfortable making real estate loans to those fixing or developing properties due to the potential risk on collateral. Many real estate investment projects require significant work, which means that if a borrower defaults on a loan, a lender is left with an unfinished property that requires extensive work to sell.
Trust deed loans are also shorter in duration than most banks are prepared to offer. The average loan term is less than five years, generally ranging from around six months to three years. Most banks are not interested in making a loan of this duration, particularly for a development project, leaving some fix and flip investors and property developers without viable borrowing options.
With all of these factors complicating traditional lending, trust deed investors can capitalize on this kind of opportunity, providing a way to promote real estate endeavors that do not entail actually purchasing real estate.
Pros and Cons of Trust Deed Investing
As with all lending opportunities, there are advantages and disadvantages to be considered. As investing can require sinking significant financial resources into a project or opportunity, it is important to understand the applicable pros and cons.
Pros of Trust Deed Investing
There are many advantages to trust deed investing for those interested in real estate to consider.
- Steady Income Stream: Due to the nature of trust deed investing, interest rates are far higher than an average loan, ranging, on average, from 7.99% to 12.99%. On a $100,000 loan with a one-year term and a 10% APR, investors can expect to earn $10,000, plus any initiation fees.
- Highly Secured Returns: Unless a borrower defaults on a loan, in which case the collateral becomes the property of the trust deed investor, returns are essentially guaranteed. Investors can feel confident that each payment will result in a gain on top of the value of the loan’s face value.
- Low-Risk Opportunity: In property investing, risk is inherent. There is always the possibility that a fix and flip will cost more to renovate than the return on the sale, or that a rental property will sit vacant for too long. These risks are not as present with trust deed investing. The risk is that a payment isn’t made and you, as the investor, will need to claim against the property to be paid back.
- Valuable Collateral: Unlike personal loans to individuals, which are often based on little but good faith and are therefore risky investments, trust deed loans are secured by the property for which the borrowed funds are used. This means that if the borrower fails to make timely payments, there is something backing the loan and the investor can sell it to reclaim their initial investment.
- Flexible Investment Opportunities: In most cases, real estate is expensive. The average home can be quite costly, and the same is true for multi-family rental properties. Using trust deeds opens the door to more moderate investments; with minimums starting around $50,000, even those with somewhat limited liquid capital to invest can get involved.
- Convenience: Shopping for property, making an offer, handling closing, and renovating a property can all be time consuming and stressful, turning some investors off from fix and flip or rental properties. Trust deed investing can be much faster and more convenient.
Cons of Trust Deed Investing
Despite the benefits of trust deed investment, it is not for everyone. Keep these disadvantages in mind when weighing the choice to delve into trust deed investing.
- Lack of Liquidity: In general, real estate is not known for its liquidity – a property must be sold in order to access the cash value, or an additional mortgage can be taken out against the equity. However, these options are available should an emergency arise. With trust deed investing, however, those exit options are not available. Once a loan has been purchased or funded, there is no real way out. Funding a loan ties up the principal until the loan is fully repaid, which can take years.
- Lack of Appreciation: One of the benefits of investing in real estate is the likelihood of appreciation. Properties purchased strategically can result in the possibility of sizable gains years down the road. However, there is no real avenue for appreciation in trust deed investing. The value of a loan is generally not subject to change. While a set return is guaranteed in the form of the interest rate, there is no room for additional growth.
- Extensive Due Diligence: Not every lending opportunity will be worthwhile. Every potential loan must be thoroughly vetted to make sure an investment is a good choice rather than a way to lose money. While all investment requires research, there are a lot of moving parts and pieces in trust deed investing. Issues like title problems or pending litigation can complicate a loan, taking something that should be a sure thing and transforming it into a risky investment.
The Steps in Trust Deed Investing
As seasoned real estate investors know, every investment opportunity requires a lengthy process. Knowing the progression of the process is an important part of evaluating a lending opportunity. Here is what to expect when entering into a trust deed investment.
- Find a Borrower in Need of Financing: Borrowers can be found in numerous ways, but using a broker is the best and most common way.
- Evaluate the Property and the Borrower: No two properties, and no two borrowers, are made equal. Before putting your funds on the line, evaluate things like the value of the property as collateral, the money the borrower has on hand, and current economic conditions. These factors will inform the underwriting process, like the amount being offered and the interest rate under consideration.
- Agree to Terms: Once an available investment opportunity is agreed to by the investor, as made available by the servicer, both parties will enter into an agreement.
- Lend Funds: Once the loan terms have been agreed upon by all parties, funding is the next step. Funding can be handled in a few different ways, including joint and individual cash accounts, self-directed IRAs, or funding via an LLC or other business entity. The invested money, regardless of the number of lenders, is held in a trust until it can be presented to the title company to fund the loan.
- After the Loan is Secured: A trust deed is a promissory note that is recorded as a public document. The details of this completed process, including the executed promissory note, the recorded deed of trust, and the title insurance policy, are distributed to the investor as evidence of the transaction.
- Receive Monthly Payments: As soon as the repayment period begins, investors begin to realize gains. After each monthly payment, both principal and interest amounts are funded back to the investor based on the terms of the loan.
- Loan Process Completed: After the terms of the loan have been adequately met and the principal and interest have been paid off, the investment process is complete. As soon as the loan has been repaid, the title is deeded back to the borrower and the investors’ names are removed. Once the title is transferred back to the borrower, the role of the investor is complete.
Getting Started in Trust Deed Investing
So, you want to consider trust deed investing. But how does that work? One of the first steps you can take is to fill out a questionnaire on our website: https://westparkloans.com/investors/ We work directly with you to make trust deed investment decisions based on what works best for you financially.
For those willing to put up the capital, trust deed investing can be a compelling opportunity. Offering a way to get involved with real estate without the demands that come with purchasing and renovating property, trust deed investing offers significant advantages. However, as with all investment opportunities, trust deed investing is not for everyone. Be sure you are aware of the pros and cons as well as the ways in which to maximize your investment opportunities before moving forward.
Scott Clift is a licensed real estate broker with Westpark Loans. He has been in the real estate industry since 1994. His team of seasoned professionals specialize in providing real estate loans for investors and other self-employed individuals. When you are ready to invest in real estate, call Westpark Loans to secure your financing at (844) 574-LOAN or by visiting westparkloans.com.