The motivation for investing in trust deeds includes the desire to place one’s investable capital into financial instruments that yield greater than other traditional investments of equal or lesser risk. Annualized yield, monthly payments (cash flow), diversification, preservation and return of capital at maturity serve as the comparison characteristics.
Investor(s) may purchase all or a portion of a loan/trust deed investment on a specifically identified property with a specific borrower(s). The lender/investor essentially becomes the bank. The financial investment will be secured by a recorded security instrument called a deed of trust on the real property. Recording means recording the executed document at a county municipality or recorder’s office that has the task of maintaining public records and documents relating to real estate ownership. The recorded instrument will become a lien or monetary charge against the property. The borrower/property owner must recognize that there is a claim against the property which impacts the transferability and restricts the free use until the claim is lifted or re-conveyed. This is done when the loan is paid in full and an instrument called a re-conveyance is recorded.
The lender/investors on the deed of trust will be named as “beneficiary” or “lender.” The recorded trust deed is held by the lender/investor’s as collateral for the invested capital. The original recorded trust deed may be held by a designated agent loan servicer by agreement. The borrower will also sign a promissory note, which is their promise to pay the investor/lender an agreed upon amount of principal plus interest over an agreed period.
Should the investor purchase 100% of a trust deed? The investor would have complete control of all investment decisions such as when to send notices to the borrower about late payments, or maturity dates, submitting a payoff demand, when to file a notice of default, or when to take possession of a foreclosed property. Many investors believe that owning 100% of a trust deed gives them better “control.” An investor may want to invest $500,000 into one loan/trust deed transaction because they may believe they have better personal control.
As an alternative, an investor may prefer investing $50,000 in fractional portions of 10 different transactions for the purpose of diversification of risk. Spreading the risk includes multiple properties in various locations, different borrowers, different maturity dates, etc. When there are multiple trust deed investor parties, each is named as a lender/beneficiary as a percentage tenant-in-common interest in the promissory note, recorded deed of trust and in the title insurance policy. Fractional interests of the whole investment may also provide diversified cash flow. Should one borrower be late on their payments or default the remainder of the investment portfolio will continue to perform.
If the total loan investment is $500,000, there may be multiple lenders/investors referred as fractional beneficiaries who will together hold 100% of the title as undivided tenants-in-common. Mr. and Mrs. Archie and Edith Bunker may invest $100,000 or 20% of the loan transaction. Mr. and Mrs. Michael and Gloria Stivic, a family trust may invest $200,000 or 40% of the loan transaction. Other individuals or lawfully authorized entities who will also own part of the loan transaction as tenants-in-common will invest in the remaining 40%.
An important part of the investor’s decision rests with the competency of the servicer. Does he/she have the background, knowledge and experience to handle unanticipated problems, and to communicate with the borrowers, investors and third-party vendors about decisions to protect the interest of all the investors?
Upon funding and closing of a trust deed investment, the investor enters a loan servicing relationship with the investment broker or servicing agent. The investor agrees to covey to the servicing party multiple delegated rights (rather than absolute rights) to take specific actions that protect the investors’ interest. Delegated rights are similar whether there is one investor or multiple investors. Delegated rights may include collecting borrower’s interest payments, depositing them into the broker’s trust account, forwarding the investors their portion of the interest payment, communicating with the borrower parties about the status of any late payments, monitor the payment of property taxes, property insurance, and handling the loan payoff and distribution of the payoff proceeds upon maturity. The servicer may also electronically deposit payments directly into an investor/lender’s bank account if the investor chooses.
Delegated rights are written into a loan servicing agreement, and should include the following:
- Appointment of a loan servicer to manage the collection process.
- Define the relationship between the servicing party and the principal party. The servicer is an agent and fiduciary of the investor/lenders for the designated purposed as explained above.
- Instructions about the receipt of funds from loan payoffs to be deposited into a broker trust account and dispersed to the principals (investors).
- Authorization for investment broker/ agent to hold original loan documents in a safe place such as a designated fireproof and tamper proof safe.
- Instructions about what courses of action to take in the event of borrower default to protect the interest of the principal investor.
- Provide for a limited power of attorney relating to the authority of the servicer to carry out and enforce the terms of the loan documents.
The actual day to day management of a loan servicer is made much easier by a dedicated loan servicing software package designed for single and multiple/fractional investors. Loan origination, active monthly payment collections, the investor’s ability to check the payment status online, and loan payoff demands, can all be software driven.
Current yields for trust deed investments are between 7% per annum and 10%, with expected monthly payments of interest, and a return of capital a maturity. This is quoted as net yield after paying a for a loan servicer. A loan servicer will typically charge 1% of the interest payment. Yield differentials include the assessment of risk such as 1st or 2nd trust deeds, property types, property location, amenities, and risk associated with the property and borrower’s ability to pay.
Note for technical minded investors:
Trust deed investments are considered securities. There are corresponding federal and state securities exemptions and regulatory requirements in California that apply and must be complied with by the procuring mortgage broker. Federal exemptions include Reg D, Reg A, and Rule 147. For state exemptions a single investor is 25100(p) of the Corporations Code. The exemption for 2 to 10 investors is 25102.5 of the Corporations Code, and transactional and investor disclosure requirements are defined under Business and Professions Code 10237-10238. Additional state exemptions used for private offerings include 25102 (e),(f),(n). 25113 is a permitted offering subject to a completed application and registration. Additional state disclosure requirements are covered under 10232.5 of the Business and Professions, and 2941.9 of the Civil Code. The latter is referred to as the Majority Rule Statute. Its purpose is to provide a framework for voting when multiple investors need to act to protect their interests. It states that a 50% plus interest can vote to make the decision thereby overriding the minority.
For investors of qualified retirement plans, like a 401(k) governed by the Department of Labor, or an individual retirement account (IRA) governed by the Internal Revenue Service the plan trustees rather than the trust deed investment broker must be the agent and fiduciary for the purpose of making investment decisions.
Every state in the U.S.A. has its own licensing & regulatory requirements. Federal laws may also apply for qualified retirement plans. Consult with a qualified trust deed broker or legal counsel for complex issues. Your trust deed broker can work with you to determine if you have the background, knowledge and experience enough to be considering investing in trust deeds as an investment strategy.
Business and Private Money Finance Consultant
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