The purpose and motivation of investing in trust deeds include the desire to place one’s investable capital into a vehicle that yields greater than other traditional investments that have equal or lesser risk. Annualized yield, monthly payments, diversification, preservation of capital and return of capital at maturity serve as the comparison characteristics.
Investor(s) may purchase all or a portion of a loan/trust deed on a specific property with a specific borrower. The lender/investor essentially becomes the bank. The investment is secured by a recorded security instrument called a deed of trust on the real property with the lender/investor’s being named as “beneficiary” or “principal lender.” The recorded trust deed is held by the lender/investor’s as collateral for the invested capital; the borrower also signs a promissory note payable to the beneficiaries/lender.
Should you invest in 100% of a trust deed? You would have complete control of your investment decisions such as when to send notices to the borrower about late payments, or maturity dates, submitting a payoff statement, 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 10 different transactions for the purpose of diversification of risk. When there are multiple trust deed investor parties, each is named as a beneficiary as a percentage tenant in-common interest on the promissory note, on the recorded deed of trust and in the title insurance policy. While a single trust deed investment may give better control, multiple investments provide much better diversification of property types, borrowers location, collateral differences, and due dates. Fractional interests of the whole investment may also provide diversified cash flow. Should one borrower be late on their payments or default the total investment portfolio is less impacted.
An important part of the investor’s decision rest 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 their interests.
Upon funding and closing of a trust deed investment, the investor enters into a loan servicing relationship with the 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 investor. 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 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.
- Instructions about the receipt of funds to be deposited into a broker trust account and dispersed to the principal (investor).
- Hold original loan documents in a safe place.
- Instructions about what to do 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 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 on line, and loan payoff demands, are all software driven.
Current yields for trust deed investments are between 8% per annum and 12%, with expected monthly payments of interest, and a return of capital a maturity. Yield differentials are the assessment of risk such as 1st or 2nd trust deeds, property types, and risk associated with the property and borrower’s ability to pay.
Note for technical minded investors:
Since trust deed investments are considered securities there are corresponding securities exemptions and regulatory requirements in California that apply and must be complied with by the procuring mortgage broker. The exemption for 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 defined under Business and Professions Code 10237-10238. Additional 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.
Every state in the U.S.A. has its own licensing & regulatory requirements, which is far too complex for this article; consult with counsel for your preferred state.
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