Trust deed investing is an opportunity to diversify your portfolio and take advantage of a source of passive income. A trust deed is an investment strategy in which you invest in loans secured by real estate.
Like all investments, there are some risks to this type of investing strategy. However, this method has some sizable potential benefits for those who want an alternative method for investing in real estate and have enough money to contribute.
How Does Trust Deed Investing Work?
Often, real estate developers need loans to pay for the upgrades, modifications, and even full property renovations they take on.
They need those funds for the flipping period, for example, when they buy the property and complete the work to sell it. They get the funds to purchase the property and make those upgrades from trust deed investors.
While developers can turn to banks and other financial institutions for these loans, many lenders do not offer these loans at a very high-interest rate, making it too cost-prohibitive for developers, tapping into their profit margins on any house flip. This is where the short-term loans from investors come into play.
A trust deed, or deed of trust, is an agreement in which the borrower (such as the developer) and the lender (or you, the investor) give a property to a neutral third party. That party serves as the trustee for the real estate.
They retain the property until the borrower pays the lender back in full as agreed to the terms of the agreement. During the repayment period, the borrower will maintain the equitable title on the real estate.
They also maintain full responsibility for the property, including all associated liability risks. However, the trustee maintains the legal title to the property.
How Can You Invest in Trust Deeds?
If you wish to participate in this process, you can buy trust deeds and earn financially from it. There are several ways to do so and some alternative options to consider.
1. Source Individual Loans to Investors
The most straightforward method is to provide a private loan to an investor. Deed investments like this may be best suited for:
- Local developers that you know and trust
- High-risk investors willing to trust in the developer
- Those with ample available cash flow
The borrower pays an interest rate agreed upon by both parties. Terms are set for the trust deed investments, and, like any other type of real estate transaction, this method allows the lender to have some level of security with the trust deed itself.
While the borrower retains control over the property, in first trust deed investing, the real estate investors have some projections thanks to the promissory notes in place.
2. Purchase Loans Backed by Real Estate from Brokers
In this method, investors work closely with brokers. These brokers present them with potential loans to invest in and, in some cases, can guide decisions by helping with due diligence. Brokers facilitate the process by connecting investors to loans, meeting the needs of both parties. This may be a good option for you if:
- You want to invest in trust deeds but are new to the process
- You have a broker you have vetted and trust to work with
- There’s ample availability of funds for you to put toward larger deals
Keep in mind that in nearly all cases, brokers have the job of finding deals. They do not do full due diligence for the investor, and ultimately, the amount of risk involved depends on the specifics of any transaction, including the type of project, the area, and the developer’s experience. The investor still has to work to evaluate deals from brokers.
See Related: Best Home Improvement Loans
3. Invest with Others as a Group
Another route involves pooling money together with other trust deed investors. By pooling funds together, it may be easier to invest in larger projects. This method may be best for:
- Those looking to invest in real estate without as much of their cash
- Those who want some oversight from who they are investing in
- Individuals who may wish to pool money together and invest in several projects
There are various resources available to find such groups, including RealtyMogul, which offers various investment opportunities where people come together to create big changes. The key to this method is to ensure you know the group’s goals and objectives, risk tolerance, and overall requirements.
Also, consider how a first trust deed fund is structured and how payments are made from these deed investments to you.
4. Invest in a deed trust fund
Professionally managed investment funds that focus on deed trusts are another route. This type of investment strategy may be best for:
- Those who are looking for a way to diversify further
- Individuals who may not want to invest a lot into any given project
- Those who wish to spread out their investment among a wider variety of projects
Trust deed investors put money into a professionally managed and overseen fund in this method. That fund invests in various real estate ventures and development projects, with the funds contributed by a pool of investors. This method is more of a traditional investment strategy in which the underlying investment is trust deeds.
These are the four main ways to buy trust deeds and invest in this type of real estate. There are some variations to this to consider as well.
5. Invest in Residential Trust Deeds
One option is to invest in residential-based trust deeds, which means the investments are going towards residential real estate development, including single-family homes, condos, multi-family homes, or other structures. This method may be best for:
- Those who want to support the development of homes
- Those looking for more stable investment strategies
- Shorter-term investments are ideal
Residential deeds of trust tend to be in place for a shorter period. If you plan to make a direct trust deed investment to a home developer, for example, this is likely to remain in place for no more than a couple of years since the project is likely smaller. Depending on the scale of the project, you may be looking at lending money to one or more property developments.
6. Invest in Commercial Trust Deeds
Commercial properties, including shopping centers, often need this type of investment. This type of investment strategy may be best for:
- Those who are looking for a larger scale investment.
- Those who can put more money into the loan for repayment over time.
- Investors are looking for a higher rate of return.
Remember that commercial property trust deeds carry significant risk because most beginning investors do not have much experience with the process, especially if investing in industry-style property. There are also concerns with environmental factors, building codes, and overall economic factors that must be considered. Due diligence is critical in this type of fund.
See Related: Best States for Real Estate Investing
Core Components of Trust Deeds Investing
Before choosing any method, it is critical to understand the specifics of these types of trusts. Here are some of the most important components.
Borrower defaults
A big question for many is what happens if the borrower defaults on a deed of trust. If the parties involved cannot agree, the promissory note allows the trust deed investor to purchase judicial foreclosure on the property. No one wants foreclosure because it is time-consuming and costly, but it allows lenders to pursue debt repayment on first trust deeds.
How borrowers pay back the loan
Often, the process is very simple. The company developing property (whether flipping or building from the ground up) will use the funds from the loan to purchase the real estate and make those upgrades. This leads to capital appreciation – the property’s value increases thanks to the work done.
The property developer then sells the property and uses the sale proceeds to pay off the borrowed funds and typically high interest rates. However, during the development process, the loan acts like any other mortgage in which the borrower must make payments on the loan to keep the loan current.
Trust deed borrowers do not take ownership of the finished project from the trustee until they have repaid the debt. That helps the investor ensure their real estate investments remain secured.
What are the benefits of a trust deed?
The benefits typically include:
- A high return from trust deed investments. Most often, with the high-interest rates charged, this is one of the best ways to earn lucrative returns on your money.
- It is passive income in most situations since, as an investor, you do not manage the project itself. During the loan period, the loan generates recurring payments until the loan is fully paid.
- It is possible to diversify risk significantly. Many investors use this strategy of first trust deeds in funds to spread their investments across various projects instead of just using a single trust deed for one property.
What are the disadvantages of a trust deed?
There are risks to consider:
- The principal amount does not appreciate in value as it could be with other investments.
- This is not a liquid investment, and without a good understanding of the risk profile, it is very difficult to overlook that your money is locked up for the duration of the loan.
- There are some legal issues a few states may impose that create loopholes where investors cannot recoup their investment in projects. There is the risk of default and foreclosure as well.
Recognizing the associated common risks, some may wish to evaluate the benefits of this type of investment strategy fully.
What can go wrong with investing in real estate loans?
The advantages are clear with these investment strategies. High-interest rates can be earned without much actual work on developing a project. However, risks are possible. That includes risks related to:
- A drop in the real estate values within the area within a short period
- Litigation related to the title of the property occurs
- A mistake occurs in the appraisal of the property, and its value is not as high as expected
- Mortgage fraud occurs
- Defects in the title lead to loss of ownership
- The borrower files for bankruptcy
Ass a mortgage lender, trust deed investments provide an opportunity to capitalize on real estate transactions, and with due diligence, lenders can make trust deed investing an overall desirable option.
FAQs
What is a trust deed investor?
A trust deed investor is a person who invests money in loans for real estate development and renovation. These investors put money into funds or directly into investors.
Three parties are involved: The borrower, who does the work to develop the property and typically has full control over it, and the investor, who lends the funds. And the trustee holds the property until the loan is paid off.
What is a first deed of trust?
The first trust deed is a modern-day mortgage. This means the mortgage lender can seek foreclosure on a property if the investment is not paid in full as agreed.
This allows the investor (through the trustee) to sell the property if a default occurs. The first deed holder has priority over any other lenders on that property.
What is a first lien position trust deed?
A first lien position trust deed is another term for a first deed of trust. The lender of this type of loan holds the first position on the property. Compared to a second mortgage, if the property owner defaults on the loan, the first lien position receives all or most of the resulting funds from the sale, and the second mortgage holder only receives funds based on what is left, if anything.
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