If researched correctly, trust deed investments offer a great yield with relatively low risk.
Trust deed investors often earn high single-digit annual returns, paid monthly.
In lots of cases, returns above 10% are possible.
These returns are very favorable relative to other investment choices with similar risk profiles.
The risk of losing money in a trust deed investment is mitigated by a built in "margin of safety.
" In this economic climate professional real estate investors are buying properties at foreclosure sales for bargain basement prices, fixing-up these properties, and reselling them for a profit.
Trust deed investing is investing in loans protected by real estate.
Most trust deed investments are often short term loans (under five years, with most loans two years or less) made to real estate investors.
Large financial institutions are reluctant to lend to this market not because the loans are particularly high risk, but because banks have a great deal of bad real estate loans on their balance sheets as a result of the loose lending practices of recent years.
Presently, banks are unwilling to make real estate loans unless they fit a very strict set of criteria.
They often do not want to lend to opportunistic real estate investors because the property which is security for the loan is not "move-in ready" at the time of loan funding-it usually needs some work.
For this reason, real estate investors have limited financing options available to them, and lenders to this market are able to command relatively high interest rates.
These borrowers can often afford to pay lenders low double digit rates of return, even though the loan is well-secured, because the borrowers are typically aiming to make an annualized return of 20%-50% on their investment.
Paying the lender a much lower return (relative to their projected returns) allows them to enhance the returns they earn on their cash investment.
By 2011, nearly 20% of the $2.
6 trillion in mortgages on banks' balance sheets were delinquent.
The secondary market for non-conforming mortgage backed securities is a fraction of what it used to be.
This is why banks have tightened their lending standards and are reluctant to lend to anyone with less than picture perfect credit.
It is precisely the banks' reluctance to participate in this market that has created the attractive investment opportunity in short term real estate loans.
The fact that banks are not lending to this market has created a supply/demand imbalance that doesn't have anything to do with the quality of the borrowers, but instead with the condition of banks' balance sheets.
The margin of safety is the difference between the loan amount, and the value of the underlying property.
The core concept of trust deed investing is that if the borrower does not perform, the lender can foreclose on the property and sell it to recoup the investment, plus any past due interest.
If the loan is sufficiently conservative, i.
e.
the property value is high relative to the loan amount, then the investment should not lose money even if the borrower defaults on the loan.
A well structured investment might have a loan-to-value of 65%.
These investments are not liquid.
In other words, you cannot decide you want your money back one day and quickly convert your investment into cash, as you could with a municipal bond or shares in a blue chip company.
You need to be willing to stick with your investment until the borrower pays off the loan, or, in case of default, until you have foreclosed and sold the underlying property.
With Trust Deed investing there is not much chance for capital appreciation.
For the most part the only returns that the investor will be entitled to will come from interest income generated from the loan.
Directly investing in deeds of trust requires that the investor identify borrowers, assess deals on their merit, and conduct due diligence on the borrower and the property.
This all requires a particular knowledge set that the investor must be acquire.
Trust deed investing is not without risk.
A small flaw in the documentation or due diligence of a trust deed could mean that an otherwise very safe investment becomes very risky.
For example, litigation or title problems could cause problems if the borrower or some other party can make a credible claim that your trust deed instruments are not valid, or that they have some interest in the underlying property that is equally or more valid, the trust deed investor might need to battle to protect the investment.
Trust deed investing is not for the faint of heart.
Newbies need to take particular care, and seek guidance from trusted experienced investors.
That being said, there are tens of millions of valid trust deeds owned by banks as well as hundreds of thousands owned by private investors.
Creating a valid trust deed and accompanying note is not rocket science.
As of 2011, investors can receive returns of 9-12% on deeds with a solid margin of safety (loan-to-value of, say 65% or less).
Even higher returns are possible for professional investors, because they invest frequently and have close relations with mortgage brokers and mortgage banks that create opportunities.
Such professional investors can frequently negotiate to receive one or more points in addition to interest as part of their investment, increasing the overall yield.