Most investors have, at some time in their lives, borrowed money to complete a real estate transaction. Generally speaking, they have not had the opportunity sit on the other side of the desk and be a lender. But, private lending gives investors the ability to loan money secured by a real estate deed of trust, or mortgage.
The investment is made up of two parts: a promissory note and a deed of trust. The trust deed is a document that provides the collateral for the promissory note. It is filed with a county recorder’s office indicating that there is a loan against a property, creating a secured lien.
(Terminology differs – some states may use a mortgage instrument, but the filing of some sort of lien is typical when mortgage loans are provided.)
Trust deed investing offers an unusual combination of high returns and consistent cash flow with a secured investment. Investors receive monthly interest payments on invested capital just as they would with a fixed income investment or money market fund.
Trust deeds also offer a vehicle for investing in real estate without the need to manage property. It’s an excellent way to diversify a portfolio. Plus, unlike publicly traded real estate related securities, such as REITs – trust deed investments are straightforward and easy to understand.
Because the loans are secured by the property, the risk is relatively low. The main risk with trust deed investing is interruption of cash flow (i.e., borrower fails to make payments).
However, this risk can easily be mitigated with an appropriate loan-to-value, or loan-to-cost ratio established at the time of note execution. If foreclosure is necessary, the property can be sold at a value that is in excess of the note balance.
Rates of Return
In today’s environment, banks are not inclined to work with single family home investors making it very difficult to procure funds. This, however, has created an opportunity for private lending that produces higher interest rates, typically in the 8-10% range.