Whether you are a firs time trust deed investor or have already been through a few deals, there are certain things to look out for that can help you minimize risk and maximize profits. CapSource has been a hard money lender for over 15 years and we have seen hundreds of trust deeds during that time. Based on our years of experience, we put together this list of 5 tips for profitable trust deed investing.
1.Know the basics
For starters, it is extremely important to understand how a trust deed works and what parties are involved in the investment. (i.e. The borrower, the lender, and the broker.) Having an understanding of the basic elements of a trust deed will give you ground to stand on when analyzing deals. We have a great section of our site dedicated to Trust Deed basics.
2. Know your broker
The relationship between you and your broker has to be one that you are comfortable with, so do your due diligence. How long have they been established? What licenses to they carry? Do they have any complaints issued against them from their state’s mortgage lending division? A reputable broker will have no problem sharing this information with you.
3. Is the loan to value ratio leveraged in your favor?
One of the key factors when trust deed investing is the particular loan to value ratio associated with a deal. This is the ratio between the loan amount vs. the value of the property being used as collateral. Before investing you should make sure that you are taking part in a trust deed loan has a conservative loan to value ratio (“LTV”). LTV is the ratio of the loan amount versus the collateral value (the lower, the more conservative). If a default occurs and you are forced to foreclose on the property, a low LTV provides better protection of your investment.
4. Make sure that the borrower has a personal guarantee on the loan.
This may be something you have to take a deeper look into, but if you are working with a good broker then it shouldn’t be hard to find. Many times the borrower in a trust deed is an entity or corporation, which is totally ok. However, you want to make sure that the loan is backed up by a personal guarantee. This does a couple things. First, it shows that the borrower is much more confident in paying back the loan, otherwise why would they risk their own personal finances. Second, in case there is ever a problem with receiving loan payments the borrower is personally promising to pay those payments out of their own financial reserves. In other words this is just another added layer of protection for you, as the lender.
5. Be clear about the length of the trust deed.
One of the key elements in trust deed investing is the length of time associated with a deal. This is how long should you expect to receive interest and have your principal investment tied to a loan. Typically trust deeds are relatively short-term investments ranging anywhere from 6 months to 2 years. Some deals will have allowable extension periods in the contract too, which is ok, as long as you know that they exist. Because a Trust Deed is a loan secured by real estate (usually commercial real estate), the payoff date is difficult to predict accurately because repayment is dependent upon the borrower either selling the collateral or refinancing the loan, both of which are complex and time consuming. In other words, a Trust Deed is not like a bank certificate of deposit. The good news is, the returns are much higher and there is security, in the form of real estate, backing up the investment.