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What is Trust Deed Investing?
Trust deed investing is basically lending money secured by a deed of trust. Essentially a loan is being made and that loan is secured by real property. Should the borrower default, the property provides the collateral for the loan.
There are two main documents when investing in this manner. First is the deed of trust, which is what is recorded to secure the investment. The other is the promissory note, which sets forth the terms of the loan being made that is secured by the deed of trust. These terms include the interest rate, default terms and maturity date of the loan.
When investing in this manner, there are three basic parties involved. First there is the beneficiary. The beneficiary is the individual who is loaning the money. This can be an individual or an entity.
The trustor is the borrower. Again, this can be an individual or an entity. The trustor, by signing the deed of trust and promissory note is making an agreement with the beneficiary. In this agreement they are agreeing to the terms of the loan, and under the deed of trust they are giving permission for the loan to be recorded against the property.
The third party is the trustee. The trustee is the party allowed to move forward with a trustee's sale in California. This happens when a default under the terms of the loan occurs and the sale of the property becomes necessary in order to secure the beneficiaries interests (and money!).
Through a trustee's sale, the property will either be purchased or title will transfer to the lender. If there is no purchaser, the lender will end up owning the property that was used for collateral. In that scenario, the lender can either sell the property on the open market or hold the property.
There are two basic ways investing of this nature is done. One is through a fund. With a fund, you contribute funds and the fund manager makes the lending decisions. Your investment return is based on the performance of the fund as a whole. The benefits to this type of investing is that your investments are not tied to a single property or just a few properties – your risk is spread across the entire fund.
The downside to investing in this manner is that you give up control of your investing decisions to a fund manager. You do not get to look at the specific deal your money is going into, and you do not have the final say on whether that deal will be funded. If the fund manager does not make sound decisions, the fund's performance will suffer.
The second way investing of this nature is done is through investing in individual trust deeds. Typically speaking an investor will work with a broker or brokers to help identify potential loans that he or she may want to fund. The investor is able to look at the individual deal and property and make a decision on whether to lend. The downside to this is that your return is tied to the specific deals you fund, but the upside is that you are able to take an active role in deciding what transactions your money will be invested in.
To break this down further, you can also fractionalize trust deed investments. What this means is that there are multiple investors on one transaction. So for example, on a $400,000 transaction that is fractionalized you may have four investors, each investing $100,000 and each owning 25% of the investment. The investments do not need to be equal to each other, an investors ownership percentage will be based on the percentage of the loan that he/she funds.
The benefits to fractionalized investing are similar to those of investing in a fund. An investor can spread their risk across multiple investments, while still retaining control and making the decision on a property by property basis whether to fund. The downside to this type of investing is that should something go wrong with the investment, there are multiple investors involved who may not know each other. They would need to be able to agree on a course of action with regards to the solution they wish to take on the troubled asset.
There are many nuances to trust deed investing, but for investors looking for an investment secured by real property, trust deed investing may be an option to consider.
Disclaimer: This publication is designed to provide accurate and authoritative information in regards to the subject matter covered. It is offered with the understanding that the publisher is not engaged in rendering legal, accounting or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.
Taken from the declaration of principals jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations.