Guest post by: Ignite Funding
Deciding where to invest your money is never an easy task. The biggest question is: Where are you going to get the most return on your investment? With the stock market being so erratic and unpredictable, people are looking now more than ever for other ways to intelligently invest their money and diversify their investment portfolio. That’s where trust deeds come into play, connecting borrowers and investors in the real estate world.
Trust deed investing provides you the ability to easily become a real estate investor, substantiated with collateral, without all the hassle traditionally involved with real estate investing. Being an investor, your name is on the deed of trust in a first lien position on the property, and the invested money is lent to a developer seeking to acquire, develop or construct their project, immediately earning you interest on your money. It’s important that you know the great significance of your role as an investor and why these borrowers are seeking your help.
Why do developers seek money from trust deed investors? Banks are less likely to lend to midsize commercial developers, and they tpically don’t lend on the land itself, which requires the developers to acquire funds elsewhere. A trust deed broker brings you, the investor, and the borrower together, essentially having you step in to play the role of the bank! Whether the interest is in the commercial or residential sector, the broker has the resources necessary to help you feel comfortable in allowing them to bring your retirement plan to fruition. In this resource, we will walk through the 8 easy steps to getting you on your way to investing in a passive and lucrative real estate investment to supplement your investment strategies. As you are evaluating what is involved in initiating your plan to becoming a real estate investor and taking your ideas off paper and into reality, it is important to speak with potential trust deed brokers. They can provide you with added knowledge on the types of projects borrowers need funding for, underwriting standards and how to mitigate risk.
This resource will outline the following topics:
- Who are the borrowers and why do they seek funding?
- How are the projects evaluated?
- How do I benefit from this process?
- How are the risk factors assessed?
- What is involved as an investor?
Should you decide that investing in trust deeds is the right passive investment for you, your trust deed broker will walk you through the easy application process. From there, they can provide you with all of the in-depth information necessary to make a strong and confident decision about which one of the many available investment projects best suits you. You can start accruing interest on your investment immediately upon the loan being funded. Once a project is completed, your capital is returned to you. It’s common to see a double digit return on your investment yearly, earning a portion of that monthly throughout the project.
Step 1 – Borrower Seeks Financing
Why do borrowers seek alternative financing? There exists a segment of borrowers who are looking for loans that are too large for community banks and yet too small for institutional banks. They need to find financing quickly so they can act on a project. They cannot wait for an evaluation period of 90 days as required by most banks. Banks also limit the percentage of acquisition, development and construction loans on their books. If a borrower does not fit into a check box, or if a bank already has that loan type filled, they won’t lend.
Trust deed brokers, on the other hand, can provide:
- Short evaluation times
- No “check box” mentality
- Short-term loans
- No pre-payment penalties
Step 2 – Evaluation and Underwriting
The next step is to evaluate and conduct a thorough underwriting review process on each project. A Trust Deed Broker looks at both the market drivers and the borrower’s capabilities, but primarily focuses on the property itself.
The evaluation process scrutinizes:
- Collateral: The property and the equity within that property
- Capacity: The borrower’s ability to pay the debt
- Character: The borrower’s actions during a downturn
- Capital: Amount borrower puts towards the property
- Conditions: Current economic and market conditions where the project is located
Because the property is the most important aspect of underwriting, part of the due diligence process should be a visit to each property funded. A trust deed broker should take a “loan-to-own” approach, meaning they evaluate the real estate project by considering, “If the borrower doesn’t pay back the loan, would the property be ideal to own and/or are their viable buyers seeking this land in the area that we can easily sell it to?” Upon approval, the broker originates the loan and only then will it be offered to investors.
Consider the diversification of your portfolio and seek out capable borrowers across a wide variety of markets and project types. When investing in trust deeds, it is important that the facilitator of the loan continuously evaluates the market influences such as job growth, economic stability and demand for homes, as these can directly impact project value.
Step 3 – Investor Chooses Loans
The investor chooses from the loans available, which loan they like, and the amount they would like to fund. As the land selected for the project is the ultimate collateral backing the investment, it is important that investors conduct their own research on the project. This could include personally visiting the site, evaluating borrower historical performance records, viewing county recorded records, etc.
Property overviews (facts sheets) are provided to investors with the following information about the property:
- Property description
- Loan amount
- Loan-to-value ratio
- Annual interest rate
- Duration of loan
- Exit strategy
…and depending on the project:
- Guarantees
- Broker price opinion value and date executed
- Borrower history
Each project underwritten is conducted under the individual state lending division regulator body where the project resides. Each state requires different licensing requirements and compliance that the trust deed broker must continuously review to remain compliant. Due to trust deed investments being governed under the lending division throughout the Southwest states, investors should meet minimum suitability standards to invest of $70,000 household income for 2 continuous years or to have $250,000 net worth, not including the value of a primary residence.
Loan documentation is required to be processed by the investor for each investment selected. This documentation outlines all components of the project and is governed by the mortgage lending division. A single special power of attorney form is required to be notarized and provides the ability to act on the investor’s behalf in processing payments and conducting active dialog with the borrower.
Step 4 – Investor Lends Funds
The minimum investment amount is $10,000. Investors can utilize a number of investment methods.
Investment methods available:
- Individual or joint cash accounts
- Self-directed IRA accounts (Traditional, Roth, Simple and SEP IRAs)
- Corporations, partnerships and LLCs
- Trusts
- Pension plans
There may be multiple investors on a loan. An investor’s lending percentage equals the investor’s principal balance divided by the total loan balance, representing a percentage of the total loan on the property.
Funds transferred are held in an independent trust account until presented to the title company to fund the loan. There are no fees to invest as the borrowers cover all costs associated with the loan. Self-directed IRA custodians may charge an investment fee to process the transaction.
Step 5 – Trust Deed is Recorded
A trust deed investment is a promissory note, payable to the investors specifying the interest rate, repayment amount and time frame, secured by the deed of trust.
Investors will receive a copy of the following documents after the funding of a loan:
- Executed promissory note
- Recorded deed of trust
- Title policy
- Insurance on the property
A deed of trust is recorded as a public document. The deed lists the investor(s) and their percentage of ownership in the property.
Deeds of trust can be recorded on a project in 1st, 2nd or 3rd lien position, however, 1st lien position loans may provide a lower level of risk.
Step 6 – Monthly Interest Payments
Immediately upon funding the loan, the investor begins to accrue interest. Interest payments are due at the beginning of the month, payable by the 10th, and are paid monthly throughout the duration of the loan, per the specific loan terms. Interest payments are immediately directed back to the investor through their designated account or directly back to the IRA.
Investors can receive their funds in several ways:
- Electronic deposit to bank account
- Electronic deposit to IRA account
- Check mailed to investor
Additionally, investors can view their statements to see all transactions to their account at any time by viewing their online statements.
Step 7 – Borrower Pays Off Loan
At the end of the loan term, the borrower pays back the loan. Upon repayment of the loan by the borrower, the investor receives principal payoff in full. This can also be viewed on the investor’s online statement.
The investor’s funds are now available for reinvestment on another loan of the investor’s choosing, or to utilize however the investor wishes.
If an investment is impacted by borrower default, the trust deed broker may employ a team of professionals to coordinate the resolution of the investor’s asset. Communications are provided to the investor throughout the process, and all resolutions are voted upon by the investors in a 51% majority ruling.
Step 8 – Property Titled Back to Borrower
Borrower is granted title to the property when the loan is repaid. The investors’ names are removed from the title, and the borrower’s name is placed on the documents. The borrower can now complete the next phase of their project, whether that be holding the property, getting more funding to develop or construct on the property, or selling the property to an end user.
Who can benefit from trust deed investments?
- Investors looking for income
- Investors looking for passive real estate investments
- Investors looking to diversify their portfolios beyond traditional investments
- Investors tired of paying broker commissions or product loads
- Investors looking to compound returns in qualified retirement plans
Ignite Funding offers first trust deeds to commercial home builders in the Southwest and provides the everyday investor with the ability to expand their investment strategy.
