Purchase All or a Fractional Portion Of A Trust Deed Investment?

By Dan Harkey

What are trust deed investments?

The borrower willingly takes out a loan and conveys a security interest in their property in exchange for the loan proceeds.? Private parties become the lenders by receiving the security interest as collateral, usually real property.? The borrowers are the trustors, and the private parties are the beneficiaries. ?

Investor(s) may purchase all or a portion of a loan/trust deed investment on a specifically identified property with a specific borrower(s).? The process involves the lender/investor essentially becoming the bank, with the financial investment being secured by a recorded security instrument called a deed of trust on the real property. Upon purchasing the trust deed, this means that the investor will have their name placed on the promissory note, deed of trust, and title insurance policy, ensuring their ownership and rights in the investment. The investor becomes the lender, receiving the borrower's payments, and has the right to foreclose if the borrower defaults.

Trust deed investments offer the potential for significantly higher yields than traditional investments of equal or lesser risk. This includes annualized yield, monthly payments (cash flow), diversification, preservation, and return of capital at maturity.? These characteristics make trust deed investments attractive and a beacon of hope for potential investors, promising a bright financial future.

It’s crucial to note that trust deed investments, like any investment, carry risks.? These risks can manifest when the borrower defaults, the economy falters, the neighborhood deteriorates, or the government intervenes. Understanding and managing these risks is essential for any investor, empowering them to take control of their investment journey.

The investor’s security interest is attached to real property:

https://www.dre.ca.gov/files/pdf/re35.pdf

Why should this concern you:

All investments should be diversified! ?Investing in multiple trust deeds on different properties and locations under different terms is a form of diversity of investments.? This good strategy ensures your investment is secure and well-informed, providing a solid sense of security.

Public recording of the deed of trust:

Recording means recording the executed document at a county municipality or recorder’s office, which maintains public records and documents relating to real estate ownership.? The recorded instrument will become a lien or a monetary charging order against the property. ?The borrower/property owner must recognize a claim against the property that impacts the transferability and restricts the free use until the claim is lifted or re-conveyed.? This is done when the loan is paid in full, and an instrument called a re-conveyance is recorded.

Who are the beneficiaries:

The lender/investors on the trust deed will be named “beneficiary” or “lender.” ?The recorded trust deed is held by the lender/investors as collateral for the invested capital.? A designated agent loan servicer may have the original recorded trust deed by agreement.? The borrower will also sign a promissory note, which is their promise to pay the investor/lender an agreed-upon amount of principal plus interest over an agreed period.

Owning all or a portion of the trust deed investment:

Should the investor choose to purchase 100% of a trust deed, they would gain complete control over all investment decisions.? This includes when to notify the borrower about late payments or maturity dates, submit a payoff demand, file a notice of default, or take possession of a foreclosed property.? Many investors find that owning 100% of a trust deed gives them a sense of empowerment and better ‘control’ over their investment, instilling confidence.

Alternatively, an investor may prefer investing $50,000 in fractional portions of 10 different transactions to diversify risk.? Spreading the risk includes multiple properties in various locations, other borrowers, different maturity dates, etc. ?When there are numerous trust deed investor parties, each is named as a lender/beneficiary as a percentage tenant-in-common interest in the promissory note, recorded deed of trust, and title insurance policy.? Fractional interests of the whole investment may also provide diversified cash flow. ?Should one borrower be late on their payments or default, the remainder of the investment portfolio will continue to perform.

If the total loan investment is $500,000, multiple lenders/investors may be called fractional beneficiaries. ?This means they collectively hold 100% of the title as undivided tenants-in-common.? For example, Mr. and Mrs. Archie and Edith Bunker might invest $100,000 or 20% of the loan transaction, while Mr. and Mrs. Michael and Gloria Stivic, a family trust, might invest $200,000 or 40% of the loan transaction.? Other individuals or lawfully authorized entities would invest the remaining 40%.

An essential part of the investor’s decision-making process is the loan servicer’s competency. ?Do they have the background, knowledge, and experience to handle unanticipated problems and communicate effectively with borrowers, investors, and third-party vendors?? This reassurance in the servicer’s competency can instill confidence in potential investors about the investment process, providing an invaluable sense of security and trust in the investment journey.

Upon finding and closing a trust deed investment, the investor usually enters into a loan servicing relationship with the broker or agent.? The investor agrees to covey multiple delegated rights (rather than absolute rights) to the servicing party to take specific actions that protect the investors’ interest. ?Delegated rights are similar whether there is one investor or multiple investors.? Delegated rights may include collecting the borrower’s interest payments, depositing them into the broker’s trust account, forwarding the investors their portion of the interest payment, communicating with the borrower parties about the status of any late fees, monitoring the payment of property taxes, property insurance, and handling the loan payoff and distribution of the payoff proceeds upon maturity.? The servicer may also electronically deposit payments directly into an investor/lender’s bank account if the investor chooses.

The concept of delegated rights as opposed to absolute rights:

Delegated rights are written into a loan servicing agreement and should include the following:

·????? Appointment of a loan servicer to manage the collection process.

·????? Define the relationship between the servicing party and the principal party.? As explained above, the service is an agent and fiduciary of the investor/lenders for the designated purpose.

·????? Instructions to the servicer regarding receiving funds from loan payoffs will be deposited into a broker trust account and dispersed to the principals (investors).

·????? Authorization is required for investment brokers/agents to hold original loan documents in a safe place, such as a designated fireproof and tamper-proof safe.

·????? Instructions about what to do in the event of borrower default to protect the interest of the principal investor.

·????? Provide for a limited power of attorney regarding the servicer’s authority to carry out and enforce the terms of the loan documents.

A dedicated loan servicing software package designed for single and multiple/fractional investors makes daily management of a loan servicer much easier.? The software can drive loan origination, active monthly payment collections, the investor’s ability to check online payment status, and loan payoff demands.

Expected yields:

Current yields for trust deed investments range between 10% per annum and 12%, with expected monthly interest payments and a return of capital at maturity.? This is quoted as net yield after paying a loan servicer, typically charging ? to 1% of the interest payment.

Yield differentials, which include risk assessment (1st or 2nd trust deeds), property types, property location, amenities, and risk associated with the property and borrower’s ability to pay, can affect the actual yield an investor receives.

Note for technically minded investors: Trust deeds are securities:

Trust deed investments are considered securities.? There are corresponding federal and state securities exemptions and regulatory requirements in California that apply and must be complied with by the procuring mortgage broker.? Federal exemptions include Reg D Rule 504, Reg A, and Rule 147.

State exemptions are in the California Corporations Code: ?Single investor is 25100(p), 2 to 10 investors is 25102.5, referred to as the multi-lender exemption.? Business and Professions Code 10237-10238 defines transactional and investor disclosure requirements.? Additional state exemptions used for private offerings include 25102 (e), (f), and (n).? 25113 is a permitted offering subject to an approval process with a completed application and registration.? Additional state disclosure requirements are covered under 10232.3, 10232.5 of the Business and Professions, and 2941.9 of the Civil Code. ?The latter is referred to as the Majority Rule Statute. ?Its purpose is to provide a framework for voting when multiple investors need to act to protect their interests. ?It states that a 50% plus interest can vote to decide, overriding the minority.

For investors in qualified retirement plans, like a 401(k) governed by the Department of Labor or an individual retirement account (IRA) governed by the Internal Revenue Service, the plan trustees rather than the trust deed investment broker must act as the agent and fiduciary for making investment decisions. ?If the mortgage broker or agent makes the investment decision, the transaction falls under the “prohibited transactions.”

Pension Plan Investors:

Pension plans oversite is part of the Employee Retirement Income Security Act of 1974 (ERISA). ?ERISA plans are administered by the Employee Benefits Security Administration (EBSA), a U.S. Department of Labor branch responsible for overseeing and enforcing the provisions of ERISA. ?The laws established requirements and guidelines for employers, benefit plan managers, trustees, and other service providers when handling federally related pension plans.

Compliance with Federal Law under ERISA requires fiduciary decisions solely made by the plan trustee(s), not the lender or mortgage broker responsible for arranging the loan. ?Plan trustees review proposed trust deed transactions, including the material disclosure documents, to make the final investment decision. ?The pension plan trustee is the plan’s fiduciary and has the ultimate authority to act on behalf of the pension plan.? It’s important to note that the trustee’s role is to make investment decisions, while the lender or broker’s role is to provide information and arrange the transaction.

Licensing and regulatory oversight:

Every state in the U.S.A. has its own licensing and regulatory requirements. Consult with a qualified trust deed broker or legal counsel for complex issues. Your trust deed broker can work with you to determine your suitability and whether you have the background, knowledge, and experience to consider investing in trust deeds as part of your overall investment strategy.

Thank you,

Dan Harkey

Educator & Private Money Lending Consultant and

949 533 8315? [email protected]? visit danharkey.com

This article is intended for educational purposes only and is not a solicitation.