You may have heard of First Deed of Trust investing, but are unsure what kind of risks are involved. Are these types of investments safe, or are they something you should avoid adding to your portfolio? To give you a clearer picture of first deed of trust investing risks, we’re covering the different traits of these investments in this article.
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How Does A First Deed Of Trust Work?
Let’s start by explaining what a first deed of trust is and how it works, as it’s a significantly different investment than a basic option, like stocks. Essentially, first deed of trust investing entails buying real estate-backed loans, and it functions in many of the same ways as a mortgage. While the two real estate terms are not identical, they do share similarities.
With a first deed of trust, non-performing loans can be foreclosed on much as a mortgage can. For a first deed of trust, this is called a “Non-Judicial Foreclosure,” and is usually faster and comes with fewer legal hurdles.
As with mortgages, first deeds of trust can span short or long-term loans, which are based on the goals of the trust investor or manager of the trust deed investment fund, as well as the type of real estate the first deed of trust uses as collateral.
Why Do Investors Prefer First Deed of Trust Investments?
First Deeds of Trust have numerous traits that make them an excellent choice for those looking to diversify their portfolios without adding significant risk exposure. What factors help reduce risk when it comes to First Deed of Trust investments?
Investors Have Collateral To Recover Assets
If the loan that’s underlying the first deed of trust isn’t paid back, the property securing the loan can be foreclosed on to recover the investment. Often, typically up to only 70% of the property value is loaned on, so if the borrower does go into default on the loan, the property can usually be recovered at below market value. An added benefit of low loan-to-value ratios is that they also protect the investor against market recessions.
Dependable Cash Flow
Another good reason to invest in first deed of trust investment funds is the dependable cash flow they can provide. Typically, investors are paid returns at a fixed monthly amount at predetermined interest rates until the underlying loan is paid in full.
Reallocation Of Returns
Investors often even have the option to reallocate their returns back into the fund to increase their earning potential. Earning dependable, compounding returns is a key reason investors choose first deed of trust funds.
Appealing Yields Relative To Returns
Another reason investors choose first deed of trust investments is that they typically pay an appealing yield relative to the risk involved. Typically, non-QM deeds of trust are shorter in duration and given to borrowers who don’t qualify for traditional bank loans, providing investors with annual returns in the high single digits to low double digits depending on the loan terms.
Risks Involved With First Deed Of Trust Investing
One of the main benefits of first deed of trust investing is the ability to minimize downside risk. If the borrower doesn’t repay the lender, the foreclosure process for a first deed of trust is faster and cheaper than a traditional mortgage foreclosure. That said, foreclosures are a reality, so how does the process work, and what risks do they pose for investors?
With first deeds of trust, foreclosures are classified as non-judicial, enabling lenders to bypass the court system and execute the terms of the trust deed and any applicable State laws. For example, in California, the non-judicial foreclosure clock begins when the lender records and delivers the borrower a Notice of Default. After that, the borrower has no less than 90 days to rectify the past-due payment.
What If A Borrower Can’t Pay By The 90-Day Mark?
If the borrower can’t rectify the default within 90 days, a Notice of Trustee’s Sale can be filed, and the property can be sold at a foreclosure sale in no less than 21 days. As you can see, this process is far faster and less complex than court foreclosure proceedings, minimizing the degree of risk involved in first deed of trust investing.
Any Other Downsides To First Deed of Trust Investing?
First deed of trust investing can provide attractive risk-adjusted returns, but there are a few downsides to consider before you start investing.
Less Liquidity Than Stocks
It’s important to keep in mind that first deed of trust investments aren’t liquid like stock and equity investments. So, if you want to balance risk, you’ll need to own a large number of trust deeds. Because of this, many investors instead choose a first deed of trust investment fund, which offers far more security and stability by distributing risk across multiple first deeds of trust.
Can’t Build Equity
Another downside for some investors is that it’s not possible to build equity in the underlying asset over the course of the investment. The only returns investors receive is their predetermined monthly payments at pre-specified rates of return. Of course, this means the returns for each month are locked in and won’t fluctuate, a bonus for many.
Real Estate Experience Is Recommended
For investors without experience in the real estate industry, direct investment in a first deed of trust can be an extremely risky and time-consuming process. They’ll need to evaluate borrowers, negotiate the terms offered to the borrower or seller, and perform due diligence on both the property and the borrower. They’ll also need to stay up to date on numerous local laws and regulations governing real estate lending.
Talk To The California First Deed Of Trust Experts Today
If investing in first deeds of trust on your own sounds too intimidating, don’t give up quite yet. Contact the expert first deed of trust investment team at Saint Investment Group!
We’re here to help you invest wisely in first deeds of trust through our managed fund. Saint Investment Group delivers consistent returns with our advanced portfolio of underlying assets. Give our seasoned first deed of trust investment team a call today to learn how you can start earning consistent, high-yield, passive income with your hard-earned capital. Call (323) 483-0291 today to learn more.
President of Saint Investment Group
Nic is a two decade seasoned expert in investing and capital raising, specializing in Real Estate and debt markets. With Saint Investment Group, he leads large-scale distressed asset purchases and innovative syndications for investors.