William Schlick has been monitoring the gloomy dispatches from Wall Street. With the credit crunch gouging global stock market indices and financial uncertainty infecting just about everyone he knows, it’s been hard not to worry.
“There’s no other way to say it—my IRAs and annuities have tanked,” says Schlick, 58, a retired California agri-business executive. “I’m trying to take the long view.”
But one portion of his portfolio that has helped reduce his anxiety is the slice dedicated to trust deed investing. A few years ago, he invested in fractional note and deed investments through Sterling Pacific Financial, LLC, a privately held real estate lending and investment firm headquartered in California. Schlick says this decision has reduced volatility in his overall portfolio—and helped him sleep better since the financial crisis hit.
“I started with trust deeds four years ago and I’ve been very happy with the performance so far...I wish I could say the same about the rest of my investments right now.”
Trust deed investments have been around for decades but still account for an estimated less than one percent of U.S. investment dollars. If the average investor has heard of them at all, he or she may have only a vague idea that they’re related to real estate. Trust deed investments are not mortgage-backed securities, the complex bundles of repackaged loans that have been maligned in recent months. And they’re not publicly traded real estate investment trusts (REITs), either. They’re much more straightforward.
Licensed trust deed investment companies (TDICs) make selective real estate loans to companies needing short-term or bridge financing, perhaps to complete a building or a renovation project. Their borrowers run the gamut from churches to shopping centers to office buildings. Firms familiar to trust deed investors include Sterling Pacific Financial, Lantern Financial Corp., R.C. Temme Corp. and The Money Brokers.
When individuals, trusts, endowments, companies, and retirement plans like IRAs and Keoghs invest money in a trust deed, they essentially become real estate lenders themselves. But the TDIC simplifies the process by handling the approval and underwriting process and servicing the loan.
Because TDICs make funds available more quickly than a bank, legal lending rates are higher and the typical rate of return to investors ranges from nine to 12 percent. Each trust deed matches with one property, so investors who work with a reputable TDIC should be able to see exactly where their money is going, what the loan-to-value ratio of the transaction is, and what monthly return they will receive. Detailed asset information, such as appraisals, encumbrance reports, and environmental reviews, should also be transparent. The deeds can be purchased in their entirety or as “fractional notes” in combination with other investors.
“Investors like our products, because they offer consistent returns in the double digits with relatively low risk,” says Joshua Fischer, managing director and principal of Sterling Pacific Financial.
Trust deeds have long been attractive to investors because of their relative predictability and their tax advantages. Income in a deed can accumulate tax free until withdrawal, making them a good fit for self-directed IRAs and Coverdell education savings plans. Now that investors have seen what can happen to a portfolio composed entirely of stocks and bonds, diversifying into trust deeds looks even more sensible.
“Retirement dollars invested with us grew 25 percent faster than non-retirement dollars in the past year,” says Sterling’s Fischer. “Given the current market, we expect that trend to continue.”
And the credit crisis has also given TDICs an unprecedented opportunity.
“With subprime lending all but gone, borrowers with less than perfect credit have nowhere else to go but to brokers who make loans with private money,” says George Eckert, vice president of the Money Brokers and president of the California Mortgage Association in Sacramento, Calif. “In many cases credit quality is better than ever, and yields are high due to a shortage of money.”
Corrected real estate markets also offer a silver lining to TDICs and their investors. Loans are being made based on today’s lower real estate values, rather than yesterday’s inflated ones.
“Today we have some of the best opportunities I’ve seen in the past five years,” says Fischer. “We can pick and choose transactions that will provide the best returns for our investors.”
Fischer says that his firm spends more time evaluating, analyzing and understanding the asset potential of every loan originated, than a traditional bank would. “Understanding the true value of the asset is the key to success in this business”, says Fischer. In many areas of the country, property values have begun to rebound, but it is important to distinguish between micro-markets to pinpoint the best opportunities.
“There can be differences from neighborhood to neighborhood and even from street to street,” says Fischer. “It’s crucial to choose a company that knows its areas well.”
Sterling Pacific has been in business for more than ten years and has never lost an investor’s principal in that time. It also distinguishes itself by investing heavily alongside its investors (management contributes about 20 percent of the overall portfolio), and by offering two mortgage pools, The Foundation Fund, LLC, and The First Floor Fund, LLC. The company has a 90 percent investor retention rate.
For a qualified investor who understands the risk/reward balance, trust deeds can provide terrific income, say financial planners.
Ginita Wall, a certified financial planner and director of the women’s institute for financial education (WIFE) in San Diego, Calif. advises potential trust deed investors to review broker’s filings with bodies like the Better Business Bureau, the California department of real estate and the California department of corporations. Choosing deeds for properties with solid loan-to-value ratios and finding buildings that have multiple uses can also help cut risk, says Wall.
“Trust deed investing is not something the average investor knows about,” says Chris Hrabak, 52, of Laytonville, Calif. Hrabak has invested in trust deeds for six years. “I have to explain to my friends how they work—and there’s always some skepticism since it’s so unfamiliar.”
But that may change, he says.
“The brutal stock market has everyone I know rethinking their entire investment strategy.”
Amy Mason Doan is a freelance writer and editor based in Portland, Oregon. She has a B.A. in English and Business Administration from U.C. Berkeley and an M.A. in Journalism from Stanford University. Her work has appeared in Forbes, The Oregonian, Portrait of Portland, Pink, the San Francisco Chronicle, Wired, the Orange County Register, the San Jose Mercury News and other publications.
