Smart Investing - January 2001

Trust Deed Investments

A Good Alternative for the Savvy Investor

by Steve Brockman

The results of the November national election have demonstrated once again what everyone already knows - nothing is certain in today’s world. This is definitely the case when it comes to making wise investment decisions. The uncertainty in the cyberspace dot.com market is making real-world, tangible real estate investing a good alternative for many investors. Such investments often take the form of a trust deed.

Trust deed investments generally feature a predictable return over a pre-determined length of time with full return of principal at maturation. In practice, these investments are the foundation of a large percentage of the real estate development in the Las Vegas Valley. Funds are pooled and loaned to development teams for the express purpose of purchasing necessary land and undertaking construction activities for a specific project.

The collateral for the loan is the property itself. The developer conveys a security interest to the project investors through a trust deed, which gives the investment group first rights to the property itself if the loan is not repaid as scheduled. Obviously, these investments occur in real time with a specific property as security. The company that offers the investment opportunity usually underwrites the property to determine the level of risk and then puts together a consortium of investors who loan the funds to the project developer.

Of course, the usual caveats apply. Becoming educated is the most important step investors need to take to gain confidence about any investment, and trust deeds are no exception. Some of the terms are different but the basic principles are familiar.

The loan-to-value ratio, which is the ratio of the loan amount to the market value of the property, is a measure of risk. The LTV is expressed as a percentage; the lower it is, the more equity the developer has in the project, and the lower the risk to the investor. For example, an LTV of fifty percent tells the investor that the loan amount is half of the appraised value of the property. The developer has a considerable ownership interest in the project and is unlikely to put it at risk by defaulting on the loan.

Another important number to consider is the yield, which is the rate of return. Most trust deed investments pay interest monthly for the duration of the loan. In fact, for many trust deed investors, predictable monthly income is a major financial objective. The yield also varies with the degree of risk. To stay with a simple example again, a loan with a high LTV of ninety percent will have a higher yield than one with the 50 percent LTV discussed earlier.

While the yield and LTV are significant measures, the total loan package is most important. Investors should focus on the experience of the company offering the loan and the experience of the team developing the property. It’s important to look for a track record of success in similar ventures. This information is included in the prospectus or offering for the loan. In addition, an investor should ask to review all resumes of the borrowers, along with their corporate and personal financial statements. The objective is to determine if the team is borrowing to do the same thing they have accomplished successfully before.

Trust deed investors should also check carefully the construction loan cost estimates and make sure there is a disinterested third party overseeing the disbursements of funds. Because trust deeds are an investment in an actual project, review all available information about the property itself, including location maps, site plans, applicable zoning restrictions and a property appraisal, if one has been done.

This process of reviewing information, called "due diligence," is a very important task to perform while developing confidence in real estate investing. It’s also important for the investor to call upon his or her own knowledge and common sense. The general economy and its growth prospects are good, which is always an important factor to consider. Some investment firms specialize in local trust deeds, and prospective investors can visit the actual project site and form a first-hand impression about the investment.

Often, the ability to know and understand the project creates a high comfort level with commercial real estate investing. This is not always possible with other investments, as the dot.com fallout so aptly demonstrates. Once again, though, the real secret is balance, both between the types of investments in a portfolio and within the specific investment under consideration.

Steve Brockman
Steve Brockman is owner of Builder’s Capital, Inc., a Las Vegas firm that arranges private money and institutional real estate loans in Nevada.