Trust Deeds For Income — When & Why

Last week I wrote about a young couple wanting to begin investing in real estate in order to produce an abundant and early retirement. The wife was opting for investing in a non-appreciating asset for cash flow, as she wanted to pay off their two car loans.

One of the comments, in part, said this:

Jeff, I understand that new investors who have day jobs should not opt for cash flow instruments over R.E., but would you address the role of cash flow instruments for someone who has been in the game longer, is retired with no day job and needs to be into some cash flow instruments to pay the bills.

By way of simple explanation…..

A note is simply an I.O.U., signed by a borrower, who gives as security his property, as evidenced by what’s known as a deed of trust. This trust deed (TD) is recorded at the county recorder’s office. (not the note) This puts the world on what’s known as constructive notice, that the owner of the property has encumbered it with borrowed money. The trust deed gives the lender certain legal rights if the terms of the note and/or trust deed are violated by the borrower. This description isn’t meant to be a dissertation on the subject, just a very simple, working definition.

Sometimes investors can indeed find themselves in the position of voluntary, or involuntary retirement, but with real estate investments not having yet achieved what I’ll call ‘retirement cash flow status’. That’s not a happy position in which to find yourself. However, there are many folks, though in the distinct minority, who are in that position and have access to plentiful liquid capital. (That’s a snooty way of saying cash. ) For those folks, lending on real estate, with the security of trust deeds can be a life saver. But how do you do it?

I’m not gonna get into the specific mechanics here. That would be a War & Peace post for which a specialist is far better suited than I. I have however invested in them myself from time to time, and have had clients do very well with them.

First you need to decide how involved you want to be. You can be a direct lender, probably using a mortgage broker who understands hard money loans. If this is the way you’re heading, I’d strongly recommend you give Brian Brady a call. He understands hard money lending much better than most — he’s in the business.

Note: Although I’ll be referring to the purchase or lending for cash flow while using the term ‘trust deed’, it’s shorthand for: note secured by deed of trust. Just so ya know.

Whenever I’ve done it, buying discounted trust deeds has been my choice. The first one I ever bought was a $10,000 TD. It was an owner carry back on an 80/10/10 sale of a San Diego area duplex. I paid less than the face amount of the note, which resulted in my actual yield being around 18% per annum. My return was significantly higher than that when the note was paid off early. WooHoo!

People have a zillion reasons for wanting to sell their TD’s at a discount. Due diligence is of course critical, as a mistake born of optimism can come back to bite you where you sit. The rule of thumb taught to me by one of my sainted mentors said this:

If after looking at the note, the borrower, terms of the sale, and the property, you can’t visualize yourself as deliriously happy to foreclose — don’t buy the dang thing.

That was his folksy way of saying you should be better off owning the property after foreclosure than owning the TD, or you should pass. It’s an approach that hasn’t failed so far. It’s the acid test.

There are ‘partnerships’ headed by professionals, who specialize in creating income via TD’s. They make it more or less seamless, and many investors prefer this approach. The return is less than buying discounted TD’s or being a hard money lender yourself, but it’s still usually in the 10-12% range. This allows for a ‘don’t bother me’ attitude on the part of the investor, which some find the clinching factor. The key is finding one with a solid track record of performance and expertise. This is the method the commenter has chosen, and she’s been very happy with the results.

The point is, if there’s a need for personal income while your real estate is developing its own, and you’re unemployed, this is a very viable solution. Here’s what’s possible if you were to invest a couple hundred thousand bucks, using the methods mentioned.

If you use someone like Brian to lend your money for you, your return will vary of course, but it will be higher than making a simple purchase money loan. If an income property owner needs $100,000 and is willing to pay you 13% interest, with interest only payments, you’ll make about $1,083 monthly.

That same capital lent for 10% in one of the group approaches will generate somewhere around $833 a month. Also, if you want out of the group there are often restrictions and/or penalties. Overall, there are groups like this with solid reputations, who do great jobs.

If you choose to buy discounted TD’s, your return will likely increase. The yield will change based upon the note’s stated interest rate, due date, payment rate, and so on. For instance, if you purchase a note secured by a TD with a due date in 44 months, and in fact it’s paid off in 33 months, your yield will skyrocket. (time value of money principle) Though I hesitate to publish a monthly payment for this approach, it will almost always be the highest one of all. Think about it. If you buy a trust deed with a current balance of $50,000 for $40,000, and the interest rate is 10%, you’re making more than 10% as a result of having less than $50,000 invested. Again, I’ll not do the numbers here. The yield goes up as the price paid for the TD goes down. If it’s paid off sooner than agreed, the yield goes up more.

Some time I’ll use a couple examples to illustrate how the numbers actually work. I used to analyze discounted TD’s in what seems now like a previous life. It doesn’t require a graduate degree in math from M.I.T.

Again, it’s important to understand the need for a specialist to guide you in this segment of real estate, although the partnership approach usually has those specialists built in — a handy factor in your decision making process for sure.

You should keep in mind the income is totally taxable, but so is the income you’d be getting at a job, right? For those investors who find themselves in the gap between future cash flows, and current needs, TD income isn’t a bad way to go — and it avoids the worst case scenario of cannibalizing your principal.

FIUL’s are much better of course, but they won’t take care of the now. And now is when you need to eat.

What are FIUL’s? Another time — soon.

Related posts:

1. You Have A Purposeful Plan — Now You Need A Lender You Can Trust — A Performer
2. Income Property: A Tale of Two Investors
3. 10% Down For Small Income Properties – Dumb Like A Fox?
4. Income Property: Saving On Expenses While Lowering Income And Value
5. Live in Paradise — But Don’t Buy Income Property There