What Investors Should Know

It is true that anyone can invest in a Trust Deed, however we encourage investors to seek out expert advice when dealing with this somewhat complicated investment area. A knowledgeable professional will be most valuable in areas pertaining to estate valuation, project management, financing, and the law. Also, working with an experienced firm significantly reduces your risk. With that said, it is also very important for the investor to have an understanding of certain key areas regarding a Trust Deed; we have elaborated on some of those concepts below.

Determining Loan-to-value Ratio

The first step in determining LTV is to determine the value of the property, something that can be a lot trickier than it sounds. CapSource focuses on 3 main areas when determining the value of a property:

Market Analysis

When we examine a potential loan our first step is to conduct a market analysis, which provides us with relative values of comparable properties in the neighborhood. Keep in mind this is not an automated valuation through a web site service. A proper market analysis is conducted by a professional who visits the property, knows the neighborhood, and can evaluate the property against comparable sales.

The Appraisal

Evaluation involves a real estate appraisal prepared by a licensed appraiser. We want the appraisal to indicate the values if the property had to be liquidated quickly. This "liquidation" valuation gives additional security that if the loan defaults the property can be sold quickly to protect the interests of the investors.

The Cost of Renovation

Valuation for renovation and construction projects can be more difficult to perform because you're valuing the cost of the work to be done and estimating the value of the property after the project is complete. You must have knowledge of the type of construction project involved, including the range of costs to complete the project. Without adequate information, a trust deed investor could loan on a property to find out later that the borrower had vastly underestimated the cost of renovation and is unable to complete the project. CapSource closely scrutinizes construction costs, require firm bids and, in most cases, on-site inspections prior to funding the loan.

Understanding the Value of a Property

One of the most important factors in trust deed investing is the value of the property securing the loan. In conventional financing, banks and other institutional lenders have relied heavily on borrower credit history to determine whether the lender should loan to the borrower. Private-money, or asset-based lending, is different. The main underwriting component of a private-money loan is the actual property itself. One must make certain that the amount of the loan is well below the value of the property. Generally, trust deed investors look for a loan-to-value (LTV) ratio of 70% or less. For a property valued at $100,000, a loan with 70% LTV would be $70,000. The lower the LTV, the better; because the leftover equity in the property (the other 30%) is what protects the investment in the event of default.

Borrowers

While borrower credit score may not be as critical a factor in private loan underwriting, borrower credit character is certainly important. Successful trust deed investors examine the credit character of each borrower to assess risk.

Personal Guarantee

This means that the owners of the entity make themselves personally responsible for repayment of the loan. If the business is unable to pay, the guarantors will still be responsible for repaying you personally. A personal guarantee is essential to every loan.

Lien Position

When a trust deed is recorded with the county clerk and recorder, it is placed in a lien position. If it is the first lien recorded, it will be in first position. A trust deed recorded after the first trust deed on the same property takes second position, and so on ...

The recording position of the trust deed is important because the trust deed in the highest priority position will receive payment from a foreclosure sale, before any lower priority positions. Thus, second lien trust deeds carry more risk of loss than first lien trust deeds.

Some trust deed investors will invest only in first liens, while some trust deed investors will accept the additional risk, with potentially higher returns, to invest in second lien trust deeds.
 

Loan Maturity

This refers to the length of time that the loan (Trust Deed) will be issued for. Understanding when your loan matures is important when analyzing risk and long term investment gains. If a loan term in 24 months, then an investor should plan on having their funds locked into the Trust Deed for at least that long. Also, once the loan matures, it is possible to compile your accrued interest and combine it with your initial investment on a new trust deed. Doing so would be how you take advantage of compounding interest.

CapSource offers short term loans that typically range from 8 to 24 months. This allows our investors to minimize risk and increase the power of compounding interest. Short term trust deeds also insulate our investors from changes in the real estate market, making our trust deeds some of the most valuable in the industry.

Documentation & Protection

It goes without saying that property documentation is key for protecting the security of a trust deed investment. It is imperative that security documents are accurate, that the property title is clean, and that the property insurances are installed on each deal.

CapSource not only ensures that all of the documentation relating to our trust deeds is accurate and correct, we make sure that all of our investors have a firm understanding of each contract.

Ongoing Management Needs

Trust deed investors should know that there is ongoing management of the loan after it is placed. The management refers to the way the money is issued to the borrower for renovations or construction and how the money is filed with the IRS.

CapSource enlists the hand of strong and reputable loan servicing companies to manage the loan after it is placed. These loan servicing companies have the proper mechanisms in place to handle monthly payments, taxes and any possible foreclosure procedures, to properly manage the loan from the day it starts, until the day it closes.