July 17th, 2012
How to Mitigate Risk on Your Private Money (Trust Deed) Investments
There is no doubt that investing in trust deeds has its rewards and pitfalls. At ExpressLoan we evaluate each transaction that we do by several criteria to make a risk determination.
The very first thing we do is develop a solid conservative “quick sale” property value. We strive to be fair while being conservative; we will not reach or stretch for value. The next most important criteria is not to loan too much, in other words depending on type of property limiting your loan to value ratio to no more than 65% (70% case by case on strong borrowers and pride of ownership properties) on detached SFRs. Offices at 60% to 65% and Industrial to 55% to 60% and in rare cases up to 65%.
Another important factor is to determine what amount of rent this property will generate. If after taxes and insurance the rent yields are around an 8% return or better on investment, in the unlikely event of having to take the property by foreclosure, it would be a strong loan too.
Of course there are other factors as well but these are the biggest areas of concern for hard money lending. Another very big issue is being in a 1st position. If we do fund a second (and we haven’t for some time now) it would need to be a very low LTV and have a small first with very good terms.
Here is some food for thought regarding the worst case scenarios;
Just on the underwriting standards above, if the property were to have to be foreclosed on, several things would have happened;
There would have been income for some period of time (first payment defaults are very rare in hard money). Unlike the stock market when you end up losing money by the stock decreasing in value, you NEVER had any income against it (small exceptions for very small dividends). This pervious income should be looked at against any potential loss.
2. To generate a loss on a trust deed investment the property would have to drop in value by 25% or more. (While this can and has happened in the past, we don’t think there is that much deflation left in real estate.)
3. So assume the borrower forces us to have to foreclose, the property has dropped by 30% (this would be extreme from where we are now) but you had income at say 10% for 12 months, it’s like the property (comparing now to the stock market where you likely had no income before taking a loss) only dropped 20% (offsetting income against loss on the same investment). If we are at 65% LTV even with the cost of foreclosure AND assuming we sell instead of rent it, it likely works out to a small gain. If there is a loss in this case, it would be very small, something much less than 5% of the investment.
As a side note; not a single person, none of our investors has ever lost any principal or interest on any loan that has been arranged by ExpressLoan. That is because of the diligence we put into determining a property value, then not loaning too much and further determining the willingness and ability of the borrower(s) to repay the debt.
We are here to assist you with your trust deed investment strategy.
Call Brent Calver at 800-635-6222 or email me at firstname.lastname@example.org for a no obligation consultation on earning high rates of return with safe, secured, trust deed investments.