The Pitfalls of Trust Deed Investing - Solution to Pitfall 3
Updated: May 24, 2021
4 Ways to Maintain Diversification.
SOLUTION #3 – Lack of Diversification If you are investing through a mortgage broker you want to be investing with a company that does not make you put a huge amount of your principle in one loan. A low barrier to entry allows you more diversification. An investment that allows a $10,000 minimum investment provides more diversification within your portfolio than an investment that starts at $100,000. If you do have $100,000 to invest in Trust Deeds, you want to diversify and put it into several different loans. There are four ways to maintain diversification with Trust Deed investments.
The first is you want to invest with several borrowers, not just one, not just two, but several different borrowers so that you have options when putting your funds into their projects. Remember if a borrower has a loan in default it is not typically one loan, it is their entire portfolio. If you have all your investments with one, you may be in for a long ride should the borrower have financial problems.
The second and probably least considered is market diversification. This is primarily due to location familiarity. When making this decision consider the last real estate collapse. A well-diversified Trust Deed investment portfolio weathered the storm as not all markets reacted the same to the downturn. Some experienced a 90% correction, while other only 10%. Every market has varying degrees of market drivers and conditions that must be considered. No two markets are the same.
The third level of diversification is within loan type. Your options in this category are the most robust and must be considered carefully as market conditions drive demand with loan type. These options may include, but are not limited to, land acquisition, development, and construction of single and multi-family residential and commercial office and retail space. This category may also include bridge financing on existing income producing structures for short durations until bank financing is obtained. Not all the options described may be appropriate depending on the market conditions. Consider the rule of supply and demand when making this decision. You would not want to be investing in commercial office space in a market that has 70% commercial office space standing available inventory and the remaining 30% at less than 50% occupancy. Steer clear of this loan type in that market. On the flipside, a market with one month of home inventory with job creation of nearly 10,000 entering the market in the next 60 days due to a new Google headquarters opening may be a good time to invest in single-family development project 10 miles from the Google headquarters.
“Do not get caught in a long-term real estate investment that do not provide flexibility for payoff of redemption for long periods of time, unless you have a crystal ball and know what is going to happen with the value of real estate in the next three to five years."
The term or duration of the loan is the fourth consideration when considering diversification. You may be asking yourself, why? This is not to imply that you are investing in a liquid investment because it is an illiquid investment, but the terms of a Trust Deed investment are relatively short-term in duration. A typical real estate investment is for many years, whereas Trust Deed investments are short-term, typically 6 to 12 months. This is primarily due to the higher rates charged than that of a bank. A borrower cannot afford to pay the higher rates for long periods of time, thus move through the project quickly or are able to obtain better financing within short order. If you are strategic with when you invest your funds with Trust Deed investments, you could create a monthly or even quarterly schedule based on loan maturity dates. Do not get caught in a long-term real estate investment that do not provide flexibility for payoff of redemption for long periods of time, unless you have a crystal ball and know what is going to happen with the value of real estate in the next three to five years.
It is hard enough to find one good mortgage broker but challenge yourself to find two to accomplish an even better blend with more options to minimize your overall risk to protect a preserve your principle. At Ignite Funding, our minimum investment is $10,000, we fund loans across the Western United States, we offer various loan types with loan durations averaging from 6 to 12 months, thus providing the greatest opportunities for diversification. These components combined increases your diversification. CONCLUSION.
Now that you know about some of the pitfalls of Trust Deed investing you will be acutely aware of what to watch out for as it relates to the conflict of interests, loan-to-own underwriting mentality, and lack of diversification risks. Instead of falling into those traps you can look for a mortgage broker who is working on behalf of both the borrower and the investor, who is invested in the performance of the loans they underwrite and who encourage investors to diversify not just within their Trust Deeds, but within their entire portfolio.