With the volatility in the stock market the past few years, many people may wonder about trust deeds and whether they are an appropriate ingredient for their investment plans. Money managers have always recommended a diversified portfolio including growth, income and cash investments. Within these categories there are many alternatives – individual stocks versus mutual funds, individual bond issues versus bond funds versus other fixed income investments, cash versus money market accounts or other liquid investments, to name just a few. There are also varying degrees of risk and liquidity within each of these. Money managers generally recommend that, as investors approach retirement, they shift a higher portion of their portfolio into income investments and away from the volatility of growth funds and higher risk equities.
Trust deeds, particularly when offered in a publicly registered fund, provide a unique combination of diversification, high monthly income, liquidity and a very favorable risk/return ratio. And unlike all stocks and many bonds, trust deeds are secured by a tangible asset – real estate. By its very definition, a trust deed fund is more diversified than an individual trust deed.
While some trust deed investors who participate in individual loans feel that they have a certain amount of control that is lacking in a fund, this is only the case if the investor owns all, or at least the majority, of a particular loan. Because loans can range from $100,000 to several million dollars, this can require a large investment that violates the “too many eggs in one basket” rule. In addition, a fund investor will continue to receive monthly returns if a few of the loans in the fund default, while the individual trust deed investor will receive no income in the event of a default until problems with that loan are resolved. Overall, the advantages gained with a fund generally outweigh any loss of perceived control for most investors.
For example, funds usually allow a smaller initial investment of around $5,000 and allow even smaller incremental investments. Individual trust deed brokers usually require an investment of $25,000 or more. Some funds also offer compounding of interest, a feature not possible with individual trust deeds. Investors should also ask about diversification and liquidity. Different funds will have differing rules and requirements governing these two parameters. Ideally a fund should diversify geographically, as well as by collateral and project type. As for liquidity, generally a fund will require investors to leave their investment in the fund for a minimum of 12 months. With individual trust deeds, the investors’ money is committed until the loan pays off.
Investors should ask about the level of disclosure and regulatory scrutiny a fund has passed. Some “intrastate” funds are only filed with the securities division within the state in which the fund is to be offered. These funds are only allowed to make loans within that state, which limits the ability for the fund to diversify geographically. An “interstate” fund must be fully registered with the Securities and Exchange Commission as well as with all state securities divisions in which it will be offered. The fund’s prospectus will spell out these and many other aspects of the fund and its management.
Lending is one of the oldest professions in the world. Trust deeds secured by tangible real property, when professionally underwritten and managed, have become a good alternative for the income producing portion of an investment portfolio.
