Pick up a copy of Money or Smart Money magazine, and you’ll find articles about all manner of potential investments. Stocks, bonds, REITs, tax-free municipal bonds, real estate – even baseball cards and Cabbage Patch dolls. But you’ll probably never find an article on trust deeds, even though these investments have been quietly yielding many savvy Nevadans double-digit annualized returns for decades.
A trust deed (aka mortgage) is much like the mortgage on your house; however, as an investor, you are the lender who receives monthly payments, rather than the borrower who makes them. Typically, borrowers are real estate developers or land bankers borrowing to purchase, develop or hold property. Also typically, because most mortgage loans are too large for one investor to fund individually, loans are made through mortgage companies which, in turn, sell fractionalized interests to investors.
For example, a borrower may have a real estate project worth $1.5 million. He wants to borrow $900,000 against it. The mortgage company endeavors to verify that the property really is worth $1.5 million – usually by getting an appraisal from a licensed appraiser. The mortgage company then agrees to lend the borrower $900,000 (a 60 percent loan-to-value ratio); it might then obtain $90,000 from each of five investor/clients and $150,000 from each of three investor clients to make up the total of $900,000.
Before lending, the mortgage company evaluates the loan to make sure the collateral is worth significantly more than the amount loaned (to give the investors an “equity cushion” against default), assembles the investor group and handles the paperwork. Monthly, as the borrower makes his payment, the mortgage company collects the money and divides it among the various investors according to the percentage they invested.
What rates of return should investors expect from trust deeds? It depends on several factors, including the quality and desirability of the collateral, the loan-to-value ratio and the reputation, track record and financial net worth of the borrower. It also depends upon whether the trust deed is in the first or second position. At present, in Las Vegas, “firsts” typically command roughly 12 percent to 14 percent per annum and “seconds” roughly from 14 percent to 18 percent and up.
Some people shy away from investing in trust deeds as sounding “too good to be true.” With the prime rate hovering around 8 percent, they wonder why anyone would agree to pay up to 18 percent to borrow money unless the person or company were a disastrous credit risk. Why wouldn’t these people borrow the money at much lower rates from their bank?
First, mortgage companies are less regulated than banks. They make decisions and fund loans more quickly. Second, mortgage companies frequently will lend more than a bank would on a given piece of property. Third, banks can be fickle, changing policies overnight from being “real estate friendly” or “raw land friendly” lenders to refusing to lend on such collateral. When this happens, quality borrowers are left out in the cold. Fourth, most banks have “one borrower limits” limiting the total amount a bank can lend to a single developer/borrower (including affiliates). Once these limits are reached, the borrower is forced elsewhere – such as to a mortgage company – to get the money needed.
In short, many solid borrowers seek financing from mortgage companies. Moreover, notwithstanding a very few highly-publicized bad apples, many reputable mortgage companies quietly generate returns for their investor/clients.
All mortgage companies must be licensed by the State of Nevada Mortgage Lending Division (MLD). Talk to several companies (and several investors, if possible), then check with the MLD at (702) 486-0780 or (775) 684-7060 – and with your attorney and accountant – before investing.