Over the recent years the California real estate has dropped 30-40% from peak value. But this doesn’t necessarily mean that California real estate is a bad place to make an investment, to the contrary, this is the perfect time for savvy investors to capitalize on an undervalued market. The most simplistic investment strategy is to buy low and sell high, and when done correctly can be applied to various types of investments. California real estate is no different, and one way to literally bank on California’s underwater real estate market is through secured loans (otherwise known as first trust deeds) rather than buying property itself. Right now a loan for 60% market value equates to 36% of peak market value. With this strategy a worst case scenario could be selling a secured property for .40 cents on the dollar while still turning a profit. Best case scenario is that the loan is paid off according to the terms of a loan contract and an investor makes an easy passive investment that is secured by real property. Either way you look at it, California First Trust Deeds can be a lucrative and safe addition to any investment portfolio.
Today a one-year California General Obligation Bond yields only 0.05% in spite of the fact that California has the worst credit of any state in the U.S. A one year Certificate of Deposit (CD) at a major bank only yields about 2% max. Investors seeking income without substantial risk have very few options in this economy. In contrast, a California loan at 60% loan-to-value frequently yields 9-12% and can be safer than stocks bonds mutual funds and CDs. Just like with any investment, there is no such thing as risk free, there is only risk mitigation. Even cash under your mattress comes with the risk of inflation. Before making any investment one should consider what the investment is, how it makes money and what the risks are. Identifying more than one of these factors in a publicly traded security can be difficult, but with CA First Trust Deeds it is simple for even amateur investors to understand.
Before making a loan in California there are a couple documents that must be understood. Almost all loans come with a document called a promissory note. A promissory note is a contract where one party makes a loan and another promises to pay the loan. This contract goes over the terms of the note, for example:
- Who is the borrower and who is the lender
- What amount of money is being loaned and what is the interest rate
- How much are the monthly payments and for how long
- What happens if the borrower defaults on the loan and how is the lender secured, etc…
Another key document in California is the instrument used to secure the loan, this is called a Deed of Trust or Trust Deed. A deed of trust is recorded in the county that the property is located and includes some information that is not contained in the promissory note, such as a trustee or third party apart from the lender or the borrower. A trustee is usually a title, insurance or escrow company who is given the task of acting as a third party fiduciary to the transaction. Once the borrower signs the trust deed, they are authorizing the trustee to step in should they default or stop making payments on the loan. In the event of a default the trustee is given the power and authority to step in and conduct a sale of the property, this is generally known as a trustee sale. In this “worst-case” scenario all the proceeds of a trustee sale go to the lender until they have received the principal and interest owed according to the terms of the promissory note.
Having a low loan-to-value is how you are secured. If you have a 60% loan to value this means that in the worst case scenario a trustee can sell the property for .60 cents on the dollar to get your principal back. Over time two variables lower the loan-to-value ratio:
1. Property goes up in value
2. The principal is paid down
Advantages of Trust Deed Investing:
- Principal is secured by your ltv
- Income and cash flow is likely to be higher than other “secure” investments
- Fewer investor look to loan money as opposed to buying real estate, resulting in less competition and more investment opportunities
- Creating, acquiring and securing a debt is not considered “doing business” in the state of California and can be done from all 50 states or even across the globe
Downside to First Trust Deeds in California:
Like any other investment you don’t want to just jump in head first. There is research to be done, competition and unknown risks that a newbie may not think about. If you don’t live in California and can’t go down and kick the tires before investing in a first trust deed then you not only risk making big mistakes, but will also lose sleep at night. Even if you’re local it takes the right knowledge and expertise to see a good investment. Finding borrowers, underwriting a loan, understanding where the property is and how it’s secured are all variables that come with experience.
Utilizing the right team is probably the most prudent move for any savvy investor. Jalapenos Leadership Industries, LLC has been helping investors make loans for over 6 years and has been in business since 2006. Ken Porter with Jalapenos Leadership contributed to this article, adding: “After buying and selling real estate and as our knowledge about private lending grew, we are continuing to increase the size of loans to underwrite by sharing the benefits of trust deed investing with other private investors. Getting together with others who are trying to reach a similar goal can be a powerful concept”.