March 20, 2001

 Notes Secured By A Deed Of Trust Remain An
Excellent Alternative For Investment Capital

By Richard C. Temme

During this period of weak stock market performance and low interest rates, few alternatives remain that make sense for investment capital.  Yes, one can invest in real estate as an alternative, if one is willing to consider the management challenges.  However, this article is not intended to discuss real estate investments.

The attraction of trust deed investments looms brighter at this time than it has for many years.  The terms "trust deed" or "deed of trust" are often used interchangeably to describe an investment in a note secured by a deed of trust.  

The single most important advice I can give anyone contemplating an investment in trust deedsis to make the level of security for your investment the number one selection criteria.   After satisfying individual safety requirements, it's then reasonable to consider rate, term, prepayment penalty, convenience and other investment factors.

Prepayment penalties often increase investor yields as a result of early payoff. The old axiom "the higher the rate, the greater the risk" is only partially true with trust deed investments. A carefully selected investment secured by a first deed of trust may be as safe, or even safer, than many lower rated corporate bonds.  Why then do trust deed investments usually earn a higher rate of return to the investor?

The reason investments in notes secured by deed of trust usually yield more than bonds, CD's or insurance annuities is that those investments are "wholesale investments".   Investors give their funds to the party paying the interest, at wholesale rates. The corporation, bank or insurance company offering the investment in turn reinvests those funds at higher rates and earns the retail rate of interest on those funds.

Trust deed investments offer investors a retail rate of interest on invested capital.   That, obviously, allows a higher earnings rate on invested capital, often without any greater risk than many bonds or some insurance annuities, depending on the level of safety selected by the investor.

Why then doesn't every fixed income investor invest in notes secured by deeds of trust?

Some investors are not interested or are not suited to deal with the concerns or inconveniences of retailing their capital.   A borrower's late payment means the investor must wait to collect the payment due on that loan.  Trust deed investors must be comfortable with the concept that they will either have their money or they will have the property securing the loan.  The possibility of unintentionally owning real estate or an undivided portion of real estate doesn't unreasonably disturb most successful trust deed investors.

Most trust deed investors are comfortable with the knowledge that, upon foreclosure, they would likely acquire the underlying real estate at a low price.  Therefore, they are willing to own the property if they must.   Most trust deed investors don't want to own real estate.  Most investors find comfort in the knowledge that the vast majority of conservatively selected trust deed investments eventually return all principal and accrued interest to the investor.  Further, relatively few trust deed investments, selected with conservative criteria, are ever foreclosed upon. This is due to the fact that private trust deed investors generally loan a lower percentage of the value of the property than do most banks and thrifts.  The borrower usually has more equity to lose when borrowing from private sources. 

Investors are cautioned that the level of security can vary substantially from one trust deed investment to another.  Where some trust deed investments enjoy a high level of security, other trust deed investments may contain a high-risk element.  Notes secured by first deeds of trust are generally more secure that notes secured by second or third deeds of trust.   Often, investors will accept a higher risk factor with a particular trust deed investment in exchange for a higher yield. Investors are strongly cautioned not to use yield as the primary investment selection criteria. Higher risk trust deeds should only be considered if the total high-risk portion of investment capital constitutes a small percent of total assets.  Even then, higher risk trust deeds may not be appropriate for many investors unless they specifically want to own the underlying real estate.

A risk benefit analysis should be performed prior to making any investment in trust deeds.  What is the risk?  What is the benefit?  Such an analysis is generally easier to calculate when the yield is lower and the risk is minimal.  Even at lower interest rates, most trust deed investments yield more than alternative dollar denominated investments.

In general, a lower loan to value ratio is considered a safer loan than a high loan to value ratio.  In general, first loans are considered safer that second or third loans. The analysis becomes more difficult when comparing a first loan at a higher loan to value ratio with a second or third loan at a lower loan to value ratio.  Inexperienced trust deed investors are encouraged to select the lower yielding but usually safer loans secured by a first deed of trust, and preferably, those loans with a lower loan to value ratio.

It is the function of R. C. Temme Corporation to provide acceptable trust deed investments, to service those investments for investors and to absorb much of the inconvenience and/or irritation for investors, thus minimizing the undesirable effects of retailing one's capital.

In the final analysis, willingness to retail one's money by investing in notes secured by deed of trust earns a much higher rate of interest than can generally be found in other dollar denominated investment instruments, often without unreasonably compromising safety.