But if you are going to invest in trust deeds for the long term, you will surely have to deal with some foreclosures. How you deal with these foreclosures will determine whether or not you are a successful trust deed investor.
Here is the first of two rules that you need to burn into your brain.
Foreclosed properties seldom* sell or lease
until they are renovated.
*In real life, "never" would be more accurate.
Suppose you foreclose on a property. Not wanting to shell out money to renovate the property, you tell your real estate broker, "Just sell it or lease it 'as is'" Folks, that property will just sit and sit for years. Years. How do I know this? Experience.
Why? For one thing, there is no commercial fix-and-flip industry. Secondly, most of your foreclosures will happen during recessions and crashes, when demand for space is weak.
Foreclosed properties always need to be renovated. If the borrower lacks the dough to make his payments, he certainly doesn't have the dough to keep his property in good repair. Therefore, it is critical, if you are going to invest in first trust deeds, that you always maintain some liquidity.
Banks are regulated by the Office of the Controller of the Currency ("OCC"), a division of the Department of the Treasury. Banks are chartered to accept deposits and to lend money. The Treasury does not want commercial banks to become huge property owners.
Therefore the Treasury Department insists that banks get their REO's (foreclosed properties) off their books right away; otherwise, the bank is financially punished. Sophisticated real estate investors know that the bank is under pressure to sell its REO's, and to do so, the bank often has to discount the property by 45%.
Because banks are under pressure
to sell their REO's, banks seldom get
more than 55% of fair market market.
Buyers of REO's therefore always want "a deal." They almost never offer the bank fair market value. How do these buyers even find out that the property is an REO? Your own real estate broker invariably rats you out. "Psst. You can get a good deal on this property. They foreclosed on it."
But here's the deal. You and your fellow owners are not a bank. The Treasury lacks the power to order you to sell your property for just 55 cents on the dollar. In order to sell it for a retail price, you have to make the market forget that this property is a foreclosure.
I have found that the best way to do this is to immediately renovate the property. Fresh paint, trash cleanup, fresh mulch, some obvious repairs, and a "For Lease" sign go a long way towards making your property look like a rental and not an REO.
It will take you a month or two to effect your minor renovations, which is good. You need to change the property's appearance and create a gap in time so any potential buyers will look at your property as a piece of commercial-investment property (a property that pays an investor an income every month), rather than a foreclosure. By seasoning or aging your foreclosure, you should enjoy 35% to 45% more in proceeds from any sale.
What Are Trust Deeds?
Trust deeds (or mortgages, depending on the state) are investments in a loan, secured by real estate, directly to the borrower. Rather than putting your money in the bank and having the bank make the real estate loan, private investors can actually make the loan directly.
The trust deed investment business is huge in California, and it has been around at least 80 years. Recent law changes now allow investors from every state to invest in trust deeds, as long as they are accredited investors. The good news is that you can earn 8% to 12% interest in first trust deeds. The bad news is that you, not the bank, take the loss if the loan goes bad.
Scary Disclosure Stuff:
Investing in first trust deeds involves substantial risk. A large and prolonged decline in real estate values is possible. Always maintain some liquidity. Foreclosed property always needs to be renovated. Before you invest with Blackburne & Sons, my own hard money shop, or any other reputable hard money outfit, you will be given a huge Offering Circular, which discloses many of the risks. Please be sure to read it, especially the Risk Factors section.