Successful Trust Deed Portfolios establish and maintain valuable capital preservation cushion known as Protective Equity. Here are the Top 10 steps Sponsors should take to Preserve Capital and maintain protective equity in a Trust Deed Investment:
- Limit Loan to Values: The Loan to Value Ratio which is the loan amount divided by the property value should generally not exceed 70% on a Purchase and 65% on a refinance.
- Maintain Conservative Projections: Realistic appreciation and After Repair Values (ARV’s) should be used on loans that require a sale as the exit strategy
- Determine Valid and Viable Loan Exit Strategies: Verify that conventional financing or a property sale are viable exits when the loan term matures. Can the credit score be improved in the required time frame? Will the property rehab be complete with a Certificate of Occupancy with the funds provided?
- Obtain Third Party Appraisals or Valuations: Many borrower provided valuation reports have different influences. Multiple Third Party valuation data points, property inspections, accurate comparables and construction budget reviews should be used to establish a realistic current and future property value.
- Obtain Letters of Explanations: Low FICO scores should come with an explanation. For example, a Bankruptcy caused by a serious medical issue should be treated differently than a borrower who is chronically late on payments and has trouble managing his/her affairs. A borrower’s involvement in Grant Deed, Refinance and Chain of Title actions should also be explained.
- Personal Relationships: Hard Money Loan Scenarios always have a “story”. To truly understand a loan scenario, a Sponsor/Hard Money should understand the borrower’s objective, stakeholders, relationships and real motivations. Many times a meeting with the borrower at the property is the best way to ensure a viable loan, correct valuation and likelihood of a successful investment for both the borrower and lender.
- Education and Licensing: BRE Real Estate Broker Licensing, NMLS, California Mortgage Association Membership and involvement are all important aspects to staying up to speed on best practices.
- Underwriting Excellence: Employing specialized Valuation, Document Management, Legal Experts, Servicing, Default Management and most importantly underwriting expertise enables better and more successful loans and Trust Deed Investments.
- Focus on Niche Products: It is tough to be all things to all people. High Yields and Capital Preservation occurs when Sponsors combine the elements mentioned in #7 and #8 above and focus on their niche lending products. When I worked at CBRE I found that the most successful brokers were those that learned a “Farm” area first and created value by knowing all the happenings in their Farm. When a Realtors pitch starts out with “I work all over”, watch out. The best Realtors choose specific areas to be experts and the best hard money lenders choose specific loan types and loan structures.
- Foreclosure and REO Expertise: Managing Foreclosures and Real Estate Owned “REO” properties can make or break the yield and capital preservation on a Trust Deed Investment. Successful Sponsors pursue all angles to get a lenders capital back including rent/rehab analysis, active property management and rehab/construction efforts to sell an REO property at the highest value in the shortest period of time.
Do you have a good technique for Capital Preservation? We would like to know.