Your questions, answered
Wall Street Wealth Management (WSWM): role, business model & compensation
What is WSWM's role in this type of lending?
Wall Street Wealth Management acts as a “facilitator” in the trust deed note investing process. We work with a limited number of turn-key partners who acquire, rehab, sell and manage the property. Our partners either keep properties in their own investment portfolio or they sell and manage for other real estate investors. Once a property note becomes available, WSWM handles the entire transaction and then remains involved as an advisor representative until the note matures.
The one thing we can’t do (by law) is to guarantee an investment. But, what we can do is to offer a layer of service not common in this type of private lending. In addition to the initial transaction process, we are always available to answer questions, help with payment issues or otherwise act on your behalf to the degree you want us involved.
Why is WSWM’s business model successful?
We have constructed the business model so that it is a win-win in the sense that our local partners earn a decent return, the borrower is satisfied with the return-on-investment (ROI) and the lender is earning what we consider to be an excellent return given the level of risk.
WSWM’s business model cannot succeed without trusted partners. We limit our activities to a handful of local turn-key partners who provide note inventory, and we use the same closing attorneys, title companies and property managers over and over again. It makes the closing process much easier and the ongoing oversight with known vendors, with whom we are continuously engaged, more efficient.
How is WSWM compensated for it’s role in the trust deed lending process?
WSWM is compensated by the borrower for Processing applications and evaluating the collateral.
Fundamentals of Trust Deed Investing
What is a trust deed – and, what are trust deed investments?
A trust deed (or a deed of trust) is a document filed with a county recorder’s office indicating that there is a loan against a property – creating a secured lien on the property, providing collateral for the lender or lenders.
Terminology may differ – some states may use a mortgage instrument, but the filing of some sort of lien is typical when mortgage loans are provided. Trust deed investments are opportunities for individuals to provide these mortgage loans privately, working through a title and escrow company and subject to real estate licensing and laws of the state.
What is meant by the word “first” when describing a first trust deed?
It is referring a first lien on the underlying property that is filed in the county of record in your favor. No other loans are in a superior position. In the event of default, you would be first in line to be paid.
What are the benefits of trust deed investing?
Trust deed investing offers an unusual combination of high returns and consistent cash flow with a secured investment. Investors receive monthly interest payments on their invested capital as they would with a fixed income investment or money market fund, but the yields are typically higher. But, because the loans are secured by the property, the risk is still relatively low.
Trust deeds also offer a vehicle for investing in real estate without the need to manage property. It is an excellent way to diversify a portfolio. Plus, unlike publicly traded real estate related securities – e.g., CMOs, MBSs, REITs – trust deed investments are straightforward and easy to understand.
Why haven’t I heard of trust deed investing before?
Most private money trust deeds are created by small companies, and are not typically sold or securitized on the secondary mortgage market – a prerequisite for trading in mainstream markets. This, combined with their smaller volume, makes them unattractive to large financial services firms to market to the masses.
WSWM: Trust Deed Note specifics
Are these individual trust deed investments or am I investing with a pool of investors?
Each individual trust deed investor is tied to only one single-family rental property. Funds are not pooled with other investors.
What is the minimum investment for trust deed investments?
WSWM’s minimum note investment is around $35,000 and ranges up to about $500,000. All notes are secured by a 1st lien trust deed on a single-family rental property.
What are the terms of the loans and how does the lender receive payments?
The term of the loan is 60 months at an interest rate of 9%. (All loans are underwritten according to the process described in the FAQ question below entitled “How is the value of a single-family home determined?”.)
Monthly payments are interest-only and are processed through an automatic payment system which allows the lender’s bank to draft the payment out of the borrower’s bank account.
Why would a borrower choose to use a private money lender – and pay a higher interest rate?
There are many reasons why a borrower would prefer a private loan to a bank loan. Most often, speed, service and flexibility are priorities. In today’s environment, banks are not inclined to work with single family home investors making it very difficult to procure funds. This, however, has created an opportunity for private lending that produces higher interest rates.
Can I use an IRA or 401(k) for trust deed investing?
Yes. Loans can be funded with self-directed IRA and 401(k) plans, or with after-tax dollars.
Do I need to see the property before investing in a trust deed?
You are certainly welcome to view a property prior to making an investment in a trust deed note. However, very few trust deed investors ever do so. The reason is that WSWM only works with a handful of turn-key partners who acquire, rehab, sell and manage the property. We meet with our partners on a regular basis and are very familiar with the quality of their work and the areas in which properties are located.
How is the value of a single-family rental home determined?
When we approve properties for financing, we don’t just rely on appraisals. Appraisals are our starting point, whether they be full or“exterior only”.
We classify properties as A to D. A being higher end, more expensive properties and D being the least desirable. Our targeted properties are classified as B- to C+. These are properties that are medium priced, have the best rent-to-value and are located primarily in areas where rental demand is high.
Six factors are important to us when performing due diligence:
- Debt Service Coverage Ratio
- Rental Demand
- Vacancy rates
- Familiarity with the market
- Foreclosure recovery of note value
Appraisal – residential appraisals are based upon Comparable Home Sales (Comps) and this gives us a good “ballpark” figure for determining value, but it will not be accurate in non-disclosure states such as Mississippi. In theses states, property sale value is considered to be private and confidential…only estimates of value are posted for public access. This skews the actual value of property in any given area. Therefore, as with commercial appraisals, we are more interested in rental income production as opposed to a house that is owner occupied and producing no income. In order to get a more complete picture, Debt Service Coverage Ratio (DSCR) must also be a primary consideration.
Debt Service Coverage Ratio (DSCR) – this formula helps lenders determine whether cash flow is adequate to service the debt. Typically, a bank requires a 1.25 DSCR. In other words, the rental income exceeds the mortgage by 25%. The formula is Net Operating Income (NOI) divided by Total Debt Service (TDS).
For example, for a $100,000 rental home, the rent will be in the $950 range. Monthly expenses for taxes, insurance, minor repairs and property management will total about $325. A $50,000 note creates a mortgage payment of $375. Net operating income (NOI) is $625 and TDS is $375. Dividing $625 by $375 equals a DSCR of 1.6 (rent exceeds mortgage payment by 60%). This is an excellent ratio.
Rental Demand – According to recent articles, this decade is on pace to be the strongest decade for renter growth in US history. In fact, the homeownership rate is back to where it was in 1993…63.7%, down from almost 70% in 2008. Vacancy rates are lower nationally than in the past 20 years and rental rates rose twice as fast as inflation. While this is bad news for renters, it is excellent news for investors and lenders. There are many reasons why homeownership is expected to decline while demand for rental housing will continue to expand. For in-depth information, do a Google search with key words “rental demand”. Also, here are a few links to recent articles: NBC News Video, Bloomberg, Washington Post, Moody’s Analytic
Vacancy Rates – historically, property vacancy rates have been below 5%. With cash flow on most properties at roughly 35%, the borrowers have more than enough income to offset an occasional vacancy.
Familiarity With The Market – as the saying goes, all real estate is local…requiring local knowledge. We have operated in the targeted markets for more than 10 years and have been working with our local partners on a continuous basis during this time period. We trust them completely and, in fact, are engaged in real estate activities with them other than trust deed notes.
Foreclosure Recovery of Note Value – If a foreclosure were necessary, would the note value be recovered along with any fees or costs associated with legal filings? Given the due diligence described above, we strongly believe the answer is yes. However, we cannot and will not ever guarantee performance of an investment asset. In fact, regulatory law prevent us from doing so.
What is Loan-To-Value (LTV) and why is it important?
Loan-to-value (LTV) is the ratio of the amount of the loan to the value of the property. If a property has a value of $100,000 and the loan is for $60,000, then the LTV is 60%. Depending upon the regional real estate market being served by WSWM, the borrower is required to invest 35-50% equity in order for the loan to be classified as low-risk.
Does the borrower personally guarantee the loan?
Personal guarantees are not required since the borrower is investing 50% in cash into the property. Also, many of the borrowers are investing with a Self Directed IRA or 401k and the IRS does not allow these retirement plans, or the owner, to personally guarantee the loan. Thus, the loan requirements do not violate the “non-recourse” (personal guarantee) aspect of the IRS rules.
Is there a pre-payment penalty?
There are no pre-payment penalties written into the loan contracts. The loan may be paid off at any time. However, it is rare for a loan to be paid off prior to maturity. If it does happen, WSWM will identify a suitable replacement for your investment.
What happens when it’s time for the loan to pay off?
All loans are written for 60 months at 9% interest with monthly interest-only payments. At the end of the term, a one-time balloon payment of the balance of the note is due. Approximately 6 months prior to the end of the term, a WSWM representative will contact the borrower and remind him/her that the note will be due and payable. Although the lender is not obligated to do so, the borrower may request an extension of terms. If the lender is willing, WSWM will assist in the process. The borrower is required to pay all costs associated with the extension.
Who are the borrowers?
Borrowers fall into two categories: 1) an individual investor who is purchasing a single-family rental home and desires to leverage the purchase through a private mortgage or 2) one of our local partners who is adding a rental home to his personal investment portfolio.
In the case of the individual investor, a cash downpayment of 35-50% of value is required. With local partners, they will have purchased a property and rehabbed it either with their own funds or a short term rehab loan. After completion of the rehab, market value is then established and a private loan from a WSWM client will replace funds used to purchase and rehab the property. In either scenario, LTV is established at 50-65% and the local partner manages the property.
Does the borrower personally guarantee the loan?
Personal guarantees are not required since the borrower is investing 35-50% equity into the property. Also, many of the borrowers are investing with a Self Directed IRA or 401k and the IRS does not allow these retirement plans, or the owner, to personally guarantee the loan. Thus, the loan requirements do not violate the “nonrecourse” (personal guarantee) aspect of the IRS rules.
Risks: Default and Foreclosure
What is the main risk associated with trust deed investing?
The main risk with trust deed investing is interruption of cash flow (i.e., borrower fails to make payments). However, this risk can easily be mitigated with an appropriate loan-to-value ratio established at the time of note execution. If foreclosure is necessary, the property can be sold at a value that is in excess of the note balance.
What happens if real estate values drop sharply during the course of a trust deed investment?
Even if property values drop, as was the case in the 2007-8 during the mortgage/real estate meltdown, it is the borrower who is affected first. But, he is still obligated to make monthly loan payments and, at maturity, pay off the loan. The best way for the lender to protect against sharp drops in market value is to insure that loan-to-value (LTV) is as conservative as possible. In the case of notes that are offered through WSWM’s turn-key partners, LTV is 50-65%…very conservative.
What if a fire destroys the building that is security for a trust deed investment?
The lender is always named as an “additional insured party” on the property insurance policy and in the event the property was destroyed by fire, the insurance company would pay off the loan.
Under what conditions would a default of the terms of the note occur?
Although no WSWM client has ever experienced a default, it is certainly possible that it could occur. Several things could constitute a default: failure to pay property taxes, insurance premium or monthly interest payment.
What is the remedy for default?
The first thing that comes to mind is to foreclose on the note. However, as your advisor, WSWM would first intervene and talk directly with the property manager and the borrower to determine whether there is a solution short of foreclosure. If no other solution is possible. WSWM would assist with the foreclosure process, which would start with invoking the “Assignment of Rents” clause in the loan documents. This would involve a notification being sent to the property manager to redirect rental payments to the lender (you). Secondly, legal proceedings would begin.
What are the steps in foreclosure, how much would it cost and how long would it take?
The process varies from state to state, but legal filings and proceedings typically cost between $1,500 and $2,000 and generally take 2 to 4 months. At the appropriate time, a trustee would be appointed to auction the property on the courthouse steps. Opening bid would be the amount of the note plus any overdue interest payments, late fees and foreclosure costs.