Note Funds vs. Individual Trust Deeds

This is a very insightful article by Lew Sichelman.

He is a nationally syndicated columnist who writes for Realty Q & A
Lew has been covering the housing market for more than 40 years, responds to readers’ questions on real estate.

We here at The Note Guys only deal with individual trust deeds. Although we have been asked many times to create a “note fund”, we aren’t convinced that is the right direction to go.

WASHINGTON (MarketWatch) — Question: I invested all my savings into two trust deed companies. Somehow, the chief executives of these two companies got to become multimillionaires, but there is no money for investors like me. Are trust deed companies Ponzi schemes? Does anyone regulate them? —K.S., Palm Desert, Calif.

Answer: I’m not exactly sure what happened here. If you mean you purchased trust deeds from the two companies you mentioned in your question (but I purposely omitted), the trust deeds and the property behind them are the collateral and your safety net, not the companies which sold them.

But it sounds to me more like you invested in outfits which promised a monthly income secured by a pool of trust deeds. That means you only own a fractional interest in the pool, and that would make the integrity of the company the issue, not the deeds themselves.

If the latter case is true, the companies are creating a mortgage-backed security. And as such, they are regulated by state and federal laws that apply to securities dealers. So if you have a beef, and it sure sounds like you do, that’s where you need to go to complain or seek redress.

I spoke with David Krunic, executive vice president of Reliant Financial, about your question. The Houston-based company buys financial paper backed by every conceivable type of property — residential, commercial, even churches. And Krunic has been what he calls “playing in the discount sandbox” for more than two decades.

He said you made a “critical mistake” in not investing directly either in individual properties or in deeds on individual properties. That way, if something should go wrong and your borrower fails to pay as promised, you “have something hard and fast” that stands behind your investment as opposed to some amorphous company.

In a quick, five-minute, down-and-dirty dissertation, Krunic also said would-be investors should stay local. Rather than invest across state lines, put your money to work no more than a car-ride away, and where you know and understand the laws, especially as they pertain to foreclosures and evictions.

Novices might want to start out learning about investing in trust deeds by attending meetings sponsored by local real-estate clubs, where they can pick the brains of those who have gone before them and avoid making the mistakes others have made. “Sit in a room with local specialists and soak up some guidance,” Krunic said.

Also avoid family deals — arm’s length transactions only, please — and overly urban and overly rural properties. Not only do they tend to be more difficult to resell, urban properties are more prone to being stripped and rural properties are more likely to be vandalized. “If you have to go in with an Uzi to collect your rent,” my expert warned, “it’s not a good place to be.”

What is a good place? “Any place where real estate has stood the test of time,” Krunic said. “That will give you a ready market when you go to resell.”

Look for properties or deeds on properties south of the frost-line, where the real estate won’t be damaged if the heat is turned off. Consider a resort area, particularly places where properties tend to hold their value, or near a college town. That way, if something should go wrong, you’ll have a vacation home you can enjoy or something you can rent to a ready-made market of college kids.

Krunic also says you should never invest at a rate of any more than 55% to 60% of current market value so you’ll have a built-in cushion of equity. “You’ve got to have insulation,” he said. “If the next payment never comes, you’ll have plenty of room to get out.”

By the way, getting out can be expensive: When you have to pay an agent to sell the place, a lawyer to handle your foreclosure, any unpaid back taxes and whatever repairs are necessary, your wallet could be $20,000 to $35,000 lighter when all is said and done.

Although Krunic said he believes investing in a company such as the ones you dealt with is a “recipe for disappointment,” he said you must do your homework if you want to go that route. Check them out with the authorities, for sure, but also ask for references from other investors and talk to them directly. Be leery of mass emails or mass snail mailings, too. It’s best that you are referred as opposed to being phished.

But even then, this expert warned, “it’s really scary” when you have to trust someone else to make your business decisions. Worse, he said, if it all falls apart, there’s nothing there for individual investors like you.

Nationally syndicated columnist Lew Sichelman has been covering the housing market for more than 40 years. MarketWatch readers are encouraged to send their real estate questions to him at lsichelman@aol.com . Answers will be presented in this column every Friday. However, because of the volume of e-mail he receives, he cannot answer every reader’s query.

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