Trust deed investments

Investors looking for higher yields with low risk often consider investing cash in trust deed notes with fixed interest rates during periods of stable consumer and asset (real estate) inflation. A trust deed investor invests cash in a trust deed note by:

  • making a loan evidenced by a note in favor of the investor and secured by a trust deed lien on real estate they qualify as adequate security for repayment on a default;
  • buying an existing trust deed note held by another; or
  • making a loan evidenced by a note in favor of the investor and collaterally secured by an existing note and trust deed held by the borrower.

A loan collaterally secured by an existing trust deed note is indirectly secured by real estate. This is a transaction a real estate broker or agent may arrange for a fee. When the collateralized loan becomes delinquent, the lender repossesses the trust deed note, not the underlying real estate.

Here, the trust deed note is not in default. On repossession of the trust deed note due to a delinquency, the lender becomes the holder and owner of the trust deed note repossessed to satisfy the collateralized loan.

Consider a carryback seller who holds a note and trust deed received on their installment sale of a property. The carryback seller wants to retain ownership of the note as a steady source of income. To borrow money, the carryback seller who holds the trust deed note temporarily assigns the note and trust deed to a lender as collateral pledged to secure the loan, a process called hypothecation.

The word hypothecate stems from both Medieval Latin and Greek. In Medieval Latin, hypothecat, the past participle stem of hypothecare or hypotheca, meant “a pledge.” In Greek, hypotheke means “a deposit, pledge, mortgage.”

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Thus, the sole security for the loan is the existing trust deed note — not the real estate. To document the collateralized loan transaction, the borrower signs and delivers to the lender a collateral note and security agreement as evidence of the debt owed and trust deed pledge arrangements. [See RPI Form 438]

The borrower also signs a security device and records it in the country recorder where the real estate is located to put others on notice of the security link between the new loan and the existing trust deed note, called a Collateral Assignment of Deed of Trust (and note). [See RPI Form 446]

On a default in the collateralized loan, the lender repossesses the trust deed note which is the security for the loan. Again, the lender does not foreclose on the underlying real estate.

Due diligence essential for trust deed acquisitions

Whether an investor purchases a trust deed note or makes a loan collateralized by a trust deed note, the trust deed broker and investor need to consider the due diligence investigation and documentation for the purchase or hypothecation of a trust deed note.

The stages for trust deed investing include:

  • due diligence investigations into the trust deed note and the value of the underlying real estate;
  • trust deed purchase agreement or agreement to hypothecate [See RPI Form 241and 242];
  • escrow; and
  • servicing and foreclosure.

During all stages of a trust deed investment analysis and documentation, the trust deed investor needs to be concerned with the risks and values connected with:

  • the payment history on the trust deed note;
  • the real estate (its physical condition, title profile, location and the income it generates);
  • the borrower’s creditworthiness; and
  • the ownership of the note and trust deed.

A trust deed investor retains a trust deed broker under a written employment agreement. The broker assists in the due diligence investigation and documentation process to reduce the risks of loss on a trust deed note investment. [See RPI Form 112]

Also, a trust deed broker likely has an inventory of trust deed note listings fully packaged under a transmittal letter for investors to consider. [See RPI Form 233]

The trust deed listing agreement

Trust deed note holders, particularly carryback sellers, often decide to sell their trust deed note. Thus, their trust deed broker’s task is to locate an investor to purchase the note.

Here, the note holder is first asked to enter into a trust deed listing agreement to establish an enforceable client relationship with the broker. A trust deed listing agreement employs the broker to diligently work to locate an investor to purchase the trust deed note, sometimes called paper, in exchange for payment of a contingency fee. [See RPI Form 112]

A trust deed broker uses the Trust Deed Listing – Exclusive Right to Sell a Note published by RPI (Realty Publications Inc.) to locate an investor and negotiate the trust dee note holder’s terms for the sale of the note. [See RPI Form 112]

The listing agreement obligates the trust deed holder as a client to pay the broker an agreed-to fee when the broker fully performs by meeting the objective of the employment — locating an investor who acquires the note and trust deed.

The listing agreement further entitles the broker to a fee when the note holder collaterally assigns or pledges the note as security for a new loan during the period of the employment or the safety clause. [See RPI Form 112 §3.2(e)]

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A real estate broker has the general duty to disclose to both the buyer and seller all material facts, conditions and terms of the debt evidenced by the trust deed note which might affect either participant’s willingness to enter into a transaction for the sale and acquisition of the trust deed note. [Barry v. Raskov (1991) 232 CA 3d 447]

The Trust Deed Listing – Exclusive Right to Sell a Note calls for the note holder’s disclosure of all material facts regarding the assignment of a trust deed note to an investor — facts the broker is duty-bound to disclose to an investor on commencement of negotiations to acquire the trust deed note.

The listing agreement discloses:

  • the terms for sale of the trust deed note, including:
    • the asking price for the trust deed note [See RPI Form 112 §4.1];
    • the annual yield on the sales price over the remaining life of the note [See RPI Form 112 §4.2];
    • the original amount, principal balance, payment terms and interest rate of the note [See RPI Form 112 §4.3];
    • any due-on-sale, late charge and prepayment penalty provisions in the note [See RPI Form 112 §4.5-4.7]; and
    • the priority of the trust deed on title. [See RPI Form 112 §4.8]
  • the real estate securing the note [See RPI Form 112 §5];
  • senior encumbrances [See RPI Form 112 §6]; and
  • any personal property included as additional security to the real estate. [See RPI Form 112 §7]

Electronic documentation

Forms and documents such as the trust deed listing agreement and disclosures used in a trust deed transaction may be filled out electronically and signed digitally. When choosing to use electronic documents, consent needs to be given by the recipient of the documents.

Consent may be given by:

  • written authorization; or
  • the client’s conduct. [Calif. Civil Code §1633.5]

A broker or an agent uses the Consent for Use of Electronic Documents and Digital Signatures form published by RPI when seeking authorization from their client for the use of digital forms, to obtain the requisite written consent for the electronic transmission of transaction documents to the client. [See RPI Form 109]

Though consent may be given through conduct, obtaining a client’s formal authorization best protects the broker’s fee in the event disputes later arise about the method of document transmission.

When consenting to the use of electronic documents, the client:

  • authorizes their agent to use electronic documents, signatures and email delivery of transaction documents in the course of the transaction [See RPI Form 109 §2.1];
  • acknowledges the right to receive a physical copy of any document provided at no charge on request to their agent [See RPI Form 109 §2.3];
  • may at any time withdraw their consent and refuse to conduct future transactions electronically by written notification to the agent [See RPI Form 109 §2.4]; and
  • may limit their consent to use electronic documents to a specific property or activity. [See RPI Form 109 §2.5]

This article was originally published February 2016 and has been updated.