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Expected losses on 1st position fractional trust deeds

Dean Ng
Posted Apr 8 2024, 15:52

I come from the world of stock and bond investing, and am looking to diversify with fractional trust deeds purchased from a HML. I'm considering 1st position TDs with <70% LTV. The RE used as collateral are either SFH, multi-fam, or small commercial (like a small retail store), and all in Calif. Can someone with a lot of experience in TDs and stock-index ETFs compare these two investments in terms of risk-adjusted returns? If a beginner buys TDs as described in this post, and they yield 10.5%, what type of losses should be expected over the long run? I've done a lot of reading and no one ever discusses losses, but surely there will be some? And given that risk-free Treasuries pay 5.3% now, is a 5% premium over that worth it?

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Replied Apr 8 2024, 17:07

@Jeff S.   I would talk to Jeff he is an expert in southern CA lending.

In the day and the day was long ago for me.. but we did all our loans as fractional in the SF Bay ARea were I had my company. AS HML sizes grew so large and private investors were funding them it was hard to get one lender to put in 500k but easy to find 10 that would do 50k each.

The fractional space has come a long way and a Good Broker is needed to place these for you.

Good Broker good first positions are  a pretty safe bet.. I still like one note one investor if able.

However as I stated if you can Get to Jeff he will be a wealth of info on this subject.

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Jeff S.#5 Private Lending & Conventional Mortgage Advice Contributor
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Jeff S.#5 Private Lending & Conventional Mortgage Advice Contributor
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Replied Apr 9 2024, 08:29

Thanks for the shout-out, @Jay Hinrichs.

“And given that risk-free Treasuries pay 5.3% now, is a 5% premium over that worth it?”

It’s worse than that, @Dean Ng. Taxes on stocks held long enough are treated as capital gains. Interest income from lending is taxed at your ordinary income rate. Ouch. The problem when you invest in a fractionalized other brokered loan is that the originator has to get paid too. Ditto syndications. Thus, your returns will be lower than if you can originate yourself, which we do.

According to Lightening Docs, the average return for a 1st position bridge loan in LA is around 11% plus 2 points for a 1st position loan. That’s close to the national average now but with a wide spread. Over time, most lenders experience a default rate of 1 to 2%. This doesn’t mean you’re wiped out (unless you invest in seconds). But it could mean you get stuck with a beat-up POS you have to sell yourself to get out whole. Investing in fractionalized loans or syndications eliminates that but at a cost.

Everyone is a genius when the market is rising, as it’s done for the past decade. Over the long run though, we made a lot of money in stocks and lost a lot of money, but the swings were intolerable. In our view, lending is much safer, predictable, and backed by equity. You couldn’t pay us to invest in stocks anymore. Each to his own.

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David C.
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Replied Apr 9 2024, 10:29

@Dean Ng

@Jeff S. explained it well ... as usual.

I've been private lending in SoCal for 13 years now, almost exclusively to SFR flippers … never lost a penny. My underwriting criteria are very conservative. As a CA broker I can originate whole as well as fractionalized loans. I've only ever originated for myself, and a few fractionalized loans between myself, family, and friends. Because of my limited capital and to avoid putting all my eggs in one basket, I'm moving more towards fractionalized.

Unlike a brokerage, I only look at loan quality, I’m not motivated by commissions, thus less likely to lose money, in my view. The takeaway here is to become familiar with determining loan quality for yourself when working w/ a broker.

In addition to the capital gains issue Jeff mentioned, there is cash drag. With the market you’re earning 365 days/yr. With short term (1yr or less) TD’s you earn only a fraction of the year. For example, if you earn 10% with TD’s for 6 months, that’s the same as earning 5% with T-bills for a year. Cash drag being the time between when a loan pays off and when the money is deployed into a new loan.

I also like syndications. The idea of a large amount of money being concentrated in one loan is a little concerning. Cash drag is shifted to the syndicator in a hard money syndication. You earn 365 days/yr, albeit at lower ROI than if you invest in individual loans.

Having been through a couple of stock market downturns, I’m out of the market for good, all in with RE. Big swings are not for me.

It’s hard to compare risk/reward between the two.

I like TD’s, hard money syndications and T-Bills … all pretty safe.

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Dean Ng
Replied Apr 9 2024, 15:15

@Jeff S.

The fractional TDs I'm considering buying are existing, performing short-term loans (6-18mo hold time) that a HML originated and are now selling (presumably to free up capital to make new loans). They yield 10.5%. So based on what you know, if a beginner were to snatch up several of these 10.5% TDs over time, and experienced typical losses for a beginner, what would their net be? 9.5%? 8%? That's what I'm getting at.

Yes I understand how different "characters" of income are taxed differently.  In that regard, long-term stocks are taxed at the lowest rate, because if I don't sell, there are no capital gains taxes ever.  (There are ways to monetize the unrealized gains without selling.)  TDs are essentially a bond and are taxed at the highest rates.  There are also note funds, but I'm not considering them because they're unsecured and pay only slightly higher than what I can get with safer  publicy traded funds.

So on the risk scale, with T-bills being a 0, S&P500 ETF being a 7, and a Meme stock being a 10, where would you put TDs with the parameters I specified in my first post?  Let's say we enter a moderate recession someday.

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Dean Ng
Replied Apr 9 2024, 15:47
Quote from @David C.:

In addition to the capital gains issue Jeff mentioned, there is cash drag. With the market you’re earning 365 days/yr. With short term (1yr or less) TD’s you earn only a fraction of the year. For example, if you earn 10% with TD’s for 6 months, that’s the same as earning 5% with T-bills for a year. Cash drag being the time between when a loan pays off and when the money is deployed into a new loan.

Having been through a couple of stock market downturns, I’m out of the market for good, all in with RE. Big swings are not for me.

I was planning to borrow against my investment portfolio at 5%, then invest that money in fractional TDs.  By employing leverage, there's risk, which is why I started this tread (to find out how risky TDs really are).  There won't be any issue with cash drag, because when the TD pays out, I can pay off my loan and wait for another TD.

Your last comment was interesting:  You said you don't like volatility but you went all-in on RE?  Do you hold physical RE?  When I think of big swings, I think of RE, especially leveraged RE.  I owned multi-fam from 2004 to 2011 so I've experienced some wild swings; that's why I'm looking at TDs now.  Being a landlord wasn't for me, but TD investing might be OK because it's just a secured bond

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Replied Apr 9 2024, 16:25
Quote from @Dean Ng:

I come from the world of stock and bond investing, and am looking to diversify with fractional trust deeds purchased from a HML. I'm considering 1st position TDs with <70% LTV. The RE used as collateral are either SFH, multi-fam, or small commercial (like a small retail store), and all in Calif. Can someone with a lot of experience in TDs and stock-index ETFs compare these two investments in terms of risk-adjusted returns? If a beginner buys TDs as described in this post, and they yield 10.5%, what type of losses should be expected over the long run? I've done a lot of reading and no one ever discusses losses, but surely there will be some? And given that risk-free Treasuries pay 5.3% now, is a 5% premium over that worth it?


Like anything, it depends. If you stick with conservative loan to values then chances of a loss are slim, there could be delays in getting paid but you should be able to preserve capital with the lower loan to values. The other component will be if these are from a HML, what is the borrowers experience? An experienced borrower with a PG will be a lot more stable than a first time fix and flipper.

Hope this helps

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Replied Apr 9 2024, 20:40

@Dean Ng your question may be difficult to answer.  If you have enough money to buy 100 loans, it’s easier to answer—you’ll most likely see a default rate in the 3-5% range, with most defaults eventually fully cured.  Maybe you have a couple losers where you lose 10-20% of your principal, which even in the worst case of two 20% losers that’s 40% of 5% which is 2%. If you are earning 10.5% you net 8.5% and have no loss of principal.  A single 10% loser is 0.5% so you net 10%. This range is about right today. If the economy or housing market adversely shift, or if you are buying from a poor originator, or buying loans with low quality borrowers/properties, these results would deteriorate.

But if you have capital for just a handful of loans, overall performance averages don’t apply. You are either lucky, or not. Get one really bad loan, you wipe out a significant percentage of your capital.  Think of this like small vs large apartment complexes—if you own a 100 unit complex and the market vacancy rate is  5%, you’ll probably have 5% vacancy most of the time.  But if you own a 4-plex, you’ll be 25% vacant, 50% vacant, or 0% vacant depending somewhat on luck.

Another risk is the “unintended partnership” risk.  If a fractional forecloses, you now own a property with several other people you don’t know.  You don’t know if you’ll like the decisions they’ll make, nor do you know how big of a pain they will be.  If the deal turns out to be a loser, you could have one co-bene refusing to sell, tying up the deal in a lawsuit to force a sale.  Now you are shelling out cash to lawyers.  If these issues sound far-fetched, maybe they are, but I get this example because I’ve seen it.

These are some of the reasons I like a debt fund. Regardless of how much you invest, your risk is spread among a broad base of loans, allowing you to track overall averages rather than luck, plus you eliminate (or, more accurately, minimize) cash drag.  There is also one decision-maker: the fund manager.

The downside is the fund manager has to get paid, so that’s a point of friction on your return.  But you also get the additional benefit of the fund manager handling everything that you would otherwise have to do, and freeing up your time is worth something.

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Replied Apr 10 2024, 07:53
Quote from @Brian Burke:

@Dean Ng your question may be difficult to answer.  If you have enough money to buy 100 loans, it’s easier to answer—you’ll most likely see a default rate in the 3-5% range, with most defaults eventually fully cured.  Maybe you have a couple losers where you lose 10-20% of your principal, which even in the worst case of two 20% losers that’s 40% of 5% which is 2%. If you are earning 10.5% you net 8.5% and have no loss of principal.  A single 10% loser is 0.5% so you net 10%. This range is about right today. If the economy or housing market adversely shift, or if you are buying from a poor originator, or buying loans with low quality borrowers/properties, these results would deteriorate.

But if you have capital for just a handful of loans, overall performance averages don’t apply. You are either lucky, or not. Get one really bad loan, you wipe out a significant percentage of your capital.  Think of this like small vs large apartment complexes—if you own a 100 unit complex and the market vacancy rate is  5%, you’ll probably have 5% vacancy most of the time.  But if you own a 4-plex, you’ll be 25% vacant, 50% vacant, or 0% vacant depending somewhat on luck.

Another risk is the “unintended partnership” risk.  If a fractional forecloses, you now own a property with several other people you don’t know.  You don’t know if you’ll like the decisions they’ll make, nor do you know how big of a pain they will be.  If the deal turns out to be a loser, you could have one co-bene refusing to sell, tying up the deal in a lawsuit to force a sale.  Now you are shelling out cash to lawyers.  If these issues sound far-fetched, maybe they are, but I get this example because I’ve seen it.

These are some of the reasons I like a debt fund. Regardless of how much you invest, your risk is spread among a broad base of loans, allowing you to track overall averages rather than luck, plus you eliminate (or, more accurately, minimize) cash drag.  There is also one decision-maker: the fund manager.

The downside is the fund manager has to get paid, so that’s a point of friction on your return.  But you also get the additional benefit of the fund manager handling everything that you would otherwise have to do, and freeing up your time is worth something.


Brian the unhappy co beneficiaries is very real.. at least it was in the day..  I had a loan on Green st. in Sf cool place my client put over 500k into reno and it had an MAI appraisal in 89 of 2.1 mil with a BOA first of 900k we made a 200k second.. We did not do a lot of seconds but for that client and that real estate we did PRIME SF Resi. Well earthquake hit on the night of the World Series as we all remember.  The northern CA RE market Tanked and I mean tanked ( we all have short memories and like to think CA never suffers degraded equities). Long story short my client could not sell and BOA went into foreclosure.  We had the right to cure and I had worked out a deal with BOA to service the the first as a Junior in possession..  So I am trying to get my bene's of my 200k loan to all agree to pony up the 50 to 70k  about there to cure and then we can rent for more than debt service no problem.. Meg Ryan lived next door even LOL. Anyway 2 hold outs and the property sold for 950k at the steps. my clients got wiped out.

Fast forward to 97 or so and that house sells for 4 million.  At the time Brokers ( me) did not have the authority to manage these.. I believe NOW though Brokers do have documents and what if authority to manage these situations.. Not necessary force the investor to pony up money but can take their position so the rest of the investors are not wiped out.  I could be wrong on this but I seem to remember reading about this in one of my CRE class's for my CA Brokers license.

Of course first positions not so much of a issue other than who ponies up for the foreclosure costs or rehab costs to get it to market.. But I suspect the deal can be structured that those that do no participate have to pay interest to those that do carry it forward ( the other investors).

This thread just made me remember that one.. I did not have the funds to buy them all out at the time other wise I would have..


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Replied Apr 10 2024, 07:57
Quote from @Dean Ng:

I come from the world of stock and bond investing, and am looking to diversify with fractional trust deeds purchased from a HML. I'm considering 1st position TDs with <70% LTV. The RE used as collateral are either SFH, multi-fam, or small commercial (like a small retail store), and all in Calif. Can someone with a lot of experience in TDs and stock-index ETFs compare these two investments in terms of risk-adjusted returns? If a beginner buys TDs as described in this post, and they yield 10.5%, what type of losses should be expected over the long run? I've done a lot of reading and no one ever discusses losses, but surely there will be some? And given that risk-free Treasuries pay 5.3% now, is a 5% premium over that worth it?

Not worthed the risk.

you could get 7 to 8 percent from interval fund that’s liquid, such as NIcHx.

also since options etf exists like TSLY or CONY I stopped looking at real estate with less than 10 percent.

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Replied Apr 10 2024, 13:52

@Brian Burke

That's very useful information.  In terms of debt funds, I'm not considering them because their yields are only slightly higher than low-risk alternatives like GSE bonds and AAA CLOs.  There are also many cases of RE investment funds going belly up or turning into Ponzi schemes. 

@Carlos Ptriawan

NICHX doesn't seem very liquid.  It has no secondary market and the investor can only redeem once per quarter, assuming there isn't a flood of redemptions.  Short-term TDs would be more liquid since I can keep rolling them. 

Covered call ETFs correlate strongly with the stock market.  I'm trying to diversify away from stock market.  

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Replied Apr 10 2024, 14:21
Quote from @Dean Ng:

@Brian Burke

That's very useful information.  In terms of debt funds, I'm not considering them because their yields are only slightly higher than low-risk alternatives like GSE bonds and AAA CLOs.  There are also many cases of RE investment funds going belly up or turning into Ponzi schemes. 

@Carlos Ptriawan

NICHX doesn't seem very liquid.  It has no secondary market and the investor can only redeem once per quarter, assuming there isn't a flood of redemptions.  Short-term TDs would be more liquid since I can keep rolling them. 

Covered call ETFs correlate strongly with the stock market.  I'm trying to diversify away from stock market.  


 If you want secondary for syndication there are bunch of funds where you can buy investment fund 40 percent discount …

Niche only liquid for 3 mo is good thing