Investing in Trust Deeds: What are you opinions, experiences, recommendations for those investing in California First Trust Deeds?

Question

I'm interested in the opinions of BP members:

As far as CALIFORNIA FIRST TRUST DEEDS  (not Texas loans, not 2nd trust deeds) what have you experienced, heard, what are your opinions, and what do you believe the general beliefs are?

DISCLOSURE:  I'm in the business, my company provides hard money loans and people invest with us.  The purpose of this thread is to actually GAIN information about what the market (as known by PB participants) thinks of this particular investment.   No one who posts will be contacted or bugged.  Thank you for your input!!!!!

Dion DePaoli · Answer

We are an active principal and broker/adviser with a national foot print with some exclusions, more institutional than private.  We are mainly cash flowing or cash flow potential folks but trade all performance as a function of the business.

I agree with Bill, getting your feet wet in your backyard is the best start.  It seems that is what your question is targeted at.

From a Seller perspective, targeting regional specific counter-parties is optimal.  Because the Buyer is localized, price execution should be a little better than that of a firm with a bigger footprint.  California in a general comparison trades ahead of most other states due to the larger property values and the backdrop of shorter non-judicial foreclosure timelines.

To some degree, California has many folks seeking assets within its boarders.  To some extent, IMO, that drives prices up and in some cases I question whether folks can make any money.

Depending on what the ultimate disposition strategy is, California can have barriers of execution as many loans quickly exceed conventional standard loan amounts becoming jumbo in nature.  This makes rehabilitation of loans with a refinance takeout a little difficult.  Because of this, some loans have been modified into low coupons.  This further creates a gap between the bid and ask since lower tier market participants have a hard time making a business out of low yields with minimal or zero leverage capability.

There is an education process out there for lower level market participants that also has its issues.  Many folks are looking at these assets now-a-days for the obvious opportunities but do not have that much experience in evaluation or workout.  To a certain extent, I have noticed a little bit of a return to the 2007/2008 group of folks who migrated from origination to distressed loan investments which clouded the water with all sorts of misconceptions and intentions.

As Bill stated, many folks looking at the space are under some presumption they can flip loans with ease and make tons of money.  Many folks are trying to break in with no capital and no value add intentions.  IMO, they are just wasting their time and energy.  The base concept of these folks relies on Sellers leaving some easily obtained yield and/or return on the table to be tapped into.  Additionally, for some reason they tend to think they are slicker than the Seller. They also tend think these assets trade like real estate.  In both cases, they don't know what they don't know, a dangerous place to make such noble assumptions.  This is also the opposite of what I said above of why a Seller wants a localized investor.  Further it ignores none of this is easy or simple.

The market makers in this business have billions of dollars.  Middle markets have hundreds of millions.  With that kind of capital comes resources, relationships and operations that are hard to replicate for lower level folks.  In general, there is no magic formula to disposition even though some folks tend to believe last night they came up with a cutting edge idea such as modify loans or knock on doors to get DILs.  None of it is really new.

All of that said, there is a gap at the lower levels that is being filled.  Securitization is not close to coming back yet so the distribution of the risk of these loans will continue in private markets.  The market is huge, so a crumb here can be very lucrative.  The best firms will be slim and efficient in order to compete.  They will have capital/investor expectations managed in line with reasonable returns and yields.  Sure, in one off scenarios you can hit a home-run but that is difficult to scale up into a real business.  Risk free rate of return is 1.5% +/-, always keep that in perspective.

I suppose one last concept to this thesis, is the counter-parties you will actual be able to do business with.  Really, not as many banks are selling off residential loans as I think some think.  The big investment banks are certainly actively trading but the littler regional or local banks do not have that much volume if any to really talk about.  Most of their stuff is worked out in the bank not all the time but seemingly the majority.  There is humorously a lot of folks who claim to do business with the big investment banks but that tends to be far from true, the trades are too large and less than 15% of companies pass initial compliance to trade with them.  You will find more private equity type folks being active counter-parties more than banks and more open in minimal trade levels and compliance than the large investment banks.  This is also a function of the pseudo step down from the large institutional investors to what I refer to as the street level guy.  The key is to find some good counter-parties and work the relationship.  If you are a buyer who will actually work the asset you will be valued as a trading partner.  Break into the market with controlled bursts of acquisitions so you can update your workflows, expectations and ultimately your execution.

Bill Gulley · Answer

I think I understand your interest in opinions here. Many seem to be interested in the paper game but are not principle investors as they are seeking a brokerage relationship to buy and sell, flipping with OPM. Those who can buy are generally advised to stay close to home in order to manage the brokers as well as the borrowers if necessary. A few have been around long enough and have sufficient knowledge to invest outside thier own area.

No matter how good of a broker one might be, no matter how honest they may be, no matter how great the loan or portfolio, investors will have several issues and risks that should keep them close to home and the broker will find it difficult to overcome the guarantee of the return of the full investment, collateralization to the investor and liquidity when required. If you think about it, that's why FDIC was established for banks, brokers simply don't have such a guarantee available.

Unless you jump through the SEC hoops, pooling funds will be an issue and pretty well discussed here, enough so that most qualified investors know to avoid such arrangements.

While there are ways to allow individuals to get involved in buying notes/mortgages, allowing the broker to service (or a servicing firm do so) participations should be avoided by new investors, where they join with others to purcahse any mortgage.

So, I'd say that the general concensus is of newer mortgage investors is to stick close to home so that they can physically manage issues that may arise. That is even if there is the greatest broker in the country with opportunities, the bottom line is a trust and security issue. After all, people do drop dead, if your key man drops out will the brokerage remain as solvent, will management suffer, will other investors be in line to share collections and who gets paid first, just some of the issues to overcome.

I know very well the temptation to go national with investors and I'm glad I stayed within my state, mostly within my immediate area.

That's my take on the mood here, others may have different opinions.