Protective Equity in Trust Deed Investments

iStock_000011278689MediumThe goal of any investor is to find an investment that allows their capital to grow over the years. But an important part of that goal is in keeping their capital protected against downside risk—or the risk of default. This can be a difficult line to walk however, since higher-risk investments generally earn the most returns, and low-risk investments have conservative gains that might not accumulate as quickly as an investor would like.

Hedging by Diversifying Risk

In a portfolio of equities, a young investor might invest 60 percent of his or her portfolio in high-risk, high-return equities, 20 percent in medium-risk, lower return equities, and the last 20 percent in low-risk, low-return equities. But this kind of portfolio can be hard to manage. It needs constant rebalancing, and will need to have risk allocations changed as the investor gets closer and closer to retirement age.

Hedging with Protective Equity

With trust deed investments, the key to your hedge and protection is your protective equity. The protective equity in your trust deed is the difference between the value of the property in a quick sale, and any debt from the loan or liens as well as any expenses related to recapturing the principal. With loan to value ratios not generally exceeding 50 percent in a trust deed investment, your protective equity will be the remaining 50 percent of the value of the property (which is the borrower’s equity) minus loans, liens, and expenses like delinquent payments, taxes, foreclosure costs, sales commissions, etc.

Protective equity is the number one underwriting consideration in a trust deed investment. In order to determine the potential protective equity in a property, an underwriter must look at each property individually and assess what potential expenses they can expect during a default and subsequent foreclosure. If a borrower should default on a loan, if the real estate market should face a serious downturn, or if a property is given a devaluation, that cushion of protective equity could be used to pay back the investor should the foreclosure process begin.

This makes a trust deed investment the perfect conservative investment for investors of any age—pre or post-retirement. Because trust deeds offer generous returns, in the range of 7 to 12 percent, and a substantial protective hedge against risk, post-retirees don’t need to worry about rebalancing assets and changing their investment focus from growth to conservation. Instead, they can allow their trust deed investment to do both at the same time.

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