In the current economic climate, rising interest rates present challenges and opportunities for investors. Do you want to know how to profit from rising interest rates?
While higher interest rates makes borrowing more expensive for developers and potentially slows the growth of real estate values, it can also create an investment opportunity for those who invest in real estate debt. Investors can take advantage of this opportunity by investing in individual mortgages, often known as a trust deed investment, or by investing in a portfolio of mortgages through a mortgage REIT.
Now is a time of opportunity for those who know the right areas to invest.
Investing in short-term real estate debt has long been considered a great investment for those seeking consistent monthly cashflow and the security of real estate. As an investor in real estate debt, you are acting like a bank. It involves lending money to real estate investors and operators using their real estate as collateral.
Let’s use the example of a real estate investor seeking a short-term loan to purchase a single-family home with the intention of renovating and selling it for a profit; this is a strategy commonly referred to as a residential fix-and-flip in San Diego. In this scenario, you are the investor, commonly referred to as the lender, who would fund a loan to the borrower. The loan is secured with a mortgage (also referred to as a deed of trust) on the property that the borrower owns or is purchasing.
In exchange for the loan, the borrower would make monthly payments over the duration of the loan and once they sold the property, you would be returned your original principal investment and any remaining interest payment.
Real estate investors borrow from a private lender because traditional banks have become very conservative in their lending. They are looking to fund longer term loans to borrowers that intend to occupy the property as their primary residence or who have very good credit and/or cashflow. Today, banks are extremely risk adverse. Because real estate investors investing in Deeds of Trust San Diego tend to have unpredictable cashflow as they are constantly buying and selling properties, they are not considered the ideal client for a bank.
Another reason why one would invest in private real estate debt is because it is short term. Ironically, by funding short term real estate loans, investors are more protected by the risk that the value of the underlying property securing the loan will lose value over the term of the loan. Another advantage of a short-term loan is that it’s semi liquid, as the investor can expect to have their investment return in 12 to 24 months.
The amount a private lender can charge for their loans is dependent upon the availability of capital. When interest rates were low, the industry was flush with money and real estate investors could borrow from private lenders at a relatively low rate.
Prior to interest rate hikes, investors could expect to earn between 7% to 8%, depending upon the risk. While earning a 7% to 8% return with the security of real estate wasn’t bad in a strong economy, especially with values in real estate increasing, there were many other options for investors.
That changed when the Fed started to raise interest rates. In doing so, the Fed reduced the amount of capital in the economy, and thus increased the cost of borrowing for real estate investors. It also weakened the balance sheet of many banks that service the real estate industry, further reducing the amount of available capital. High interest rates created a perfect storm to distrupt industry, allowing investors in the private real estate debt market to earn more profit.
The rates private lenders can earn by investing in individual trust deeds or a mortgage REIT have increased considerably since 2022. Where investors could expect to earn in the mid 7% range, many investors are now earning between 8% to 11% with the same or even lower risk profile. Furthermore, the number of opportunities has also increased as banks continue to pull back on their lending.
Taking advantage of the current opportunity in the private real estate debt market can be easy. The most direct option is to invest in individual trust deeds.
As an investor in a trust deed, you are the lender, and your investment is secured directly on the underlying property securing the loan. The borrower pays you directly, often in monthly installments, until such time as they pay off the loan. If the borrower is unable to make the payments or pay off the loan in the agreed upon time, you (the investor) have the option to foreclose on the property and get your original principal returned.
The second option offers a more diversified approach. Instead of investing in a single trust deed, you can invest in a portfolio of loans. known as a mortgage REIT. This option is often considered a much more passive approach to investing in private real estate debt.
The advantage of the mortgage REIT is that your investment is diversified. If one of the underlying mortgages stops paying or pays off, your monthly income isn’t disrupted because the other loans in the portfolio continue paying. Additionally, when investing in trust deeds, you are required to find each investment opportunity and then manage incoming payments, monthly statements, etc. This involves considerable administration work for the investor that is often undesirable. With a mortgage REIT, the fund manager is responsible for selecting loans, due diligence, and managing the collection process.
Another advantage of a mortgage REIT is that you can control the amount and timing of your investment. With a trust deed investment, your investment is based upon the size of the individual loan and when that loan is funding. If the loan size doesn’t match your available capital, you may need to pass on the opportunity leaving you with no income until such time as you identify a matching loan. On the other hand, the mortgage REIT allows you the flexibility to invest nearly an y amount on your schedule.
Lastly, one of the biggest advantages of the mortgage REIT over a trust deed investment is that you are eligible for a 20% tax deduction on the income. Known as the Qualified Business Income Tax Deduction or the acronym QBIT, the deduction was added to the 2017 Jobs and Tax Act. It allows income earned through a pass thru entity (such as a mortgage REIT) to be eligible for the deduction. Furthermore, because the income is generated through a REIT, the income isn’t subject to an income cap.
The recent rise in interest rates has created an ideal opportunity for investors to profit in the private real estate lending market. As the Fed decreases the amount of money in the economy by raising interest rates, the value of the money that investors have also increases. And as a result, investors can earn a much higher return.
Investors should take action by taking advantage of this market opportunity. Either invest in individual trust deeds (or mortgages) or a mortgage REIT to start earning high returns. Both avenues offer investors consistent monthly cashflow, the security of real estate, and the opportunity to take advantage of rising interest rates.
No matter how you decide to invest, take advantage of the opportunity today.
Brock VandenBerg is the President of TaliMar Financial and the Fund Manager of TaliMar Income Fund I. Mr. VandenBerg established TaliMar in 2008 to provide real estate investors and operators a secure source of capital. As the company grew, Mr. VandenBerg launched TaliMar Income Fund I, a mortgage REIT, to allow investors to participate in the consistent monthly income earned by the growing loan portfolio. Since established TaliMar, Mr. VandenBerg has funded over $380 million in loans and currently manages over $55 million in active investor capital.
Prior to establishing TaliMar Financial, Mr. VandenBerg spent 5 years with KeyBank Private Equity Group as a financial analyst and another two years with Federal Deposit Insurance Corporation (FDIC). While at the FDIC, Mr. VandenBerg participated in the closure of over 10 banks and the sale of over $1 billion in real estate debt.