There has never been a better time to invest in the private real estate debt market, commonly referred to as trust deed investing. The rise in interest rates, the liquidity crisis within the banking industry, and the volatility in the stock market have all led to record returns.
Though the industry has matured, attracting some of the largest private equity firms and investment banks, individual investors can still participate and earn the attractive returns.
Prior to the Great Recession of 2008, the private real estate lending market was a little-recognized industry generally made of up mom and pop investors and small mortgage funds. They provided private money loans to real estate investors who didn’t have access to credit through more traditional banking outlets. This was because of poor credit, inconsistent cashflow, or the risk associated with the real estate securing the loan.
Many investors preferred to invest their capital in the private lending industry because it offered consistent monthly income, the security of real estate, and they could 10%+ on their capital. Also, the loans were short term and many of the properties they were securing their loans were local to the investor. Many of these investors had either a background in real estate or were looking for less volatility than alternative investments such as the stock market.
The returns that investors could expect to earn from the private debt market drastically changed starting in 2010. In search of yield in a near zero interest rate environment, the private real estate debt market started to attract private equity firms and hedge funds.
At first, these firms provided liquidity to mortgage brokers who originated these loans by investing in each loan individually. They started to take the place of private investors.
As the industry evolved, these capital providers began purchasing entire loan portfolios and securitizing them for public debt sales. The result was a record amount of capital entering the market, thus driving rates down to industry lows. Where once investors could expect to earn 10%, they were now earning less than 7%.
One of biggest advantages of Wall Street entering the private real estate debt market is that it has legitimized the business from a once fragmented industry, to a main stream investment vehicle.
The industry is no longer dominated by mortgage brokers selling “one off” loans to individual investors. Instead, the multibillion-dollar industry has now become serviced with companies handing everything from loan origination, loan servicing, legal, accounting, and fund management.
The industry has benefited from a trifecta of sorts.
First, the Fed raised the overnight lending rate from 0% to 5% in less than 12 months. As a result, banks are charging a much higher rate to borrowers, allowing private lenders to also increase their rates.
Second, as banks search for liquidity to strengthen their balance sheets, many have reduced their lending. Also, many loans that are nearing maturity and would have been extended, are now being called due. This created a huge void for the private lender industry to fill.
Lastly, the volatility in competing investments such as the stock market, has pushed many investors to allocate capital to the private debt market. Stocks are no longer as attractive, and the market has proven too risky.
So, just how attractive are private debt market returns? Well, investors can expect to earn returns that match pre-2008 levels. Many investors are earning 9%+ or greater, depending upon the risk profile of their investment. The industry standard first position loan secured on a residential property in a core urban market are earning returns from 9% to as high as 11% in many markets.
If the Fed continues to raise its rate, private debt market returns should continue to increase.
A big change in the industry that led many investors to revisit the private real estate debt market are the tax advantages of a mortgage fund, and specifically the mortgage real estate investment trust (REIT).
Within the Jobs and Tax Act of 2017, investors receive a 20% tax deduction, known as the qualified business income tax deduction, on income earned through pass-through entities. These pass-through entities include an LLC, Corp, LP, or similar type entity. The hurdle for many high-net-worth investors however, was the tax deduction phased out when the individual earned over a certain amount of income.
But there’s a loophole. Within the tax legislation is a provision that if the income is earned from a dividend via a REIT, the income isn’t subject to an income cap. Thus, the popularity of the mortgage REIT was born amongst high income earners.
Investors that don’t have access to institutional investment sources can take advantage of the opportunity by investing in “one off” trust deeds or a mortgage fund comprised of a diversified pool of mortgages.
Many investments have low barriers to entry with minimum investments of $50k or less. For those looking to take advantage of the diversity and tax benefits of a mortgage REIT, you will generally need to be an accredited investor. Either way, the risk adjusted returns that the private real estate debt market is currently offering are very attractive and should be considered in your investment portfolio.
Brock VandenBerg has been investing in short term real estate loans for over 20 years. During that time, he established TaliMar Financial, one of the leading private lending companies serving the residential and commercial real estate market. Mr. VandenBerg also invests in the private real estate debt market on behalf of high-net-worth investors, family offices, and institutional partners through his private mortgage REIT, TaliMar Income Fund I.
Prior to establishing TaliMar Financial, Mr. VandenBerg spent two years working with the Federal Deposit Insurance Corporation (FDIC) managing the closure of failing banks and the sale of their loan portfolios. His experience at the FDIC helped shape the strategy he uses today to minimize risk while maximizing returns for his investors.