Expected losses on 1st position fractional trust deeds

[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?

[Jeff S.]

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.