Real estate-backed notes have become a more attractive investment option of late, given the tumultuous state of the stock market and the expanded market for private loans that has resulted from the bank financing crunch. And, not surprisingly, since the core of our business at Sterling Pacific Financial is identifying quality real estate lending properties and offering investors “no fuss” participation through our trust deed investments, we’re generally very supportive of this trend.
Of course, even an investment as straightforward and easily understood as a trust deed investment has potential pitfalls. One such pitfall that has gotten more attention recently is the foreclosure-blocking strategies more defaulting borrowers are pursuing.
When trust deed investments back carefully selected, cash-producing properties and well-screened borrowers, the need to foreclose should be relatively rare. Nonetheless, the ability to foreclose is one of the chief advantages of a private real estate loan, since the equity in the property is what secures the lender’s capital. If the lender needs to foreclose but can’t, what was a relatively low risk investment becomes a very high risk investment — even, potentially, a total loss.
How are borrowers forestalling foreclosure? A strategy that has received a fair bit of media attention is to demand that the lender produce the note. When a lender attempts to foreclose without producing the actual promissory note attached to the property, and the borrower requests that it be produced, courts frequently deny (or at least delay) the foreclosure. Why? Unless it can be confirmed that the note is currently owned by the foreclosing lender, the borrower would still be liable for the obligation in the event that the note turned up in a third party’s hands — even if the borrower had already relinquished the property.
What does this mean for investors in private loans? If you’re writing and servicing your own loan(s), of course it’s paramount to confirm you have all the needed documents (paying special attention to what’s legally required in the state in which you’re lending), and to make sure they’re secure and accessible to you should you need to foreclose. Of course, working with a trust deed investment company with a successful track record of managing these transactions can help you avoid many of these headaches. When you choose a firm to invest with, be sure to ask them about their servicing operation’s foreclosure record — e.g., has the firm ever been denied a foreclosure for failure to produce a note in court (or any other reason)? Choosing the right partner can make investing in private loans much easier — while also squeezing out any unnecessary risk.