For new investors entering the private lending space, two primary investment structures tend to come up: trust deed investing and real estate debt fund investing. Both can offer attractive, asset-backed returns—but they differ significantly in terms of structure, investor experience, compliance burdens, and scalability.
This article will walk through the mechanics of both models, weigh the pros and cons of each, and explain why a pooled investment fund often presents a more efficient, scalable, and legally sound path forward for both fund sponsors and investors.
What Is Trust Deed Investing?
Trust deed investing involves investors funding an individual real estate loan (often referred to as a “note”) secured by a deed of trust on a specific property. In this model, the investor becomes the beneficiary under the deed of trust and receives interest payments directly from the borrower.
The investor can hold the note individually or with others through a fractionalized interest or co-lending structure, in which multiple investors participate in a single loan.
Pros of Trust Deed Investing
- Direct asset-backed exposure: You know exactly which property and borrower your capital is tied to.
- Control and transparency: Investors often appreciate the ability to underwrite individual deals and select only those that meet their personal risk profile.
- Higher yields (potentially): Especially on riskier or non-performing loans, individual trust deed investments may yield higher interest rates.
Cons of Trust Deed Investing
- Lack of diversification: Your capital is exposed to a single asset and borrower. If that borrower defaults, your entire investment could be at risk.
- Limited liquidity: These investments are typically illiquid until maturity or payoff.
- Administrative burden: You or your servicer must handle borrower interactions, collections, and foreclosure proceedings if needed.
- Compliance complexity: Each transaction involving a fractionalized trust deed must be evaluated individually for compliance with federal and state securities laws, a task that becomes more cumbersome and riskier over time.
The Compliance Challenge: Are Fractional Trust Deeds Securities?
Yes—fractional trust deed interests are generally considered securities under both federal and state law. Each time a lender fractionalizes a loan among multiple investors, that loan becomes subject to the disclosure and registration requirements of the Securities Act of 1933, unless an exemption applies.
This means:
- Each transaction must either be registered or fall under a valid exemption (e.g., Regulation D Rule 506(b) or 506(c), or limited state offering exemption);
- You must track the accreditation status of investors (especially under 506(c));
- You may need to make state blue-sky filings;
- You must disclose material risks adequately to avoid liability under Rule 10b-5.
If you’re funding multiple loans per month with multiple investors, this quickly becomes administratively and legally burdensome. Worse, if handled incorrectly, non-compliance can expose you to serious regulatory and civil liability.
Fund Structures: A Streamlined Alternative
A real estate debt fund is a pooled investment vehicle (typically structured as a limited liability company or limited partnership) that raises capital from multiple investors and deploys that capital into multiple real estate loans. The fund holds the loans, and investors own membership or partnership interests in the fund itself, not in the individual loans.
Basic Fund Structure Overview
- Fund Entity: Typically, an LLC or LP, managed by a sponsor (Manager or General Partner).
- Offering Exemption: Most private funds rely on Rule 506(b) or 506(c) of Regulation D of the Securities Act of 1933 (“Reg D”) to avoid public registration. Under 506(b), general solicitation and public advertising is prohibited but non-accredited investors may participate (within limits); under 506(c), general solicitation and public advertising is allowed, but all investors must be accredited, and verification of accredited status is required.
- Investor Ownership Interests: Investors purchase equity interests in the fund, which entitles them to a preferred return and/or a proportional share of the fund’s income, typically from interest on underlying loans and/or fee income.
- Use of Capital: The fund manager deploys capital across multiple loans based on a defined investment strategy, providing built-in diversification.
Pros of Fund Structures
- Diversification and Continuous Capital Deployment: Investors are automatically diversified across a portfolio of loans, reducing the impact of any single borrower defaulting. Additionally, capital is continuously deployed and reinvested across multiple loans, meaning investor money is working year-round—generating returns consistently rather than sitting idle between individual note payoffs.
- Streamlined Compliance: The offering is structured once, under a single exemption, and applies to the whole fund—not each individual loan. This removes the need to reevaluate securities law compliance on a loan-by-loan basis.
- Professional Management: The fund manager handles underwriting, loan servicing, and workout/foreclosure processes—removing operational burdens from investors. Unlike trust deed structures, fund managers don’t need to wait for individual investor approval on each loan, allowing for faster decision-making and more agile deployment of capital across opportunities.
- Access to Leverage: Fund structures can more effectively utilize leverage by borrowing against the fund’s assets to increase lending capacity and enhance investor returns. Because the fund holds a diversified pool of loans and is professionally managed, lenders are more comfortable extending credit facilities to the fund. This allows the fund manager to scale loan origination, bridge funding gaps, and optimize return on equity—all without requiring additional investor capital for each new loan
- Institutional Readiness: Funds with audited financials, formal compliance policies, and investor relations infrastructure are better positioned to attract larger investors, including family offices and institutional capital.
Cons of Fund Structures
- Less transparency/control: Investors don’t select individual loans and must rely on the manager’s underwriting and discretion.
- Fees and expenses: Funds often charge management fees, which can reduce net returns compared to direct lending.
- Longer commitment: Most funds have lock-up periods (e.g., 1-2 years) before capital can be redeemed, which may reduce liquidity for investors.
- Manager reliance: The fund’s success is heavily dependent on the sponsor’s expertise, operations, and integrity.
Why the Fund Model Wins in the Long Term
From a legal and operational perspective, trust deed investing becomes increasingly inefficient and risky as you scale. While it may work for a small group of deals or friends-and-family capital, once you’re doing multiple deals per month or bringing in external investors, the fund model provides clear advantages:
- One securities offering instead of many.
- Centralized legal compliance.
- More investor-friendly reporting and diversification.
- Greater operational efficiency and consistency.
Moreover, investor expectations are evolving. Sophisticated investors increasingly want the benefits of passive investment, diversification, and streamlined reporting that only fund structures can provide.
Final Thoughts
For private lenders looking to grow sustainably, the fund model offers a superior structure—legally, operationally, and strategically.
As always, fund formation should be done in consultation with qualified securities counsel to ensure compliance with applicable securities laws, state lending regulations, and tax considerations. The time and cost to properly launch a fund is well worth the long-term payoff.
If you’re considering whether to transition from trust deed investing to a fund or launch your first private lending fund, the Fortra Law team is here to help.
