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Two ways to get investment income in a low-return environment

Investment income can be scarce in low-return environments. Read more to learn about two ways to maximize investment income, despite the environment.

Many investors preparing for retirement, or in the early stages of it, are seeking ways to substantially聽increase the amount of聽monthly income they generate from their assets. These are tough to find in today鈥檚 low-return, low-interest-rate environment.

Fortunately, there are two investments that are worth considering: trust deeds and peer-to-peer lending.

Trust deeds

If you鈥檙e comfortable with real estate investing, consider trust deeds, a type of private real estate loan. Institutional investors favor these loans, but they can also work for individuals.

A typical trust deed arrangement might start this way: A real estate entrepreneur wants to聽purchase a $500,000 house, hoping to rehab it and sell it at a profit. He has $250,000, but needs to borrow the other $250,000. If he waits for a bank loan, a competing investor might snap up聽the property 鈥� so to save time, he goes to a private lender for聽a trust deed.

Under the trust deed, the buyer borrows $250,000 from the lender 鈥� working through a third-party loan originator who underwrites and facilitates the loan 鈥� for one year. For the speed and convenience, the borrower pays a much higher rate then he might for a mortgage, typically 8% to 12%. In most cases, the borrower makes interest-only payments each month and a balloon payment of principal at the end of the term.

Let鈥檚 say聽you鈥檙e the investor聽in this deal, and you agree to a loan at 10% APR. If all goes well, you鈥檒l receive聽12 interest payments of $2,083 each, totaling $25,000, and at the end of the year, you鈥檒l get your $250,000 back. And聽if the borrower fails to make the monthly payments, you take possession of the property.

There鈥檚 no set minimum for investing in a single trust deed. They can be fractionalized 鈥� that is, divided into several聽portions聽鈥� but聽loan originators generally prefer to deal with聽one investor per loan.

Finding trust deeds in which to invest can be difficult. Your best bet is to reach out to advisors or brokers who have established relationships with originators in the space.

If you like the concept of trust deeds, but don鈥檛 want to hunt these deals down, you might聽invest in a trust deed fund run by a professional manager. These funds currently pay between 8% and 11% per year and have minimum investment amounts that聽start around $50,000. They also tend to require investors be accredited by SEC standards.

Peer-to-peer lending

Peer-to-peer loans are another way you might be able to generate monthly income at decent rates, provided your state permits it (most do). These are consumer loans that, unlike trust deeds, aren鈥檛 based on collateral. Borrowers typically use proceeds to pay off higher interest rate credit cards, fund home improvements or grow a small business.

If you鈥檙e interested, you can聽find borrowers through online marketplaces, such as聽听补苍诲听. On the sites, lenders can view prospective borrowers and decide to whom they want to lend 鈥� and the interest rate they want to charge 鈥� using an algorithm that determines credit risk.

Lenders receive rates between聽5% and聽23% on loans, depending on each borrower鈥檚 credit. Lending Club and Prosper聽charge fees of聽about 1% to 5% annually.

There are also funds that will invest in these loans on your behalf, but these funds often have higher investment thresholds than trust deed funds. Lending Club offers several funds that invest in its loans, but聽investment minimums start at $500,000.

Managing risk

Both trust deeds and peer-to-peer loans can protect investors聽from rising interest rates, because they鈥檙e held to maturity and have short durations. But they also have risks.

If your trust聽deal goes sour and your borrower forces you to take possession of the property, it might be worth less than your investment in it. So it鈥檚 important to do your homework before investing. If you鈥檙e not up to this, consider hiring an advisor with experience in this market.

Investing in a trust deed fund won鈥檛 necessarily protect you from real estate market crashes. Many, though not all, trust deed funds went bust in 2008. I like to invest with trust deed funds that have a good track record through multiple down markets 鈥� but this doesn鈥檛 guarantee that they鈥檒l make it through the next one. Before you invest,聽analyze a聽fund鈥檚 portfolio and loan loss reserves. As with individual trust deeds, you may want to have a professional do this.

Peer-to-peer loans also carry risks. Returns from both sites are based on loan repayments, and there are no guarantees or protections in case borrowers default. Lending Club and Prosper both聽recommend that investors spread their investments over several loans, reducing the impact if any one borrower fails to repay them.

If you do invest in聽peer-to-peer loans,聽your investment should be聽part of a diversified investing strategy, and shouldn鈥檛 represent聽your聽life savings. Lending Club notes in its prospectus that investing is suitable 鈥渙nly for investors with adequate financial means,鈥� 鈥渨ho can bear the loss of their entire purchase price.鈥�

It鈥檚 critical that you educate yourself or seek the help of a financial professional before investing in either trust deeds or peer-to-peer loans. But if you exercise due caution, both of these types of investments can be great income generators at a time when investments that produce good returns are few and far between.

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