It is not a question of which is better. Investing directly in real estate equity and investing in trust deeds are simply two different types of investments, each with advantages and disadvantages.
With any investment there are two possible sources of return, income and capital appreciation. A direct investment in real estate can generate income and also appreciate in value. Trust deed investments only generate income.
That being said, there is a great deal of risk associated with a direct real estate investment. There is the possibility that properties generate negative income or lose value. Well-structured trust deed investments on the other hand, have a margin of safety not present in real estate ownership, due to a low loan-to-value ratio. In other words, the loan is secured by a property that is worth significantly more than the amount of the loan, which protects the lender in the event of a default. Additionally due to the recent credit crisis and banks’ unwillingness to make these types of loans, the current yield on trust deed investments is significantly higher than what is available from a direct real estate investment.
Additional differences between the two types of investments are that income from real estate has favorable tax treatment, while trust deed interest income is treated as ordinary income. Also, real estate investors can use leverage to enhance their returns. And real estate investments lend themselves to a “buy-and-hold” approach. Trust deed investments have a natural maturity, at which time the investor must find a new investment in order to continue earning a return.