Buy a Rental Property with your IRA – yes you can!

People across the country have had the ability to utilize their retirement accounts to buy investment property for many years. Yet this ability to do so with a self directed retirement fund remains one of the least known and understood ways of financing a real estate transaction.

One of the main reasons for this lack of knowledge is that the companies that offer the self directed service are few and far between and the major companies that hold the countries retirement accounts do not offer this service. So of course they don’t tell you that you could go else where, they tell you it is not possible. I am here to tell you it is possible and to shed a little light upon the subject.

With distressed homes (foreclosures, short sales, estates, run down homes, ect. . .) selling at record low prices, real estate is a huge opportunity for investors who are holding cash to buy up these houses. Plus there are specialty lenders out there who will help investor leverage retirement savings, through non-recourse loans to buy larger rental properties.

As we know, we should be buying up properties at the lowest price point and then holding as the prices appreciate up and then sell at the top of the housing market. Now we may not be quite at the bottom of the housing market, but here in Kansas City this spring we have seen a lot of activity in the home buying market, especially in the entry level home. This is a great bread and butter house for the investor as these homes can be rented, offered on lease to own or contract for deed, or sold to first time home buyers. So, while we may not be bottom, we are fairly close and a it’s a great time to buy.

We need to keep in mind that properties purchased with IRA or other retirement funds, can’t be used for personal purposes. You can’t live in it, office out of it, or rent / sell to family. Doing so would put your retirement assets at risk of being penalized by the IRA on the entire value of the account.

Investing in real estate can be fairly easily understood by anyone who knows how to buy or sell a house, can find properties at steeply discounted prices, and has the ability to rent the property out for monthly income over the short term. Investors can build up equity with appreciation by investing in rentals with their retirement accounts, a fairly low risk strategy in these uncertain times.

I have been reading up online and found an article on www.marketwatch.com by Chris Pummer that listed six reasons why buying real estate with an IRA is potentially lucrative and a wise move today.

“A solid alternative to the stock market.” When the stock market starts dropping like it has, many investors turn to hard assets, like gold and they are buying up all the gold they can. The other hard asset that investors turn to is real estate and right now houses are at record lows. I have seen houses for $100 in Detroit and under $1000 here in Kansas City.

“An investment well-suited for long-term investors” While the stock market goes up and down on a daily basis, the up and down of a real estate cycle is a much slower proposition. While we may not be quite at the bottom of this current real estate cycle, we are getting close and buying at the bottom and making income over the long term with rental while the market goes back up and then selling high when we get near the top would be a sound investment for our retirement account.

“Purchasing a significantly undervalued asset” Right now across the country and across the metro you can buy property selling for as little as 20% of their value from just a few years ago. In some areas, if you are willing to buy Junkers and do major fix up, you can buy properties for next to nothing,. And in some cases you can buy a pretty house, one needing no work for less than the cost of the fixer upper and repairs to that fixer upper.

“A steady income generator” As many companies are not paying out any dividends on stocks or if they are at much lower rates, rental properties offer a much better, fairly steady income from rent. A rental in good repair and well managed can offer rental income every month, it does not go up and down. Plus the property is appreciating a little bit every year.

“A safer means to play the stock market” For those who do not want to abandon the potential profits on the stock market, as it is at record lows as well, having a rental home and reinvesting the rental income back into the stock market as it comes in is a great way to dollar cost average your stock holdings back up. Just like you put a few dollars a way each week when you were building the account, putting a few $100 in rental income back into the stock market as it comes in over time will build your stock holdings back up and at the end of the day, you still have a hard asset in the rental property that is still generating income through rent and appreciation.

“The ability to flip real estate with no tax bite” and this one is the biggie. If you have a Roth IRA that purchases a real estate investment property today and sells it for a huge profit in say 5 years, you owe no taxes on that profit. Or if you have a traditional IRA and earn that profit, you don’t pay taxes at sale time, but rather over time as you draw that money out during retirement when you have a much lower tax bracket.

And because the market is starting to come back in starter home neighborhoods, you can buy and fix up and sell for a profit now to build up your account and as long as it is with in your Self Directed IRA account it is tax free with a Roth account or tax deferred with a traditional account.

More control I have added this one to the list as I have much more control on the profitability of my rental property than I would if I were invested with say General Motors or Chrysler.

Now many of you out there may be in the group that does not want to deal with finding a property to purchase, repairing or maintaining the property, or renting and managing the rental, there is an option for you too with a self directed account.

There are many investors out there who do this day in and day out. They buy, fix up, rent, and manage and sell investment properties from houses to apartments to commercial. They have been in the business for many years and they know what they are doing. These investors need cash funding for their properties and they have several choices for funding their deals:

Their own retirement accounts, but this will limit how many properties they can invest in.

Using bank loans, but right now in today’s market, other than FHA and VA loans, that investors cannot use, there are not many loans being made.

Seller Financing, they can ask the sellers to carry the note and pay them the interest they would have offered the bank.

Your Retirement Funds, you can become the bank for these very experienced investors, earn a solid return on your investment , and grow your accounts.

You do need to be educated on becoming the bank to protect your retirement funds, but almost all investors are willing to pay a solid rate of return for the use of your funds. The shorter the term they borrow, the higher the interest rate. The longer the term they lower the interest rate. You could expect to make between 5% and 15% return on your investment, and if you were to offer up a short one day to two week loan, maybe even much higher rates of return if you charge a flat fee.

To get started using your retirement funds to invest in real estate or to become the bank your first steps would be to select a custodian to hold your funds. A custodian company is one that is set up specifically to manage retirement funds and have established ways for you to buy and sell real estate.

There are more and more custodian companies opening up across the country. I don’t know them all and just because I don’t know them does not mean they are not ones you may want to check out. But some things to look for:

Ask them what their fees are, not only annually for holding the fund, but to wire funds, to sign documents, to mail checks, to make wires.

I have also heard of a few companies that will manage your funds and then help you set up an LLC with in the fund. I don’t know that this is wrong, but according to every attorney I have ever asked, the setting up of an LLC is practicing law and I don’t think an IRA custodian is supposed to be practicing law, they are also not supposed to be telling you how to invest your funds.

There are several companies that do offer education on how one could invest their funds or they may have a sister company that offers the education. But they do not tell you how you should invest your funds. They leave it to you to absorb the education and make your own investment choices.

You also want to find out how easy or hard it is to talk to someone at the custodian company. Some people think that having the custodian be in town is an asset, but I have had experience with an “in town” company that did not return anyone’s calls while the “out of town” company answered the phone, had online chat, and were very responsive.

Some companies you may find include:

Equity Trust Company

Entrust

IRA Services Trust

Pensco

Fiserv Trust

Millenium Trust

Sterling Trust

After setting up your account, you need to study up who you are prohibited from doing transactions with: spouse, parent, children, or anyone of lineal decent. Or companies that any of these people own more than 50%. You will find though that brothers and sisters, aunts and uncles, and step children are not prohibited.

Then if you decide to buy property instead of being the bank you need to determine who will manage the property. You could do it yourself, but you would want to be sure to get a good insurance policy to protect against claims that could come up from your IRA being the owner of the company. You want to protect your retirement assets as much as possible.

When you have repairs made, they must be paid for by the IRA and if you collect any rents it must be paid directly to the IRA. The next question is, can you do repairs yourself on the property and this is a bit of a gray area as the materials would need to be purchased by the IRA. While you working for free is not a problem, buying paint or windows at Home Depot with your IRA could be a little tough. The general consensus that maintenance repairs are fine, but repairs that would increase the value of the property should be done by a 3rd party.

The other options would be to hire a property management company that will handle all aspects of the property and charge between 8% and 12% of the monthly rental income plus rent up fees and maintenance costs.

To learn more about how you can get your IRA funds busy doing real estate deals, join us at the Tuesday April 12th General Meeting for Mid-America Association of Real Estate Investors. You can find out more by visiting their web site at  MAREInet (.com if you want to visit) or calling 816-523-4400 x 222.