Your retirement funds are sacred, they represent years of hard work hard work and sacrifice. You want to invest in something that you know will be secure but will also bring you great returns. That’s why many educated investors choose real estate. Unlike investing in a company, a property can’t go bankrupt; it is always going to hold value. Even if the building burns down, the ground under it is still worth something. Secondly, property almost always appreciates – especially in the long term. Property values go up with inflation, and as areas become more developed property values are driven up by scarcity. Populations continue to grow, real estate is a limited resource, and people will always need somewhere to live.
Self Directed IRA’s
If you walk into Fidelity or Schwab and tell them you would like to invest in real estate from your IRA they are going to tell you that you can’t do that. What they mean is – you can’t do that with them! Most financial service companies don’t offer real estate investment options because they are getting a commission from the other investments they offer you. In order to invest tax efficiently in real estate, you will need a self directed IRA. You do this through a self directed IRA custodian who will manage your account and make sure that all of your transactions are legitimate. There are a lot of rules, and your custodian can give you more information, but here are the basics: your IRA is an entity directed by you but separate from you. You cannot buy or sell, partner with, or lend from your IRA to yourself or any disqualified person. Disqualified people include a parent, grand parent, daughter, son, grandchildren, and spouses to all of the previously listed entities.
What can you invest in?
You can buy vacant land. You can buy rental property as long as (1) it is managed by a property manager rather than yourself and (2) all the property revenues and expenses flow directly in and out of your IRA account rather than your other personal accounts. If you want big returns to grow your retirement fund, I recommend using a Roth IRA because you are investing money that you have already paid taxes on which means your investments will be growing completely tax free! I recommend using that Roth IRA via any of the following possible strategies.
Joint Venture on Flips or Developments
You can joint venture with a non-disqualified real estate investor who flips or develops. As a joint-venture partner your IRA may provide all of the funds to buy and flip the property, or your partner may use some of their own money and or a hard money lender to mortgage the property. When you’re IRA partners in a transaction you cannot make any personal guarantees regarding funding, so any loans are strictly asset based (on the property) and are non-recourse. As a partner you have the opportunity for great upside but JV partnerships can be risky. There is no guaranteed rate of return, and depending on your agreement, if your partner loses money on the flip you share in the loss.
Private lending to flippers is a great strategy because it provides high returns and your loan is secured by the property. Interest rates will often range between 8-16% which usually depends on the lender and the flippers experience. Lending to someone who has done a lot of successful deals is obviously a lot safer than lending to someone who is brand new, so an experienced flipper can often usually find more lenders and better rates. If someone is offering you unusually high rates, you will want to be very careful it probably means that everyone else is turning them down, and it might not be the best investment.
Note investing is where you become the bank rather than a landlord. You can buy the note from an institution or another investor, and now the property owner makes their mortgage payments to you. If they don’t make their mortgage payments, you can foreclose and take over the property. One reason why notes are such a great investment is because you can often buy notes for a big discount off the unpaid principal balance. This means that your yield will be higher than the interest rate of the loan because you’re not just getting interest and principle back on what you paid for the note, you’re getting principal and interest payments based on the original principle of the note. For example, if you bought a non-performing 10 year note for $65K with a $100K unpaid principal balance at a 6% interest rate and got it performing, from the interest and principal payments on a $100K note your yield would be 16.53% for 10 years. If the homeowner refinanced to get a lower rate you would be paid out sooner and your yield would be even higher because you would be realizing the $35K spread sooner.
In order to invest in notes from your IRA, you need to have a third party servicing company service the notes for you. A loan servicing company is similar to a property management company, they make sure that the borrower is paying their mortgage. Most investors choose to use a servicing company any way because when the investor goes to sell the note the servicing company can validate that the borrower is making their payments thus making the asset more valuable.
There are many different ways and strategies for investing in notes. You can buy loans from motivated sellers and sell them to other investors for a profit. You can buy first mortgages, seconds, or subsequent loans. You can buy performing loans (loans where the borrowers are making the payments) and hold them for cash flow. You can buy non-performing loans at big discounts and have your servicing company work out a loan modification with the borrower to get the note performing again and then keep for cash flow (like the example we used earlier) or flip to another investor. Or you can foreclose and take title so you can sell the property.