Is It Better To Hold SFR Investments Inside Or Outside An IRA or 401K?

Question

I have a self directed 401K which would allow me to buy real estate inside the plan. I have a local friend that invests and he hold RE outside his retirement plan. I am curious as to the pros and cons of both avenues. I am buying SFR outside my plan at the moment. What do the pro's do?

Thanks!
John Thedford

Steven Hamilton II · Answer

John Thedford,

Consider a joint venture with the other person in which the 401k provides the cash and they do everything else.  All of the earnings have to go back to the 401k.

Will Barnard · Answer

Michael, you are twisting my words and splitting hairs he. I did not say YOU should be ignored, but your poor anomaly should be. Wen I stated you could get better returns by lending, I assumed you understood that to be secured by a note, which is secured buy a trust deed in most states, mortgage in others. So lending is securitized by a document against real property and if the amount of that loan is well under the current value, you have mitigated risk. Never did you state what the cash flow was, if the hold laws in a bad neighborhood or good one, etc. in other words. You posted no details other than an 8% return from holding RE and claim t is lower risk than my suggestion through your arguments.

I never stated that the higher returns were derived from or promised by "prophets".
While I agree that typically, higher returns usually come with higher risk, a smart investor can achieve both double digit annual returns and low risk via note/trust deed investing.
I also agree that understanding risks is important as they relate to returns. You simply assumed that my opinion of higher returns doing loans vs by and hold in a retirement plan came without thought to risk, when in fact it did nt. I would even argue that I could invest with less risk in my format than in your buy and hold example you posted.

Michael B. · Answer

Absolutely it's ridiculous to compare a roulette wheel to investing in trust deeds. But not any more ridiculous than to refer to high yields without referring to risk. Risk is a player in every investment decision, whether that decision is a treasury bond, a house, a trust deed, or a roulette wheel.

So why does putting investment returns in the context of their risk offend you so much that you ask that I be ignored? I never said that trust deed investment was equivalent to the roulette wheel. I actually didn't know we were talking about trust deeds so I couldn't have been comparing the 2. My initial reference to risk was that houses can often yield a very low risk 8%. To which you responded that higher yields are possible. I agree, but without knowing the risk involved that's a meaningless number. Hence the obviously offensive reference to putting it on black.

Retirement savings is about getting good returns while balancing risk. There are always ways to rev up returns, but they involve increased risks. Maybe that increased risk is appropriate for a retirement fund, maybe not.

Stocking picking systems will promise huge returns if you follow the right guru. And real estate has more than it's share of prophets, all of whom for a fee will lead you to the Promised Land.

But without understanding the risks involved the promise of higher returns is meaningless. That was my only point.

John Thedford · Answer

Will: I am in total agreement. I have always felt that a 1st lien position with a very low LTV is almost a guaranteed return. In the event the file bankruptcy or, in the present condition with a death of a borrower on one of my loans, that the worst that could happen is a return of principal. If I am overlooking something besides that please let me know. I am originating one this week that should have double digit returns at a minimum and for two years or less. Thanks all for your insight!

Best of luck to all...
John Thedford
Naples, FL

Will Barnard · Answer

I am not saying that nobody should invest in buy and hold if they only get an 8% return, but I am saying that one should excessive your options of vehicles for the best returns while mitigating risk. While buy and hold without using leverage is fairly safe, so is a trust deed with a low LTV and it is more passive. So, back to the point, qualified retirement plan funds are best used in notes/trust deeds as opposed to buy and hold. Keep the buy and holds outside of plans and utilize the tax benefits of BOTH vehicles.

Michael B. · Answer

No doubt about it. You can get even better results by placing it on black on the average roulette wheel. Assuming things work out.

Accounting for risk is even more important in retirement savings than in regular investments. And there's definitely a place for riskier investments in a well balanced portfolio. But understanding that risk and balancing it with more and safer investments is vital. Large losses of principal is devastating to a long term plan.

Michael B. · Answer

I like holding SFR's in my retirement plan. A couple of thoughts:

Without leverage, it's eminently doable in most areas of the country to hit an 8% yield holding a SFR, and that's not counting any appreciation that may come your way. In a time when the risk free rate is around 2%, that's an outstanding return with very little risk.

A couple of people have mentioned lending from the SDIRA. Everybody has to find their own level of acceptable risk. For me, that's a step beyond where retirement funds go. Holding clear title to the asset that's earning is a good thing. But to each his own.

The tax advantages of owning from a house within an SDIRA are different than owning outside. But that doesn't mean they don't exist. Depreciation and deductions disappear, but the ability to push out recognition of profits for decades (or forever in a Roth) makes growth easier.

Successful retirement investing is about 1> preservation of capital, and 2> finding an acceptable return. In that order. Holding one or more houses in retirement funds may help achieve that goal.

Ann Bellamy · Answer

Personally, I lend from my 401k, but would not hold SFR's in it.  the reason has less to do with taxes than with convenience:

I am not an expert on 401k's but I believe that if you do anything for the property - changing the lightbulbs,  signing a lease, etc.  you can create a prohibited transaction.   Which can invalidate all the tax benefits of your account.   I think you need to manage a property manager, which can be cumbersome and expensive for just a couple of SFR's.

Lending is much easier, and is fairly easy to make sure you don't make a mistake and do something prohibited.

John Thedford · Answer

Thank you Will! I appreciate your advice. A local friend of mine holds RE outside his plan and that is what I am currently doing. I asked this question so that I would make the right decisions in the future with more acquisitions. I am presently doing 1st liens with my 401K so I am glad to know that the pros like you believe the is the best course of action.  Now I know that my friend is doing the right thing holding RE outside the plan, and any future acquisitions on my part will definitely be held outside my retirement plan.

Thanks! Everyone here is GREAT!!!
John Thedford

Is It Better To Hold SFR Investments Inside Or Outside An IRA or 401K?

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