Self-directed IRAs have caught on like wildfire in the last few years. Five years ago, almost nobody had heard of a self-directed IRA. That’s all changed. Now it seems like everyone is trying to figure out how to pull money out of stocks, bonds, CDs, etc. and capitalize on the deeply discounted real estate market. While some investors are just tired of the volatility of the stock market or insanely low interest rates, other investors see the tremendous upside to investing in a severely depressed real estate market.
I talk to investors almost every day who are wrestling not with whether they should move IRA money into real estate, but how best to invest IRA funds in real estate. Of course, the answer to this question will be different for everyone. It really depends on the amount of money someone has to invest, their risk tolerance and the amount of active involvement they want to have in their investment.
With the emergence of non-recourse loans, IRA investors now have the ability to buy investment property through an IRA with approximately 30%-35% down. This has been tremendously beneficial for investors who, for example, want to leverage their money into three houses as opposed to one paid completely with cash. For an investor whose goal is to acquire as many properties as possible with his IRA money, this is a great tool. With that said, I have found that non-recourse lenders have become increasingly selective about where they will lend and how much they will lend.
If an investor finds that he cannot obtain a non-recourse loan, the question typically becomes whether or not he wants to pay all cash for an investment property. If an investor has substantial IRA funds, it may not be as risky to buy one or more properties outright. However, if an investor is going to invest the majority of his IRA into a single property, it may be wise to consider other alternatives before putting too many eggs into one basket. Investing in rental properties is inherently risky, and sinking the majority of one’s wealth into a single property may not be a prudent decision.
For those investors who don’t want the risk of owning an investment property, along with the burdens of tenant interaction, vacancy headaches and maintenance issues associated with ownership, a good alternative may be to partner with other real estate investors and become a lender. That’s right; you can use your IRA money and essentially become a private lender to other real estate investors who are experienced at buying and selling real estate in this market. In most cases, your private financing is worth 12% or more to an experienced investor and your investment is secured in first lien position by the property itself. Assuming you have partnered with a reputable, experienced real estate company, this can be a very low risk alternative to owning investment property while still obtaining a high yield return.
It’s important to understand that conventional lending institutions are extremely cautious and conservative right now. Bottom line, there is little capital available for real estate investors. Due to this hard fact, even successful real estate companies are willing to pay 12% interest on your private financing to fund their business. For those investors who like the thought of a high interest return without the headache of owning property outright, becoming a private lender to a more experienced investor may be the perfect alternative.
photo credit: Joe Shlabotnik