SAN FRANCISCO—An increasing number of investors are becoming interested in investing in commercial real estate through self-directed IRAs, a practice that has been active for quite some time. Mike Howe, a relationship manager with locally based Pensco, tells GlobeSt.com that the increased interest has been spawned from a combination of market volatility, a downed economy and low interest rates.
“People have been able to use their IRAs to increase in all types of alternative assets for a long time,” says Howe. “It wasn’t necessarily a popular thing to do, but it’s become increasingly better now to invest in alternative assets for a lot of people based on their risk profile. You need to evaluate your own risk profile, but you could make a higher return for your investment through a self-directed IRA rather than putting your money in a savings account of CD now.”
Howe says there are generally two forms of investing in commercial real estate via a self-directed IRA: directly or indirectly through a private-equity vehicle of some kind. A third way to invest is by being a mortgage holder, whereby the IRA acts like the bank, and the investor is paid back principal and interest from the mortgagee.
A direct investments means the client is making all the investment decisions, with a qualified custodian to help guide them. The client can transfer funds from another qualified account—either a 401K rollover or a transfer from another IRA—and the funds can go toward any type of alternative investment they want.
“Once the money is in a qualified account with a qualified custodian, you are free to do what you want,” says Howe. “Of course, there are tons of rules on what you can and can’t do due to the general market volatility and probably also the fact that alternative assets are becoming more accessible to people via crowdfunding platforms. They’re readily available for people now who didn’t have that option in the past.”
The way that an investor invests through an IRA depends on how much legwork they want to do as an underlying client, what their risk profile is and what they feel comfortable investing in, says Howe. “Direct real estate is much more legwork and labor intensive for the underlying client because they need to go out and find a mortgage broker and send in the right paperwork to their self-directed IRA custodian vs. indirectly through a fund where they fill out their documents. The custodian will provide the transparency, technology and administrative support that lets investors buy, hold and sell non-traded alternative assets within their retirement accounts. In the latter, the investor is pretty much hands off, just like a LLC member.”
If you don’t mind doing the legwork and want to do a direct real estate investment, you get to choose the piece of property you’re going to buy vs. an indirect investment where the investor doesn’t necessarily know which properties they’re going to buy and perhaps don’t care, says Howe. “With direct, you get to actually choose, and you have more control over what happens. If you’re buying as a rent or lease transaction, you get to choose who rents your property and what the lease terms are. Indirectly, you’re going to have less control, but also less responsibility.”
Rules for investing via a self-directed IRA include who is allowed to live in the property (not the investor or immediate family members), where the funds come from (only a qualified IRA account), from which account the expenses and taxes for the property are paid (only from the qualified IRA account) and who collects rent checks (usually a third-party manager is required.) Other rules also apply.
Using self-directed IRAs to invest in real estate has become popular for all-cash buyers who are not institutional buyers. As GlobeSt.com reported recently, tapping self-directed IRAs and appealing to friends and family are two ways that smaller all-cash buyers making residential purchases, Daren Blomquist, VP of RealtyTrac, tells GlobeSt.com. As fewer institutional buyers are making residential purchases, smaller all-cash investors are moving in.