A few weeks ago we looked at the case of Rachel: a successful nurse who had $200k in her 401(k) and wants to get into real estate. Rachel had no previous real estate experience and wanted to jump right away into big commercial deals. We explained in Part 1 why that would not be a good idea. That being said, let’s take the time today to explore what would be a better alternative for Rachel’s real estate dreams.
Before we jump into real estate nitty gritty, let’s just make sure that you’re using the right platform. If you plan on using your IRA or 401(k) funds to invest in real estate that you actually own (as opposed to a REIT,) then you need a self directed platform that makes sense for that kind of investment. The two basic options are a self directed Custodian IRA or a self directed Checkbook IRA. They both can invest in real estate, but the Checkbook model makes the process easier and cheaper. ‘Nuff said.
In the business of real estate, the world is your oyster, but (at least in the beginning) it’s best to stick close to home. First of all, you have a much better understanding of the properties in your neighborhood. You live and work there, and you should have a feel for what can rent, what can sell, and what is a money pit just waiting to happen. A second vote in favor of local real estate is the management issue. If you’ve never managed a property before, you’re going to find that there is a short but steep learning curve. To manage that curve when you’re living hundreds of miles away can be exceedingly difficult. Your first property should be close enough to home that you can easily access it whenever the need arises.
Once you’ve made the decision to stay local, the next question is which kind of property to buy. Everybody’s imagination is set on fire when they see shows like “Flip This House”, but is a flip really the best deal for your retirement fund? Flips can certainly earn you a nice chunk of change in a short period of time, but unfortunately the standard reality is not as promising. Many investors get into a property at a price that (they feel) can’t be beat, and they do so because they’re certain that they can flip it within a month or two. Many of these same investors then end up sitting on a property that they find is not so easy to sell, and they take a tremendous hit for the monthly mortgage and upkeep. If this is your first foray into real estate, and it’s your retirement funds that are on the line, it would be wise to start with something more conservative. This is especially true if you want an asset that can accrue in value, as well as provide some kind of income. From that perspective, a rental - be it a single family or multi - is an ideal solution. If you put your retirement funds into a rental, then there will be a monthly rent check in addition to the property value itself. The rental income helps mitigate swings in the real estate market. Up or down, you should have a steady source of income coming from the property. That being said, there are still two points that you have to seriously consider before putting your self directed IRA funds into a rental. The first is landlord responsibilities. Unless you hire a property management firm, you will have to be busy as the landlord of the rental. This includes collecting the rent, dealing with tenant complaints, and facilitating repairs and maintenance. The second important consideration is the rentability of the property. If you have a rental unit that nobody wants to rent, you obviously will not be making any money on it. A good source for this kind of information is a trustworthy real estate agent. He/she will usually have a solid grasp of the local market, and will be able to inform you as to your chances of easily finding a tenant. This covers the general concerns that an investor should consider when looking to place real estate in an IRA. However, even a property that looks ideal on paper might still be highly unsuitable as an investment. In an upcoming blog we’ll discuss some of the real questions you should be asking when looking at a specific property.
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