Retirement Funds: Real Estate Investment Strategies For Secure Future

Investing in real estate is a great way to diversify your retirement portfolio and build a steady source of income for your later years. While it can be a risky move, the potential for long-term gains and tax advantages make it an attractive option for many.

There are several ways to go about investing your retirement funds in real estate, each with its own set of rules and considerations. From using a self-directed IRA to investing in real estate stocks and funds, it's important to understand the ins and outs of each approach before diving in.

In this article, we will explore the different strategies for investing your retirement funds in real estate, the potential benefits and drawbacks of each, and provide you with a comprehensive guide to making informed decisions about your financial future.

Using a self-directed IRA to invest in real estate

A self-directed IRA is a type of retirement account that allows you to invest in alternative assets beyond traditional stocks, bonds, and mutual funds. This includes investing in real estate, either directly through property purchases or indirectly through real estate investment trusts (REITs) and other vehicles.

Benefits of Self-Directed IRAs for Real Estate

Self-directed IRAs offer several advantages for those looking to invest in real estate:

• Diversification: You can invest in a range of property types, including residential, commercial, land, and more, providing greater diversification than traditional investments.
• Tax advantages: Your real estate investments can grow tax-free (Roth IRA) or tax-deferred (Traditional IRA), shielding you from volatile stock market performance.
• Geographical flexibility: You are not limited to investing in a specific geographical area, allowing you to explore real estate opportunities across different markets.
• Control: You have more control over your investments, as you can choose the properties you want to purchase, sell, or rent out.

Choosing a Custodian

When using a self-directed IRA for real estate, you will need to select a custodian who specializes in these types of accounts and can guide you through the process. The custodian will handle the transactions, paperwork, and financial reporting to ensure compliance with IRS regulations.

Rules and Restrictions

It is essential to understand the rules and restrictions that come with using a self-directed IRA for real estate:

• Investment purpose: Any real estate purchased through the IRA must be strictly for investment purposes. You, your family, or any "disqualified persons" as defined by the IRS cannot use it as a residence or vacation home.
• Ownership: The IRA owns the property, not you. This means that all expenses, repairs, taxes, and other ownership costs must be paid by the IRA, and any rental income generated goes back into the IRA.
• Prohibited transactions: You cannot purchase property from or sell it to any "disqualified persons," including family members and certain related entities. You also cannot sell, lease, or exchange property you already own to your IRA.
• Financing: Paying in cash is common, as getting a mortgage within an IRA can be challenging. If financing is needed, non-recourse loans are typically required, and unrelated business income tax (UBIT) may apply.
• Maintenance and repairs: All maintenance and repair expenses must be paid from the IRA. You cannot perform the work yourself, as this is considered a prohibited transaction.
• Liquidity: Real estate is a relatively illiquid investment, so accessing funds quickly by selling a property may be difficult, especially during a market downturn.

Steps to Get Started

To start investing in real estate through a self-directed IRA:

• Choose a custodian: Select a custodian that specializes in self-directed IRAs and real estate investments.
• Fund your account: You can fund the account through cash contributions, rollovers from existing IRAs, or rollovers from employer-sponsored retirement plans (following like-to-like rules).
• Find a property: Research and identify the property you want to purchase, ensuring it aligns with your investment strategy and complies with IRS regulations.
• Instruct your custodian: Inform your custodian about the property you want to purchase, and they will handle the transaction on your behalf.
• Manage the property: Once the property is in your self-directed IRA, ensure all expenses are paid from the IRA, and any income is deposited back into the IRA.

Using a self-directed IRA for real estate investing requires careful consideration of the rules and regulations, as well as a thorough understanding of the potential risks and rewards. It is always recommended to consult with a qualified financial advisor or tax professional before making any investment decisions.

Investing in real estate stocks, mutual funds, or publicly traded REITs

If you have access to a 401(k) through an employer, you might also be able to find real estate-related investment opportunities. However, an employer-sponsored 401(k) can have a more limited range of investment opportunities compared to a personal IRA. With that in mind, if you have a 401(k) with your employer and cannot find suitable real estate-related investments, you can also open an IRA—either a traditional or Roth IRA—and find real estate investments through that account. But you will need to do your due diligence first because there are limits on an IRA if you also maintain a 401(k), and you will want to learn about the tax implications of owning both retirement accounts simultaneously.

This is the most passive and straightforward way to invest your retirement account in real estate. In essence, you can simply find stocks, bonds, or mutual funds to purchase, just as you would with other types of traditional retirement investing. The only difference is that you have chosen real estate as the industry in which to invest.

REITs are companies that own (and often operate) income-producing real estate, such as apartments, warehouses, offices, malls, and hotels. The most reliable REITs have a strong track record of paying large and growing dividends. Many online brokers offer publicly traded REITs, and REIT mutual funds and ETFs—meaning you can buy them in the same place where you can buy stocks.

REITs tend to be more tax-advantaged and less costly than real estate mutual funds. They are required by law to distribute at least 90% of their taxable income to shareholders annually through dividends. Additionally, REITs do well when interest rates fall and rents rise, as their dividends become more attractive relative to bonds.

Real estate mutual funds invest primarily in REITs and real estate operating companies using professional portfolio managers and expert research. They provide the ability to gain diversified exposure to real estate using a relatively small amount of capital. Depending on their strategy and diversification goals, they can give you a broader asset selection than can be achieved by buying REIT stocks alone. You can also quickly move from one fund to another, though you'll want to check for any back-end loads or applicable redemption fees.

The major advantage of these funds is the management's analysis and research—a deep dive you can forego in what are often murky waters. This can include details on acquired assets and management’s perspective on the viability and performance of specific real estate investments and as an asset class. More speculative investors can put money into a family of real estate mutual funds, tactically buying more for certain property types or regions.

However, real estate mutual funds may be less liquid, less efficient for your taxes, and have higher management fees than REITs or REIT ETFs.

Borrowing against your IRA or 401(k) to invest in real estate

There are risks associated with this method. Owning an individual piece of real estate requires active attention to the property and carries the risk of loss, such as losing tenants, property damage, or loss of equity in a down market. Additionally, if you were to take out a mortgage to buy the property and then lose your job, your entire outstanding mortgage balance might become immediately due.

If you are considering borrowing against your IRA or 401(k) to invest in real estate, it is crucial to conduct thorough research and educate yourself on the tax implications, legal ramifications, and financial risks involved.

• The real estate property will not be held within the retirement account, so it will not benefit from tax-deferred earnings.
• Borrowing against your retirement account can provide access to investment funds without incurring immediate tax or penalty.
• There are substantial risks involved with owning an individual piece of real estate, including the potential loss of tenants, property damage, or loss of equity.
• If you take out a mortgage to purchase the property and lose your job, your outstanding mortgage balance may become immediately due.
• It is important to consult with a financial professional to understand the tax implications, legal issues, and financial risks fully.

Investing in real estate through a crowdfunding platform

Crowdfunding platforms allow investors to finance real estate projects with the goal of profiting from capital appreciation or passive income. They are a form of alternative investment that is growing in popularity.

Real estate crowdfunding platforms pool investors' money to fund a real estate project or investment. This is often done by investing in a private REIT (Real Estate Investment Trust). However, some platforms also give investors access to private real estate development projects.

Benefits

Crowdfunding platforms have significantly lowered the barriers to entry for this type of alternative investment. They offer low account minimums, simple fee structures, and user-friendly interfaces.

They also provide investors with access to commercial real estate deals that were previously only available to large investment houses and wealthy individuals.

Things to Consider

• Accreditation status: Some platforms are only open to accredited investors, who have a net worth of at least $1 million or an annual income of at least $200,000.
• Liquidity: Real estate crowdfunding investments can be illiquid, so they may be better suited to investors who can afford to be patient.
• Risk: Like all alternative investments, real estate carries heightened risks, including volatile prices and lower liquidity.
• Fees: While some platforms have low fees, others have complex fee structures that vary by investment.
• Research: It is important to thoroughly research any crowdfunding platform before investing, paying attention to the restrictions, tax issues, and risks.

Examples of Platforms

• Fundrise: Offers access to a range of real estate debt and equity investments with a small initial investment.
• EquityMultiple: Focuses on commercial real estate and technology, with a range of private real estate investments.
• Yieldstreet: Provides access to a range of alternative investments, including debt and equity positions in real estate, legal cases, and art.
• RealtyMogul: Offers REIT funds and individual commercial real estate investments to both accredited and non-accredited investors.
• CrowdStreet: A platform for sophisticated commercial real estate investors, offering debt and equity deals provided by experienced property professionals.
• DLP Capital: Serves affluent clients with a range of real estate debt and equity funds.

Investing in a non-public REIT

Non-traded REITs can provide retail investors with access to otherwise inaccessible real estate investments, along with certain tax benefits. They are considered illiquid investments, as they are not traded on national exchanges and may not have a steady income stream initially. Early redemption of a non-traded REIT can result in high fees that lower the total return.

The minimum investment amount for non-traded REITs typically ranges from $1,000 to $2,500. These REITs are usually sold through broker-dealers, who may charge high upfront fees that can reduce the principal and any potential returns. It is important to note that selling shares in non-traded REITs can be significantly more challenging than their traded counterparts.

Non-traded REITs have the advantage of low correlation with the stock market, which can help diversify investor portfolios. The value of these investments is determined by an appraisal of the properties owned by the trust, rather than stock market volatility. As a result, managers of non-traded REITs tend to focus on long-term investment goals.

When considering investing in a non-public REIT, it is essential to carefully review the offering materials and be aware of the risks involved. While non-public REITs offer potential benefits, there are also challenges and restrictions to consider.

Frequently asked questions