There are a lot of would be investors that want to get their retirement funds out of the stock market and into alternative tangible assets like real estate. But a lot of account holders have a problem; they don’t have enough funds in their retirement account to buy a rental property. Sure there are great deals in real estate today, but that doesn’t matter if you don’t have enough money to grab those good deals.
Today we are going to explore ways to use other people’s money in your self directed retirement account so that you can invest in this buyers market.
The first method is partnerships. Partnerships are probably the most common way of raising capital and for me it is the easiest way to raise capital. A partnership is created when there is more than one person or IRA investing together to buy an asset. I have used the IRA owned LLC method to create partnerships and it has worked very effectively. We have created a Limited Liability Company and have added those IRA accounts as members for example a member would be ABC Custodian FBO John Smith IRA and ABC Custodian Jane Smith IRA and so on. I have an LLC that I manage that has eight different members. Ownership of the LLC is determined by capital contribution. If my IRA has contributed 50% of the total capital to the LLC then my IRA owns 50% of the LLC and would receive 50% of the profits from the investments the LLC makes.
The best way to create partnerships is to talk to your friends and family. More often than not they are unaware that they can use their retirement accounts for alternative investments. Most Americans think that their only investment choices are in the stock market. If you talk to your circle of friends about their ability to get out of the stock market and into assets they control and manage they will thank you for it.
Another way to use other people’s money in your retirement account is through non-recourse loans. These are loans that your retirement account would obtain; remember it is prohibited for you to extend credit to your IRA. So you are not able to get a loan for your retirement account based on your good credit history. Let’s go thru the steps that it takes to get a non-recourse loan. First there are certain lenders out there that understand this concept and will lend to an IRA, not very many lenders understand this concept and will not lend to your retirement account. What the bank will be looking at is the value of the property, how much can the property rent for and how much cash is in your IRA. They typically require 50-60% down they are usually 2 to 3 percent higher than a typical loan with their interest rate and they want you to have in your cash reserves 10-20% of the loan amount after you close. It sounds like it has a lot of requirements but you must remember the bank is not lending you the money to buy the investment property, there is no recourse against you in the event of a default. The bank is lending to your IRA and your IRA owned LLC will now have a property titled to it and it will now have a mortgage. I have two mortgages in my IRA owned LLC, without the help of non-recourse loans there is no way that I would be able to invest in two rental properties. It’s a great way to use other people’s money.
Another way to use other people’s money is thru the use of a simple prom note. Mostly this is done without collateral, so it could be a little more risky. Most people I know that do this are doing this with people they know and have a good comfort level with. My IRA borrowed funds from my brothers IRA and that allowed me to invest in a project that required me to be a qualified investor. I was a qualified investor but I had no cash in my IRA. So with the help of my brother and his IRA I was able to take advantage of a great investment opportunity. Prom notes are easy and quick. Most self directed custodians just require that you create a promissory note and both parties sign and deliver it to the custodian. Of course for me I have checkbook control of my IRA funds and I never ask my custodian to get involved in the transactions my LLC are engaging in. I always have a good paper trail for all of my transactions that includes good well written promissory notes.
If your strategy is to fix and flip then you may consider a hard money loan. You will pay anywhere from 13-18% for this type of loan. But you are typically out of these loans in 90 days or less. I know of a hard money lender that charges 18% guaranteed 90 days of interest in other words you have to pay him at least 90 days worth of interest. Let’s say you identify a property that cost 100K and this lender requires 40% down that would require you to come up with 40k to purchase this property. He will put in 60k and will require a minimum of 90 days worth of interest at 18% that equals $2700.00. Let’s assume you sell the property in 70 days for 150k. Your lender will be paid back their principal of 60k and interest of $2700.00 for a total of $62,700.00. After your original $40k your profit in a 70 day loan is $47,300.00. Hard money loans are great for short term loans and if structured right it is good for both the borrower and the lender.
An important reminder that if you are considering using other people’s money in your IRA you need to familiarize yourself with the UBIT rules. Always continue to educate yourself about the power of self directed IRA and ease of an IRA owned LLC.
Timothy Schubert CISP