Sep. 26, 2008
Investors and second homebuyers in Texas see the long-term potential of some depressed properties, but many possible players simply don't have the ready cash to make the purchase. Besides, fuel prices are up and the kids need back-to-school clothes, plane fare, and rent for an apartment.
But if you really find a can't-miss opportunity, what about the possibility of using your Individual Retirement Account to make the deal? Even though the appreciation rate of real estate in some areas has slowed dramatically, many people are comfortable with property as an investment, especially given the inconsistent movement of stocks and bonds.
You cannot use IRA money to buy your own residence or any other property in which you live. It has to be used for investment property. Then, when you retire, you can direct your IRA to sell the property so that you can use your retirement funds for living expenses, or to turn the property over to you as a distribution at the current market value.
The challenge with real estate IRAs has been lack of funds to make a meaningful purchase. Historically, real estate IRAs had been purchased with cash, and the trust then held the property free and clear. One way to solve the huge challenge of paying all cash was to get several investors to buy shares in one property.
Now some banks are discovering the real estate IRA niche and granting a "non-recourse loan" to the trustee for specific properties. Non-recourse means if the loan goes into default and the lender needs to foreclose, the property would be the only asset the lender could claim. It's similar to a non-judicial foreclosure where the property becomes the lender's only focus.
David Nilsson, president of Guidant Financial (www.guidant.com), a Kirkland, Wash.-based company specializing in investment strategies, sees a few lenders now making IRA-leveraged loans to customers with good credit scores and large downpayments.
"Lenders like to see 40-to-50% equity in the property plus more coming in monthly in rents than going out in mortgage payments," Nilsson says. "The loan might not work in all IRA real estate deals — for example, vacant land."
The key to making your investment dreams become reality via an IRA-leveraged loan is a huge downpayment (rolling your combined IRAs, or old 401(k), into one lump sum) plus the ability to rent out the property most of the year. Is your destination a year-round attraction? If not, will rent from the prime months carry the mortgage payment for the months it remains vacant?
IRA-leveraged loans usually carry slightly higher fees and rates than a conventional mortgage, but the package often is attractive to investors, especially if a property has the potential for rapid appreciation.
"Once consumers and real estate professionals really understand it, the concept will catch on much faster," Nilsson predicts. "It's a loan nobody has spent a lot of time thinking about until the last few years."
Where the loan absolutely makes sense is with a small, traditional investment property like a duplex, triplex, or fourplex in a good location. Unlike a vacation destination, income is not dependent upon seasons. Rents would flow to a self-directed program administrator who would then make the monthly mortgage payment to the IRA-leveraged loan lender. The administrator also would make payments on taxes and insurance.
The IRA-leveraged loan is made to the IRA or plan, not to an individual. Rules preclude an owner from using his or her personal credit to influence the loan. Since the loan is non-recourse, the lender can only seek relief from the secured property in the event of default and foreclosure. The owner's other assets cannot be claimed — similar to a non-judicial foreclosure.
(The advantage generally associated with judicial foreclosure is that it may be possible to obtain a deficiency judgment against the owner if the proceeds from the sale of the property are insufficient to satisfy the debt. A judicial foreclosure is usually more costly and time consuming because it requires court proceedings.)
"The typical customer of an IRA-leveraged loan probably would have significant other assets," says Nilsson. "But remember, the loan is not made to them; it is made to their IRA. It's a different twist with some considerable possibilities."
