There are lots of different ways to use a self-directed IRA to invest in real estate. You can purchase properties outright, of course, and your investments can run the gamut from single-family residential real estate, multi-family units such as apartment buildings, commercial properties, industrial properties, undeveloped land, and even farmland.
Due to its very nature, the market for virtually every type of real estate investment is going to be different then the trading markets for stocks and mutual funds. Real estate is an illiquid asset class, and it’s not uncommon for buyers to borrow a significant portion of both the funds required for purchasing properties, using the property itself as security for that borrowing.
Sometimes these buyers won’t be able to satisfy their repayment obligations, and the entities that provided that financing will want to use the property as a means to satisfy the debt. The well-known foreclosure process is often used in the context of residential borrowers failing to repay their mortgages. The “short sale” is a similar process.
A short sale is a negotiation involving the sale of property where the proceeds of the sale will be less than the outstanding debts and liens on that property, but which releases the defaulting borrower of any further liability. A seller generally agrees to submit to a short sale if they aren’t able to continue making payments on their mortgage, but doesn’t want to go through the additional expense and possible credit rating damage of the traditional foreclosure process.
As with property foreclosures, the short sale process can present investors with opportunities to purchase properties at below market prices. Here are some factors to consider before you pursue this type of opportunity with your self-directed IRA.
Many prospective home buyers (investors or otherwise) avoid short sale scenarios because they can sometimes be an extremely long and drawn out process. A short sale requires that all of the parties who hold liens on the property, which will likely include the bank or finance company who gave the first mortgage on the property (as well as any subsequent mortgages or home equity lines of credit), any tax liens, and any other indebtedness consent to the terms of the short sale. In many cases some lien holders will only receive a small portion of the money they’re owed. Getting all these consents can often take a great deal of time.
Understand that the short sale process isn’t as easy to understand as a traditional sale of property. Unlike an arms length sale, or even a traditional foreclosure, there can be many levels of negotiation, with different sensitivities among the different stakeholders. In some cases getting professional help can make the difference between the transaction happening or not.