Tips For Managing A Large Real Estate Portfolio In Your Self-Directed IRA

Real estate is a perennially popular investment type for individuals to pursue within their self-directed IRAs. The ability to invest in real estate – both developed and undeveloped properties – can provide an investment and risk profile that generally can’t be mirrored with traditional stock market investments.

But holding real estate within a self-directed IRA can also require a greater level of investment involvement as compared to those other asset classes.

With stocks or mutual funds, the only investor decision is generally just whether to buy or sell. But with real estate, you’ll need to take a much more active role in your investment. And as your real estate portfolio grows ever larger (as is often the case, because many investors view real estate as the ultimate “buy and hold” asset, and therefore tend to add to their positions more than they sell existing investments), you will want to make sure you’re managing your portfolio as efficiently and effectively as possible.

1. Have a Plan.
One of the biggest differences between real estate investments and other investment types is simply the transaction costs associated with making the investments. You can buy stocks, for example, and pay a relatively small commission – and if you quickly change your mind about the suitability of that investment you can sell it the next day and similarly pay a similarly small commission. That’s not the case when it comes to real estate. You need to do your research and planning ahead of time to be comfortable that you’re making the right decision.
You may also wish to consider how subsequent additions to your real estate portfolio in terms of risk and exposure to particular market downturns will affect you. For example, if you own multiple units in a single neighborhood or very small geographic area, then you’re bearing risks (both to the upside and downside) associated with that area’s growth.

2. Stay Active.
By “staying active” we mean that you’ll want to stay on top of your investments and frequently monitor the local market conditions, the condition of the property, and that your tenants are meeting all of their tenant obligations. The value of your investment can erode over time if you’re not paying close enough attention. When you monitor your investments you may also be able to identify opportunities or efficiencies to be gained across multiple real estate investments in your account.

3. Seek Out Professional Assistance.
The larger your real estate portfolio, the more you stand to gain by using a professional property management service. While you’re permitted to perform repair and management related tasks on your own investments, you can’t compensate yourself for your time or effort – doing so would constitute a prohibited “self-dealing” transaction. This is true even if you’re in the business of providing these services to other clients.

But you can hire an outside company or individual (provided they’re not related to you) to perform these services. Not only might that just bring a higher level of professionalism and service to your investments, it can also save you time and energy by not having to manage a growing portfolio yourself.

Selecting Your First Real Estate Investment For Your Self-Directed IRA

Let’s say that like many individuals who are setting up their first self-directed IRA, perhaps drawn to the offerings of custodians such as Quest Trust Company because of the investment flexibility that such an account gives, you’re interested in using your new account to invest in real estate.

What are the next steps? How do you go about choosing your first real estate investment for your self-directed IRA?
What’s Your Prior Experience? When it comes to any new investment, there’s always some degree of learning as you go. But if you have very little or no experience with owning or managing real estate, then you may want to consider a more straightforward property for your first self-directed IRA investment.

What’s Your Investment Budget? Another key consideration is going to be the size of the investment budget for your first property. The more money you have available, the more options you’ll have.

As you formulate your budget, be sure to take into account the fact that any expenses for maintaining the property you buy must also come from within your self-directed IRA. This might be new contributions you are able to make each tax year, but these are subject to the annual contribution limits. Plan to either have your real estate generate enough income to pay for these expenses, or to incorporate other assets into your account in order to cover the real estate carrying costs.

What’s Your Current Portfolio Composition? Regardless of your preferred investment type, you always need to take care to avoid having too much of your portfolio committed to a single asset class. If you already have exposure to real estate in your portfolio (perhaps through banking stocks or REITs), then you want to factor that into your new investment considerations.

What’s the Purpose of the Real Estate Investment? Are you considering this real estate investment solely for potential gains, or do you have other goals in mind? For example, some people use their self-directed IRAs to purchase vacation or other properties that they intend to use themselves once they reach retirement age.

As you consider these types of investments, remember that the IRS regulations prohibiting self-dealing, meaning that you cannot use (nor can anyone in your family use) the property you buy until you take a distribution of it from your account during retirement (or face significant penalties if you take that distribution prior to retirement).

Start Small. Many first-time investors find that the best way to become more familiar with investing in real estate is to start small. This might be a single-family home, or even a condominium. Having a small investment in real estate can give you the opportunity to learn more first-hand, without over-committing your retirement portfolio to this type of asset.

Even though real estate is a fairly unique investment asset, it’s still subject to traditional financial analysis. Make sure you familiarize yourself with the local and broader real estate environment before making your first investment with your self-directed IRA.

Investing In Oil And Gas With Your Self-Directed IRA

When people think of the “alternative” investment types they can purchase with a self-directed IRA, they generally think of precious metals, real estate, private equity and private debt. (And let’s be clear, it’s probably unfair to think of these as “alternative” investments because they are fully authorized by the IRS regulations relating to IRAs.) Another asset class, and one that perhaps comes to mind as often, relates to the oil and gas industries.

Because oil and gas investments are less common, let’s discuss some of the basics for making those investments with a self-directed IRA.

Don’t Ignore the Learning Curve. Oil and gas investments are arguably one of the most complicated types of investment that you can make. Concepts of mineral interests, surface rights, working interests and royalty streams are not generally encountered with other investments.

Because many oil and gas investments are relatively illiquid, it’s absolutely essential that you do your due diligence on any potential investment, and fully understand the nature of the arrangement you may be participating in. As with any other investment, don’t rush into an oil and gas opportunity if you don’t fully understand all the relevant terms, provisions and risks.

Types of Oil and Gas Investments. There are a number of different ways to make investments in the oil and gas industries, including not only the commodities and futures contracts, but interests in the refining and drilling companies, as well as investing in land or mineral interests where drilling is taking place (or likely to take place in the future).

Other Energy Projects. Even though we’re focusing here on oil and gas investments, understand that other energy industry projects may provide you with similar opportunities. If you don’t find any suitable oil or gas projects to invest in, consider solar energy projects, wind energy, biofuel, or water energy projects as well.
The developments of just the past few years solidly demonstrate just how much potential there is for oil and gas activity within the United States. But you may also wish to consider other projects that may exist outside the United States.

Tax Considerations. Depending on the type of investment you’re considering, you should check whether there are tax incentives available for investments made with non-taxable funds. If so, and you have enough funds available in your taxable investment account, then you may wish to make the investment outside of your self-directed IRA in order to maximize your benefits. However, many of these tax breaks have expired as domestic development has boomed, so most potential investments may still be suitable for your self-directed IRA.

Also consult with an expert to understand how UBTI (Unrelated Business Taxable Income) might impact your investment. This concept (which can be an issue for self-directed IRA owners when they seek to use debt financing to make an investment – such as getting a mortgage for a real estate purchase) can result in an immediate tax bill for certain types of investments.

The key in all aspects of an oil or gas investment within your self-directed IRA is to do your homework.

A Survey of Different Real Estate Investment Types for Your Self

Real estate can be a great investment option for individuals who either currently have, or are interested in opening, a self-directed IRA. An IRA with a self-directed custodian such as Quest Trust Company will open up the possibility of investing in all legally authorized asset classes, rather than the limited subset of choices that traditional custodians (such as banks and discount brokers) offer. Along with real estate, an individual can use a self-directed IRA to invest in certain types of precious metals, as well as private equity, debt and mortgage instruments.
Because most of us are at least somewhat familiar with the basics of real estate, if not real estate investing, this is one of the most popular choices for self-directed IRAs. Below is a survey of some of the most popular real estate investment types, as well as some of the pluses and minuses of each.

1.    Single Family Homes
Single-family homes are perhaps one of the easiest ways to begin investing in real estate. You only need to do due diligence on a single structure and property prior to investing, and you only have to worry about repairs and upkeep, as well as finding a tenant, for a single location.
But single-family homes offer no diversification in terms of location or tenants. A single-family home only has one tenant, so if things go poorly with that individual, your investment returns will take a hit. Consider, for example, what would happen to you or your investment returns if your property sits vacant for several months (or more) between tenants.

2.    Multi-Family Housing
Some self-directed IRA investors choose multi-family housing units (which can include duplexes, large single-family homes that have been subdivided into multiple units, or even apartment buildings) in order to gain diversification. When you have a dozen units in your portfolio, for example, your returns are not necessarily impacted significantly when one of the units has a short-term vacancy.
But with multi-family properties you are more likely to need professional assistance with management. Be sure to factor these costs into your pre-investment financial calculations.

3.    Commercial Properties
You can do away with the concerns over residential tenants altogether by using your self- correcting IRA to invest in commercial real estate. Possible commercial real estate investments include office buildings, storefronts, and even undeveloped property that you believe will eventually be suitable for commercial development.
These types of investments can prove lucrative, but they do require a higher level of expertise and knowledge of local market conditions than is generally required for residential investments. Most of us simply don’t have any first-hand experience with commercial properties to have an immediate reaction to the suitability of the potential commercial real estate investment.

4.    Real Estate Investment Trusts and Private Mortgages
Finally, there are other ways to participate in the real estate investing markets without having to hold property directly. You can use your self-directed IRA to invest in real estate investment trusts (essentially an investment vehicle that owns and manages investment properties), or even originate mortgages to private individuals and businesses who wish to finance their purchase of real estate.
Regardless of the type of real estate investment you may select, be sure to understand all of the relevant points with any potential transaction, and that the investment is a good fit for your overall portfolio.

Should You Steer Clear of Real Estate Foreclosures Within Your Self-Directed IRA?

real estate foreclosureSavvy retirement savers are likely to consider every type of investment that’s available to them. Unfortunately, individuals who set up IRAs with traditional custodians are missing out on a wide range of investing opportunities. Those who set up a self-directed IRAs with custodians such as Quest Trust Company can invest in private equity, certain precious metals, and even real estate.

And there are many potential types of real estate investments. Depending on an investor’s account balance, their willingness to take on debt within their IRA, as well as their appetite for risk, they can invest in residential properties. commercial properties, industrial or farmland properties.

In recent years, given the number of residential properties that have faced (and continue to face) foreclosure, more investors are looking at foreclosures as having good potential for significant long-term gains. But there are a number of factors that can make investing in real estate foreclosures more challenging than a straightforward market transaction, so you’ll need to consider each of them before you decide whether foreclosures are right for you.

Long Investing Timeframe. Because there are many legal steps and obligations that must be met as part of the foreclosure process, it can take significantly longer to buy a foreclosure property than to buy a property on the open market. The timing varies from state to state, but the entire process can extend for a year or more in some jurisdictions.

No Opportunity for Appraisal or Inspection. It’s quite likely that once a property goes far enough through the foreclosure process that is ready for public auction, there will be no opportunity to conduct an independent appraisal or inspection on the property. In instances where a pre-auction inspection is allowed, it is often little more than a quick “walk through” by the prospective bidders. Since conducting your research and having a good idea of what you’re getting into is important for any investment – real estate or otherwise – this information gap must be taken into account.

Unhappy Prior Owners. With foreclosure properties, not being able to conduct an inspection is likely to be even more important than would be the case for an open market transaction. It’s not unheard of for property owners who are being foreclosed upon to stop their normal upkeep and maintenance of the home (and in more extreme cases even do intentional damage to the home and its infrastructure).

No Occupants. During those stages of the foreclosure process in which no one is living in the home, it can quickly fall into disrepair or perhaps become a target for theft. Even if there are no personal effects in the home, thieves might target copper tubing, wiring, appliances and other fixtures.

Local Market Dynamics. Finally, it’s important to realize that sometimes you get exactly what you pay for. Look behind the reasons for the foreclosure – did the neighborhood become unreasonably expensive to quickly (in which case there may be more foreclosures in the same area, thus perhaps making it harder to realize a profit on the property you’re interested in)?

Don’t automatically assume that a foreclosure property will yield large investment returns. Take all the relevant factors into consideration so that you can decide whether a particular property is right for you.

How to Compare Real Estate Investments with Other Investment Types

real estate investmentIt can be financially risky for an investor to become overly committed to a single investment class, Becoming too focused on a particular type of investment makes it difficult to maximize the performance of an investment portfolio because not all investment options are being considered.

While the single most important factor in each investment choice you make is likely to be the expected or anticipated investment performance, most investors are also likely to consider overall portfolio diversification as well as suitability of any particular investment to their individual risk profile. Comparing investments within a particular investment class (for example, one stock versus another stock) is relatively straightforward, but it can be more challenging to compare across different investment types.

Since real estate is a particularly popular investment for individuals that have a self-directed IRA with a custodian such as Quest Trust Company, let’s examine some of the factors that are relevant to comparing real estate investments to other investment types.

Liquidity. Liquidity is perhaps the biggest distinguishing factor between real estate and many other types of investments. When you hold investments in publicly traded stock, for example, it’s easy to open or close investment positions whenever the market is open. Some investors may even trade in and out of a particular stock multiple times within a given trading day.

In contrast, the timing of a transaction to buy or sell real estate is generally measured in days or weeks (and often even months). It’s therefore important to assess your liquidity needs before making any real estate investment. Investors or retirement savers with significant other assets, or whose investing timeframe is very long) are generally in a better position to bear the potential downsides of relatively illiquid real estate investments.

Leverage. Using leverage (i.e., borrowing money to make an investment) is generally much more common for real estate investments than other investment types. With the proper use of leverage an investor can significantly boost their investment returns, but only if your total cost of borrowing is low.

Furthermore, in the context of a self-directed IRA, using leverage to purchase real estate can trigger certain unrelated business taxable income (“UBTI”) liabilities for the IRA. If the UBTI rules are not fully understood, an investor who uses leverage to purchase real estate in a self-directed IRA can find themselves in a very bad financial position trying to come up with the funds to pay those taxes.

Expenses and Taxes. Real estate investments generally involve a much higher level of ongoing expenses. Whereas investments such as stocks and mutual funds may not cost you anything beyond your brokerage commissions to buy and sell, owning real estate comes with property tax liabilities, maintenance and upkeep fees, as well as possibly even management fees. These expenses are generally tax deductible against any income you receive on the property, but the value of this deduction will generally be lost within a self-directed IRA. When trying to compare real estate with other investments, be sure to fully consider all associated expenses.

Regardless of the size of your self-directed IRA, there’s a good chance that real estate can help you meet your retirement goals. Understanding how to compare real estate investments with other investment types is the first step in making the right financial decisions.