Real Estate Broker’s Guide For Retirement Planning (Part 3 of 3)
The two most common ways to use SDIRAs in real estate are:
(1) Purchase an investment property (2) Fund a real estate loan
Purchase of an investment property:
A real estate agent listed an REO fourplex that was in pretty bad condition. The owner prior to the lender getting it back from the foreclosure proceedings drained the property, did no repairs or maintenance, just collected the rents from the tenants as long as he could. Eventually two of the tenants moved out because of the poor conditions and the other two quit paying rent because they learned the owner was going to lose the property to foreclosure. They called the owner’s bluff and quit paying and the owner disappeared from sight. About 12 months after the notice of default was filed the lender now owned the property and listed it with a local real estate agent. The agent upon listing the property gave the two remaining tenants “cash for keys” and both tenants packed up and vacated their units. The property was now 100% vacant.
A Buyer’s agent had the perfect buyer for it. He had been working with John for a couple of years. John was self-employed owner of a computer company. John couldn’t fix anything but his childhood friend was a general contractor and was able to do all the needed work on John’s previously acquired properties. John did have experience owning rental properties, all of which were bought in similar condition to the fourplex. Over the years John had taken advantage of the opportunity to set up an IRA and always contributed the maximum to it. John was not aware that he could use his IRA to invest in real estate, something he understood and loved being involved in. John had been very fortunate with his IRA investments by investing in mutual funds that had performed real well. When his knowledgeable real estate agent shared with him that he could set up a Self Directed IRA and invest in real estate, he knew this was the perfect situation for him. He contacted one of the Custodians from the list I provided and completed the paperwork that enabled the new Custodian to have his existing IRA rolled over into a SDIRA. His timing was perfect, two months later the stock market did its meltdown. John had $177,000.00 now sitting in his SDIRA in which to invest in real estate.
John and his agent were very selective; they didn’t jump at any deal. They waited over a year until the right deal came along. A deal that John could use his skills to maximize his return on investment.
The property was listed for $275,000. John and his agent knew that this fourplex had sold for $200,000 more than the list price three years earlier. John’s agent presented an offer for full price the first day it hit the market. John had already been preapproved for a 55% loan to value non- recourse loan with the bank that he had been doing business with for years. Within a SDIRA the loan has to be non-recourse so don’t expect any loan to be more than 65-70% loan to value. Don’t forget that the law requires the property to be the only collateral. There can be no personal guarantee which allows the lender to come after the SDIRA holder in event of foreclosure.
John had estimated the rehab of the property would be at least $15,000 with a worst case cost of $20,000. In his proposal he used the worst case figure knowing that with a $125,000 down payment and $5,000 closing costs he would still have $27,000 left in his SDIRA. The remaining funds could be used for holding costs as he was rehabbing the property and screening for good tenants. John’s contractor friend estimated that he would have the property in A+ condition within a month.
Within three months John with the help of his real estate agent had four quality tenants each renting a unit at $850/month. John is now receiving in excess of $1,200 per month that is going into his SDIRA.
Monthly Operating Statement:
$3,400.00-Monthly rents of $850.00 X 4 units
-$200.00-6% allowance for vacancy
-$1,000.00-30% operating expenses. John’s agent does management
-$900.00–$150,000 non-recourse loan for 30 years at 6% interest
Bottom-line is $1,200.00+ per month is going into John’s SDIRA. Each month the management company sends the Custodian a check, John never handles any of the funds. John’s SDIRA is only earning 8% per year, but John has already turned down two offers in excess of $370,000 to sell his A+ fourplex which is one of the most desired properties in town.
What excites John the most is that if he decides to sell the property he doesn’t have to do a 1031 Exchange to defer taxes. The sale proceeds will go directly into his SDIRA and will be deferred until he starts withdrawing funds after he turns 59 1/2.
John’s real estate agent has shared John’s success story with a couple of his existing clients as well as three solid referrals who would like to form a business group with John for future projects. Some of the investment funds will be from SDIRAs and some will not be. Properly set up this is allowable. They have a couple exciting possibilities that they are making offers on.
Fund a real estate loan:
This is my favorite area of SDIRAs. I started arranging private investor loans in 1997 and was given the opportunity to see the power of controlling your retirement through SDIRAs. As I started meeting private individual investors and I brought potential loans to them I was amazed that many of them had millions of dollars to fund real estate loans. Often when it came time to vest the loans (the beneficiary name on the loan) it was vested in part or in whole in a SDIRA.
Over the years as I developed my investor relationships I enjoyed the investor’s stories of their financial successes. Many of the investors started having their SDIRA invest in real estate loans back in the 1970’s. When they originally started they were usually buying seller carry back notes at a discount. Eventually that changed to broker arranged real estate loans as the laws changed in the early 1980’s. Broker arranged loans created an opportunity to be in compliance with usury laws. Of course they still bought discounted carry back notes as the opportunities appeared. The broker arranged loans were the type of loans that I was presenting to them. They typically were a loan that for various reasons needed to be funded by a private money source. Loans where:
(1) Borrower had lots of equity and needed quick loan (2) Borrower was in foreclosure (3) Borrower has an unusual type property (4) Borrower had poor credit (5) Borrower needed funds for tenant improvements to lease out the property
The list was endless with reasons borrowers needed a private investor funded loan. It was very challenging and exciting to arrange these loans. The guidelines on the loans were often unique to the particular situation, but the loan to value very seldom changed:
Single family owner occupied 70% Maximum loan to value
Single family non owner occupied 65% Maximum loan to value
Commercial 60% Maximum loan to value
Industrial 55% Maximum loan to value
Land 35% Maximum loan to value
Of course certain situations dictated higher or lower loan to values. As an example a residence in Newport Beach, CA would definitely generate a higher comfort level and higher loan to value than a house in a less desirable part of South Central Los Angeles. Every loan would have its own pluses and minuses which would factor into the rate/terms and loan amounts.
The recent passing of the SAFE Act in 2008 has had the effect of inspiring many new laws on both the state and federal level that have a great impact on single family loans.That is why it so important to do business with professionals. Work with people who know the laws, are members of the proper industry professional groups such as California Mortgage Association in California, have experience and a proven track record. The last thing in the world you need is a real estate loan that violates the law.
Recently my company had a loan request for a warehouse building brought to us. The building was free and clear in a nice industrial section of Southern California. The owners of the building had recently inherited it and were not in need of a large amount of cash, which in this case the buyer/borrower didn’t have. The owner was willing to carry back a 2nd trust deed if the buyer/borrower could arrange a loan. The buyer/borrower had very poor credit due to the rapid expansion of his business and the constant need for cash that he wasn’t paying back on time. The buyer/borrower had been turned down by every lending institution in town. Frustrated because the building would be perfect for his expanding business and with the possibility that the seller would be willing to help with the financing this was an opportunity that he couldn’t lose.
The sales price was $1,700,000 which appeared to be a very fair price, but as always we ordered an appraisal from an appraiser who specialized in this type of property. There is too much at stake to guess on the value of a property. The potential liability in event of something going wrong with the loan later on because of an “inflated value” presented to us by either the borrower or mortgage broker is a very high price to pay. We also required an environmental report due to the type of property. Don’t skip any steps, do your due diligence.
The appraisal did come in at the $1,700,000 sale price. We agreed to make a loan for $1,000,000, which was about 60% loan to value. My investors were happy to get 10.25% monthly interest only payments for five years with a two year prepayment penalty. My investors were very secure with a 1st trust deed on a nice warehouse in a fairly decent area of Southern California.
The buyer/borrower was very happy because he was able to acquire a great property for his growing business without expending valuable cash reserves. He was well aware with his poor credit and the need to get a stronger financial statement it was going to be at least two years before he was going to a bank loan.
The seller of the property was also very pleased because they received a million dollars and a monthly payment check from the $700,000 second trust deed that they carried back from buyer. 100% financing didn’t provide the needed protection for the seller of the property. They also got a personal guarantee from buyer as well as cross collateral on another property owned by the buyer.
Privately funded real estate loans are an important part of real estate financing, especially in today’s tight real estate finance market. Through your SDIRA you can participate in them.
I can hear you thinking, “I don’t have that kind of money to fund loans”. I don’t either, yet my investors and I would do these loans. You are allowed to pool your SDIRA (or other investment funds) with other investors to make loans. Often this is accomplished with a loan pool or with a private money lender that is skilled at grouping investors together. The group of investors would take title to the loan as “tenants in common” and have an undivided interest per their percentage of the loan. It wasn’t uncommon to have six to eight investors on one loan.
By the use of grouping investors together to fund a loan I received a statement today for my share of a $150,000 loan that goes into my SDIRA. I did this loan with two other investors six years ago. The loan amount of $150,000 is secured by a $650,000 lovely single family vacation home(non owner occupied) in a great part of Southern California. The loan pays 12% interest and the monthly payment from the borrower always arrives on time. 12% sure beats the wild swings of the stock market lately. You that are familiar with the Rule of 72 know that 12% will double your investment in six years.
Take this opportunity to use your real estate skills or the skills of a real estate professional to take control of your future. Use SDIRAs to create an abundant retirement for you and your family.