Lessons from the Pros

Real Estate

Real Estate – It’s all about the MONEY

One of the biggest objections I hear from people about becoming a real estate investor is, “I don’t know where to get the money.” It’s easy for us as seasoned investors to say, “Don’t worry, if you have a good deal the money will come,” because we’ve experienced it, which has given us confidence. Our goal is to provide you with the tools and knowledge so your confidence can grow quickly as an investor as well. There are many resources for finding money, and one of the greatest resources we’ve found for OPM (Other People’s Money), is Self-Directed IRAs. In this article, we are going to look at some basic guidelines for lending money out of a SD IRA. This will be relevant whether you are the borrower or the lender. First of all, money in a SD IRA can be loaned out to any person who is not a “disqualified person.” A disqualified person is defined as: Individuals or entities between whom or which an IRA is prohibited (absent a special exception) from engaging in any direct or indirect sale or exchange or leasing of any property; lending of money or other extension of credit; furnishing goods, services or facilities; or transferring to or permitting the use of IRA income or assets.

  • Fiduciaries (which in the case of a self-directed IRA includes you, as the IRA owner);
  • The following family members of the IRA owner:
    • Spouse
    • Parents
    • Grandparents and Great-Grandparents
    • Children (and their spouses)
    • Grandchildren and Great-Grandchildren (and their spouses)

[NOTE: The term “disqualified person” under the Internal Revenue Code does not include siblings (brothers and sisters) or aunts, uncles and cousins of the IRA owner.] definition provided by Equity Trust Company. A loan made out of a SD IRA can be unsecured, but most often is secured by assets such as real estate, equipment, stock portfolio or anything of value.

Free WorkshopFrom a borrower’s perspective it’s like creating your own “private bank.” How do you find individuals willing to loan money out of their retirement? Let people know it is a possibility and then direct them to service providers that can setup an SD IRA and facilitate it.

Here are some guidelines:

  1. Loan only on property that would be a good investment for the IRA. You need to always have a “plan B.” If property is used as collateral for the loan and if the buyer defaults, the IRA could end up being the owner of the property.
  2. Make sure the borrower has some “skin” in the game. For example, don’t lend money for the purchase and the repairs. It’s best if the borrower escrows money for the repairs so you can make sure the repairs get completed.
  3. Don’t lend money to someone you would have a hard time foreclosing on.
  4. It goes without saying that everything should always be in writing with clear and defined late fees and default action steps.
  5. If a loan goes into default, make sure to take action immediately. Delaying the process can be very costly. The foreclosure process can always be stopped once it has begun, but by taking immediate action it demonstrates to the borrower that you will keep to the letter of the contract.
  6. The loan is best structured by having a payment due every month, even if it is an interest only payment. There are two main purposes for collecting monthly payments; one to make sure the borrower is moving forward on the project, and two because if there aren’t payments due on the loan, the loan can’t go into default and, therefore, foreclosure isn’t possible.
  7. It’s important to hire a professional to help with the process. In an IRA that is Self-Directed, the owner makes the final decisions; however, it doesn’t necessarily mean they possess the knowledge to properly evaluate the property, borrower and coordinate the process. A professional would investigate the borrower, coordinate with the title company, order the appraisal and make sure insurance is in place, as an example. These costs are usually passed on to the borrower as part of the up-front loan cost.
  8. Make sure a title insurance policy is part of the closing process.
  9. Make sure the hazard insurance for the property also names the IRA as additional insured.
  10. Always ask for a personal guarantee. Remember plan B. If the property decreases in value, then just foreclosing on the property might not be enough to satisfy the note.
  11. Ideally, a loan made from the IRA should always be in first position.

As the borrower, this can be an excellent way to finance your quick turn properties and have access to quick financing at a reasonable cost.

As the lender, this is an excellent way to invest your retirement money to achieve a high return with comparatively low risk. If you want to learn more about a Self-Directed IRA contact OTA Tax Services.

Diana Hill

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

Join over 170,000 Lessons from the Pros readers. Get new articles delivered to your inbox weekly.