Buy Foreclosures With Your IRA
CNBC Real Estate Reporter
While home prices still haven't hit bottom nationally, demand is starting to grow, especially for distressed properties on the low end of the market.
Large scale investors, like hedge funds and other private equity firms are rushing in with cash on hand, and that gives them the upper hand in competition for these properties.
So how does an individual investor, without extra cash lying around, get in? Retirement funds.
It may sound risky, but with strong rental demand and relatively little supply of single-family homes, it could be far less risky than the stock market. That's because your gains are largely coming from rental income, not home appreciation, which is why this works so well in today's market.
"Here in Reno, prices are half of what they were at the top of the bubble, so, yeah, it might go down a little bit more but I don’t think it will go to zero, like some of my stocks have gone to zero," says Terry Vander Ploeg, who invested $105,000 in a Reno foreclosure.
The catch is that you have to do it through what's known as a self-directed IRA. Not a lot of firms do this, but some do: Guidant Financial, Sterling Trust, IRA Resources and PENSCO are a few. The firms act as custodian of your self-directed IRA, holding the property and dealing with all associated expenses.
"It's really an account that provides greater flexibility than what a third party administered 401K, for example, would provide," says Kelly Rodriques, CEO of PENSCO, which has doubled its assets in the past four years. "That's in part because real estate has become a pretty well priced or at least valued investment area, given the downturns," according to Rodriques.
Rich Pregel had money in a 401K from a previous employer and experience in the real estate business. Late last year he decided to put his money to work in real estate. The 48 year old Cincinnati resident bought a commercial foreclosure in his home town to rent.
“I’m generating close to $80,000 on $140,000 investment after expenses, it’s pretty much a no brainer,” says Pregel, who used a self-directed IRA.
This type of IRA does carry restrictions. The property must be used purely as an investment, with all the income going directly back into the IRA. The owner may not occupy the home or even use it as a vacation property. The owner can manage the property, doing maintenance and supervising the renting, or can hire a rental management company which would be paid for out of the IRA.
It is also possible to get a mortgage through the IRA, but it has to be what's called a non-recourse loan.
"It’s a loan that can only seek the property, the collateral, as its sole recovery, if the property goes into default, so you as an individual can’t sign up to guarantee the loan," says Rodriques. The IRA is not just purchasing the property, but it is responsible for liabilities and payments.
All this may sound complicated, but some say it's worth the extra time and energy. With a rising number of foreclosed properties coming to the market this spring, and banks far more willing to do short sales on troubled loans, opportunities are everywhere.
"Right now, we bought it for a good price, put some money into it to get it up to rentable specs, and now we’ll see," says Vander Ploeg. "We have a renter in, and we’ll see how it goes. You’ve got to have the right renters."