Investing in rental property with a self-directed IRA or Solo 401(k) is a fantastic way to diversify your tax-sheltered retirement savings. As an asset class with a performance profile not generally linked to financial market cycles, real estate can help you grow and protect your wealth.
With income property, your retirement plan can hold a solid asset with stable value that produces consistent and predictable income through cash flow. Real estate also has the potential for appreciation over time.
In order to maximize the performance of your IRA’s rental property investment while minimizing your risk exposure, it’s valuable to treat the activity like a business.
Whether your goal is to diversify with a single property or to acquire a portfolio of properties to replace your income once you retire, having certain structures and milestones in place to chart your progress can enhance the endeavor.
The plan you create will vary based on your goal. Below are some of topics to consider as you formulate the plan best suited to your needs.
Investing in your own local market may or may not provide the best income property opportunities, especially if you live in a high-priced big city. Sometimes looking at a different neighborhood in your own city or even another state can make more sense.
Think about whether your goal is to purchase fewer higher-cost properties in more desirable neighborhoods, or a larger number of lower-cost properties to create better diversification. Will cash flow or appreciation potential be more of a focus for your strategy?
In terms of market analysis, it’s important to think about how you’ll evaluate the short- and long-term prospects for any market where you choose to invest.
You may be able to fill some of those roles yourself, but likely not all. If you choose to invest at a distance, you’ll rely more on service providers than you might need to when investing in your local market.
For purposes of a real estate investment plan, identifying the resources you’ll need, where to find team members, and how you’ll measure their performance over time are all important considerations.
Thinking about what types of property you’ll invest in and how to acquire those properties will have a big impact on how the rest of your business plan develops.
If your IRA will be purchasing distressed properties at auction, you’ll need to be prepared in advance with your checkbook IRA LLC or Solo 401(k) and have familiarity with the auction process. You will also need a team of contractors to get that property into rentable condition.
If, on the other hand, your plan is to work with a realtor or turnkey provider, the process of purchasing a property will be slower and you’ll have more time to formulate a ready-to-rent plan for any necessary repairs or upgrades. There may not even be a necessity for significant work to be done on the property.
Your IRA or 401(k) can purchase properties in an all cash transaction or choose to use mortgage financing. If you’re considering using mortgage financing, it will be beneficial to speak with non-recourse lenders in advance to understand what’s possible in terms of loan-to-value thresholds and type of property.
Conventional non-recourse lenders are not generally going to write loans on properties that need significant amounts of rehab work. In those situations, you may need to purchase the property with cash in the IRA, and then refinance with a lender once the property has been placed in service and is generating rental income.
You can also use private or hard money lenders to acquire and rehab properties, then refinance into a lower rate long-term loan from a more conventional non-recourse lender.
A critical part of any income property plan is the initial process of getting your newly-purchased property rent-ready and able to be marketed to potential tenants. The more efficient you can be in this phase, the faster your IRA will start receiving income in the form of monthly rents.
Right after your retirement plan purchases a property isn’t the best time to begin this type of planning. You want to be able to hit the ground running.
If you’re purchasing a property via normal realtor channels, you’ll likely have about 30 days or so from initial contract to closing. Use that time to think about any work that will be necessary to make the property safe and appealing.
You’ll also want to line up in advance any necessary contractors you’ll need to hire to make repairs or upgrades and have a plan for which types of services will need to be done in which order. Painting before installing carpet is generally a better order of things, as an example.
Will you self-manage or hire a property manager to run the property? There are advantages and disadvantages to both approaches. Knowing in advance which approach will work best for you is important.
If you choose to hire a property manager, arranging these services prior to acquiring a property will greatly improve the process and minimize your purchase to rent-ready timeframe.
If you’ll self-manage, you’ll need to consider a sub-plan of your business plan to address the various policies and procedures you’ll want to have in place to effectively perform this role in compliance with both IRS rules and local tenant-landlord laws.
Any business plan needs to consider the things that can go wrong and try to have processes in place to address the most likely points of failure. Making sure your IRA has quality landlord insurance is something to be sure to think about in advance.
You also need to think about having some cash reserves in place within the IRA or 401(k) in case it takes longer to get a property rented or if an extended vacancy or unexpected repair comes up in the future. The amount of reserves will be less for an all cash purpose than for a mortgaged property, as the mortgage payment needs to be factored into the latter case.
Another possible hiccup in a successful rental plan is the need to evict a tenant. Knowing what this process looks like and having an attorney you can rely on to execute the process can keep you from being caught “flat-footed” if the need arises.
Saving for retirement is typically a long game. If you’re looking to use income from rental properties in your IRA to support yourself in your golden years, you’ll want to work towards creating a portfolio that will produce sufficient income.
Using leverage allows you to acquire more properties more quickly, but reduces your amount of cash flow. Purchasing properties all cash will mean fewer properties, but potentially higher monthly income.
A strategy that relies on leverage in the early stages, but accelerated mortgage payoffs prior to the need to start drawing income can work well.
Some investors start with one or a few single-family rentals, and then upgrade to apartments or commercial properties once they accumulate the necessary account value to do so.
Each scenario is different based on the amount of capital available and time to retirement. Thinking proactively about how many properties will be acquired, whether leverage will be used or not, and how the income from properties will be used — to invest elsewhere, take as distributions, or use to acquire more properties — can be a good way to ensure you maximize your changes of achieving your goals.
With any rental property, there are several possible exit strategies.
Some investors want to hold properties for the long term and rely on the monthly cash flow. In other cases, there may be a certain level of appreciation in property value, where it makes sense to sell and lock in a capital gain that can then be used to acquire more or large properties.
Another approach is to acquire a newly updated property to hold as a rental, then sell just ahead of the next major repair cycle for core systems like roofing or HVAC and thereby avoid large capital expenses.
Another popular option is to hold income-producing rentals well into retirement, and then start selling of the properties but holding back a note as one ages. This allows you to keep a solid asset that produces consistent cash flow, while also creating a quick liquidity burst in the form of the down payment from the purchaser.
Getting out of being a landlord in exchange for being a lender can also appeal to some folks as they move up in years.
Thinking in advance about what type of strategy will be best suited to your needs will help you formulate the best plan. It’s kind of like reading the last chapter of a book first to see if it goes somewhere good.