Archive for January, 2009
Self-Directed IRA: Getting Private Investors To Co-Sign With You Part 4
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will you co-sign?
will you co-sign?
Getting Private Investors To Co-Sign With You
This is the last installment in a multi-part series on real estate investing with IRA’s.
- Click here to read Part 1: Introduction To IRA investing in real estate.
- Click here to read Part 2: Investing With Your Self-Directed IRA
- Click here to read Part 3: Finding a Custodian For Your Self-Directed IRA
Emily Cressey: Real Estate Investor and Investment Coach
This section is not so much about IRA investing as it is about one bonus technique for getting your deals funded. The nice thing about this technique is that it doesn’t require you to have credit, money or friends with money. What it does require is friends with good credit who are willing to share that credit with you.
I have heard a lot of promoters use the idea of a “credit partner” as an aid for real estate investors with bad credit. But the truth is, that you as an investor may have great credit and STILL want to use this technique. Why?
Why does it make sense to work with credit partners if you already have good credit?
- First, using your credit is a risk… some people may not want to take that risk.
- Second, a good credit score is only one factor when it comes to getting a loan. Especially now that the banks are cracking down and enforcing logical lending standards again, you may need other things like assets, income, low debt-to-income ratios, or real estate experience in order to qualify for your property loan.
- Third, many banks will “cut you off” after a certain point. Once you have a given number of loans in your name (5-10), they may not be willing to extend you any more credit.
- A fourth reason is that some investors may be “saving” their credit for bigger deals, or certain types of deals, and may prefer to work with credit partners for deals outside of their primary focus area.
I could go on and on, but you can see that there are a number of reasons that an investor may want to work with credit partners. It’s important you are clear on your motivations and can explain them clearly, as this is the first thing many potential credit partners will ask you. They’ll say, “If it’s so easy and low-risk, why don’t you just go get the loan yourself?” You’ve got to be prepared to answer them.
The correct answer, of course, involves explaining any of the items on the above bulleted list that apply to your situation.
Why private investors are especially important for COMMERCIAL real estate investors.
In some cases, with commercial real estate investments especially, you may find that banks will require multiple guarantors in order to approve your loan. I’ve been involved in deals with 3-5 guarantors required by the bank. It makes sense to have good people you can work with when these needs arise. If you’re involved in other smaller projects, like single family homes and the like, you may want to avoid having these on your credit record (by working with private investors, there too, so you can keep your credit clear and available when it comes time to apply to the bank for a loan on a bigger project that is a real home run.
What does a credit partner do?
A credit partner’s role is very simple – he or she signs on the dotted line when you are out getting a bank loan to buy a property. Usually they
will sign for a first mortgage for the entire amount of the loan – 80-90% of the value of the property. The bank uses their income and credit profile to help qualify you for the loan term and rates and they make the credit partner fully liable for the amount of the loan in the event of default. (Assuming the loan is personally guaranteed and you didn’t get no-recourse financing.) That means that if you buy a property, and can’t make the payments, the bank will pursue a foreclosure which will RUIN the credit score of your credit parnter. If the bank is unable to get full satisfaction of the amount owed from the resale of the foreclosed property, they can come after your credit partner with a judgement. If you’ve co-signed on the loan with your credit partner, these ramifications will apply to you, too.
So, the downside is pretty dire if the property has little equity and the credit partner values his good credit. However, the good news is that the credit partner can get involved with none of his own cash, and – if you’re a good investor who can take care of the investment and not let it get behind on payments or foreclose – the credit partner has the opportunity to make money on the deal without putting in a dime of his own. That means an “infinite” rate of return, for relatively little work on his part.
The key to bringing credit partners on board is having a deal that they can feel secure in. That means, they trust you to manage the property, and there is some equity in the property going into it, so if things do go south and the property must be sold quickly, there is enough collateral there to pay off the loan in full. You can further protect your partner, if he is somewhat real estate savvy, by writing up documents that indicate the IF you allow the property to get behind on payments, the title will revert entirely to your partner (with no rights left to you) and he will have the control of managing it, repairing it, selling it, etc. as he deems fit in order to protect himself and his investment.
How to pay your real estate credit partner?
So… how does it make sense to reimburse a credit partner? This is a tough question to answer in the abstract. I would say the MOST generous
situation (don’t excede this…) is to split the profits in the deal 50/50. On the low end of the spectrum would be just a flat fee of some sort ($1,000 one-time fee) for getting them to go to closing and sign on the loan for you. Most investors that I know set up some sort of profit sharing situation with their partners, but the truth of the matter is that it’s whatever you can negotiate. If find that on your first few deals, it’s better to be VERY generous with your credit partners to get them on board and excited about putting the deal together. If you’re early in your investment career, they probably see this as a somewhat risky operation, and it may take some significant time for them to do their due diligence and get all the paperwork handled once they’ve decided to go ahead with the deal.
Once you’ve got a few successful deals under your belt, fund raising will become much easier and private investors and credit partners will be willing to work with you – generally with less due diligence involved and a lower profit expectation on their part. In general, though, don’t be greedy, make it worth while for everyone you work with to do business with you. And treat their money and credit with the same or better respect as you would your own, if you were signing on the loan.
Parting Thoughts On Using Credit Partners In Your Real Estate Investments
Although working with credit partners can be very easy and inexpensive for all parties involved, remember that you are still making an investment and taking on some risk. Be sure you hold the deal to a high standard of profitability and do everything you can to minimize risk. Having solid parameters for your deals will help you ensure that you don’t get tempted to “cheat” and put together a marginal deal just because it’s easy to do. Remember, real estate investing is all about being able to survive in the long term through downturns in the market. Keep your focus on 5-10 years in the future, not 5-10 months. Remember your reputation, and always do your best to protect the people that you’re working with.
Where do you start with your self-directed IRA?
This is Part 3 of a Multi-Part Series on Investing with Self-Directed retirement accounts.
In order to be able to participate in the type of “creative” investments mentioned in the last article – things like mortgages, real estate, businesses, etc. – with your tax-sheltered retirement funds (Roth and Traditional IRA’s), you’ll need to have a custodian for your account that allows you to truly self-direct your funds into the many different types of investment articles allowed under the law.
A good self-directed IRA custodian will help guide you through the thorny process of designating your investments, ensuring your investment partners comply with applicable reporting standards, and making sure your IRA funds maintain their tax-protected status by complying with applicable law. Look for great service and a track record to rely upon. After that look for reasonable fees.
Here are a few custodians we’ve worked with, that you may want to consider:
1) Pensco Trust (http://www.PenscoTrust.com) – This company has a more complicated fee schedule. There is a $50 set up charge, plus an annual maintenance fee of $350 for accounts valued at $1 – $69,000. After that, there is a sliding scale that reflects both a fixed fee, plus a percentage of your portfolio’s value. Click here for the fee schedule: http://www.penscotrust.com/fees/ira_fees.asp
2) Equity Trust Company (http://www.TrustETC.com) – Formerly known as Mid-Ohio Securities. This company charges a $50 set up fee and account maintenance fees based on the assets under management, starting at $190/year for the smallest accounts (you can begin with just $1.00) and ranging up to $440/year for $200,000 under management. The fees cap out at $1,850/year for a million or more. These fees are all-inclusive and the company avoids nickle-and-diming you with transaction-related fees.
3) First Trust Company of Onaga (http://www.ftconaga.com) – I was not able to find a published fee schedule on their website. They do charge fees for each activity you request of them, but whether or not this is cost effective will depend on their fee schedule, your portfolio size, and your anticipated activity level. I suggest you call the company to find out more about their rates.
These are three good companies that investors we know have worked with. Any of them would be able to help you invest your retirement funds in a non-traditional investment vehicle, as long as the investment type was allowed by the US government and the investment followed the rules about being an arms-length transaction. Check out these vendors and decide which one is right for you. Call them up and get the forms you’ll need to switch over your funds.
In the next article, I will will explain how to find OTHER people with funds in their IRA’s who will be your private investors when you have a deal come through. Educating them about how to get control over their funds so they can invest in your deals is a great next step! Stay tuned for more information on investing your IRA in real estate!
Until next time….Emily
Investing with YOUR Self-Directed Individual Retirement Account (IRA) Part 2
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self-directed IRAs
Individual Retirement Accounts, IRA’s, are usually started one of two ways – either by rolling over a 401(k) account from a former employer or by going to your local stock broker/mutual fund specialist/bank or other financial institution, and opening the account with a small deposit – often the minimum allowed, and then feeding it over the years, buying new shares or adding a bit from your salary each month, but never exceding the legal maximum contribution limit – $5,000 a year in 2008 and now indexed to inflation for 2009 and beyond.
Needless to say, your method of entering the IRA arena can make a big difference in the 
amount of money you actually have in your IRA that is available to invest. If you have a 401(k) at work, you can sock away up to $15,500 of your own money each year, plus whatever amount your employer wants to match on top of that. This means you can accumulate assets inside your retirement plan more than three times faster through your 401(k). The downside of 401(k) investments, is that you are very limited in your investment choices – you can only invest in the options that your employer and benefits coordinator makes available to you.
If you want to use your savings to invest in real estate, putting them into a 401(k) won’t pay off until you leave your job and are able to roll that 401(k) over to an IRA. So, if you plan to stay gainfully employed with your current employer long term AND you want to invest in real estate, I would consider first funding your 401(k) to max out any employer matching offered, then max-out your ROTH IRA. You can use your IRA funds to invest in real estate if you have a self-directed custodian, which we’ll get to in a minute.
If you have funds available beyond that, you can do what I do, save them up in a non-retirement account (just cash in the bank) and put them into deals you’d like to buy yourself. (One of the big hang-ups, which we’ll also see, with investing your IRA in real estate deals is that there are extra taxes to pay if you get a loan, and you’re not supposed to buy deals from youself (self-dealing).
So, if you have an IRA (either traditional or ROTH) set up, let’s take a look at it… it either has a big amount of money, or a small amount of money in it.
Depending on how involved you are in real estate investing, and how much access you have to different high-quality deals that are being put together, you may or may not want to use a small IRA to invest in real estate. For example, if you do a lot of no-money down deals where you buy houses for a dollar subject to the existing financing and that type of thing, then yes – you could pretty easily get some of those deals into your IRA even if it was small. But watch out – you or your family members can not be the property managers for that property – you’ll have to hire an independent outide firm, which can be costly for smaller properties.
Emily Cressey
If you’re just starting your IRA now, and say you have $5,000 – $25,000 in your IRA, that might not be enough to bother with trying to get into a commercial real estate investment with. For a high-quality commercial property, you’re going to have to put 20% down in most cases in today’s real estate environment, and that can be quite a sum. Additionally, if there is a mortgage on the property your IRA buys, the IRA will have to pay taxes on a portion of the property’s rental income at your ordinary income tax rate (ouch). This is called Unrelated Business Income Tax (UBIT) and it applies unless you use funds from your IRA to purchase the entire property free-and-clear.
You can find a lot of good high yield real estate investments for your self-directed IRA, but you just have to make sure you know the rules and follow them as they are very strict – penalties can include the failure (and taxation) of your entire IRA balance.
Here are some things you can invest in with your IRA:
1) Mortgages
2) Buy a property free and clear
3) Buy a property with a mortgage and pay UBIT
4) Buy a share of a company that is acquiring a piece of real estate.
When my partners in Grassland Investments and I first started putting together deals with private investor’s money, a number of them wanted to participate in our deals using funds from their self-directed IRA. That meant, we got to find out a lot about how that works. It was actually very clean for the type of deals we have done. We bascially created a new company, an LLC, that was acquiring a property using a mortgage. Our investor clients bought shares of this company for $25,000 each. They are then entitled to distributions that the company makes, just like if they owned stock in the company. This has worked well for our investors.
The key to investing with your self-directed IRA is to follow all the rules and avoid prohibited transactions and activities.
You will need an advisor to lead you through all the steps because they can be pretty dicey, and a mis-step is expensive!
If you are considering investing through your IRA, consider these steps:
1) Get Money Into IRA. Feed your IRA so it is big enough to have it be “worth while” to do self-directed investments. You don’t want to pay http://www.trustetc.com/company/fees.html to your custodian and park your money in a low-yeild savings account while you wait for a big deal to come along. Especially if your IRA is so small, you likely won’t have enough in your account to participate in a big deal for a while yet. When my Roth IRA was young, I started it with Vanguard.com because they had very low fees and I was able to invest in mutual funds and money market funds while I built up the account value.
2) Find an Investment. Once you have an IRA that is big enough to invest with, start looking into what type of investments you’d like to make. If you want to stay with stocks and bonds, most any IRA custodian will do. If you want to invest in something more unusual, like a privately held company, or real estate – as is the focus of this article – then you’ll need a self-directed custodian, finding one will be the focus of the next article. When you identify the deal type you’d like to do, you’ll know how much money you need to invest. Are you looking at buying $25,000 shares in a LLC that’s making an investment? Are you buying a house for $200,000 that’s free and clear? Are you giving a rehabber a hard money loan of $50,000?
3) Place the Funds with a Custodian. When you are ready to invest, and I would say not TOO long before that because the annual fees can be pretty steep, go ahead and transfer your funds over to your chosen custodian. It takes about 30 days for them to get you set up, so make sure the types of deals you’re looking at have that time frame available for the funding, otherwise, you’ll have to put your funds in earlier.
If you want to use your IRA for investing in real estate, it can be done, you just have to figure out how. Hooking up with a good self-directed IRA custodian who specializes in facilitating investing in real estate will really help you make sure you are covering your bases.
Like many things in real estate investing, there’s a lot of detail here that it doesn’t necessarily make sense for you to master yourself. Understand the basics, and hire a professional to help you with the specfics. You need to work on just two things. First – getting enough money into your IRA so that you can do the type of deals you want, and second – finding good, qualifying deals that will justify the use of your IRA funds.
Crank the numbers and look at the fees to find out how much you’ll earn on the investment, how much you’ll pay the custodian, and how that compares to your other investment alternatives. The other thing to take a look at is how long it will take you to find a deal.
If your money is going to be out of the market for 6+ months while you look for a deal, there is opportunity cost there. You could be earning an average of 11% on that money in the stock market or 7% on that money in bonds, so depending on your deal flow and investment savvy, bear that in mind too.
It is for these reasons that I don’t recommend starting to invest in real estate with your IRA utnil you have about $25,000 in your IRA account unless you are a real “player.” investing in real estate full time, well connected with other investors, and confident in your risk and returns on deals.
Any questions? Let me know here…
Also, stay tuned for the next post on finding a great self-directed IRA custodian who will help facilitate your non-traditional IRA investments.
More Self-Directed IRA Investing News and Articles:
- Mosca: How long does it take to have that money available to put into real estate? Madsen: The longest period of time is going to be to take your money where it’s at and to get it into a self-directed account. … - 401(k)s and Retirement Planning · Audios for Real Estate Investors · Blog · Books on Real Estate Investing and Money · Buying Houses Creatively · Financing All · Financing Commercial · Financing Houses · IRAs · IRAs and Self Directed … - In a Self-Directed IRA program the investor conducts their own research and chooses where to invest. There are numerous alternative investments available such as real estate deals, trust deeds or mortgages which can and should be part … - If you’ve got a self directed Roth IRA right now you should be able to invest in real estate now, but check with your financial advisor first. So, back to Roth IRA investments in real estate in 2008. Why would you? … - Oh by the way, this same self directed IRA and process can be used for single family property, commercial property, mortgages, hard money loans, private money, etc. So get that account working a little smarter for you! Posted by Real … |
Until next time…..Emily
Tags: IRA, self-directed IRA, individual retirement account, 401k, 401(k), real estate investing, commercial real estate investing, investing your IRA in real estate, IRA real estate investing, high yeild investments, IRA custodian