Self Directed Retirement Plan: Real Estate Investing Guide (Part 2)
“A wealthy person is simply someone who has learned how to make money when they’re not working.” ~Robert Kiyosaki, Rich Dad Poor Dad
The key to retiring rich is to ensure that your investment portfolio has enough passive income generating tools. In the first part of Real Estate Investing with Self Directed Retirement Plan, we discussed different investment options available in the physical real estate industry, including single-family homes, multifamily homes, commercial real estate, and mobile units. However, maintaining a physical property isn’t a viable option for an average self-employed professional or small business owner. In this part, we are going to discuss some alternate real estate investing options that offer the benefits of real estate investments, while keeping the maintenance requirements to the lowest levels.
Self Directed Retirement Plan Investing: Alternative Real Estate Investments
- Mortgage Notes
- Tax Liens
- Real Estate Investment Trusts (REITs)
Mortgage Notes
There are several ways to access real estate with tax-advantaged Solo 401k accounts, starting with mortgage notes. Mortgage notes are promissory notes backed by mortgage loans, promising repayment of the principal amount along with a specified interest rate within a given period. You can buy mortgage notes with your Self Directed Retirement Plan, although make sure that the payments are going back to the retirement account only. There are multiple options for investing in mortgage loans, including:
- Direct mortgage lending- Some agencies act as mediators between homebuyers and investors, allowing investors to lend money directly to the borrowers. You need to consider the market value of the property and the credit strength of the borrower before making an investment.
- Mortgage-backed securities (MBS) – Mortgage-backed securities are similar to bonds, except for the fact that they are secured by mortgage pools managed by institutions such as Fannie Mae or Freddie Mac. Unlike direct mortgage lending, your responsibilities and risks are minimum in MBS.
- Purchasing existing notes– Instead of directly lending the mortgage, you can purchase existing notes from the second mortgage market. These notes already have a repayment history, allowing you to analyze the payment pattern of the buyer, and you can purchase them through a local broker. You can find secondary mortgage notes with huge discounts, maximizing your overall returns on the investment.
There is no doubt about the scarcity of good performing notes, especially with a large number of mortgaged residential properties still underwater. According to RealtyTrac, more than 7 million U.S. residential properties were seriously underwater at the end of 2014, representing 13% of all the mortgaged properties in the country. With the stabilizing real estate environment, it is likely that the value of these properties will appreciate, bringing them close to their market value.
In addition to providing a regular income, mortgage notes come with multiple exit strategies, making them an exciting investment vehicle. If you plan to add some physical real estate in your Self Directed Retirement Plan or choose another investment tool in future, you can easily sell these mortgage notes in the secondary market. However, it is important to educate yourself about mortgage notes before your first purchase, and it might help to consult your Self Directed Retirement Plan provider about the purchase.
Tax Liens
Before getting started with tax liens as an investment option for your Self Directed Retirement Plan, you must know that this investment vehicle is suited for knowledgeable investors only and it is best to perform due diligence before purchasing tax liens. Tax liens are generated when a property owner is unable to pay taxes, and the local municipality enforces liens, giving the lien-owner the right to foreclose in case the amount is not paid. In the process, the authority receives due taxes, while allowing lien-owner to obtain them along with interest payment from the homeowner. You can purchase tax liens in municipality auctions and their average rate of interest may vary between 5% and 36%. The majority of the municipalities are auctioning tax liens online nowadays, and you can submit your bid from the comfort of your home.
If you wish to add tax liens in your Self Directed Retirement Plan portfolio, start your research with the average bids for similar liens followed by a complete background check of the property and its surroundings. It always pays to narrow down your research to the minutest detail possible, so that you may not end up overbidding for the lien. Always choose a Self Directed Retirement Plan that offers true 401k self directed investment feature, allowing you to focus on the research instead of custodial approvals.
Real Estate Investment Trusts (REITs)
Real estate investment trusts (REITs) own a large number of commercial or residential properties for gainful purposes and their primary source of income include rental income and interest on mortgage repayments. According to the latest information, more than 210 REITs trade on NYSE and NASDAQ, which means you can invest in them by simply purchasing their shares. Unlike other stock investments, REITs have a stable track record, although they are likely to react to major stock market events. According to the current federal rules, REITs need to distribute at least 90% of their income to their shareholders through dividends, hence, offering a stable income source to the investors. The IRS allows investing in REITs through Self Directed Retirement Plans such as the Solo 401k. If you plan to invest in REIT through your retirement plan, structure the transaction properly, so that its returns go back to the retirement account only.
Next in Series: 401k Self Directed Plan: Real Estate Investing Guide (Part Three) Last in Series: 401k Self Directed Plan: Real Estate Investing Guide (Part One)