While traditional and Roth IRAs provide a great foundation for someone to save for retirement, they have their limitations. IRA Account holders have a limited range of investment options, such as stocks, bonds and mutual funds, and they have limited availability for changing these investments.
Self-directed IRAs (SDIRAs) allow an existing traditional or Roth IRA account holder to transfer their IRA funds into a new account that they manage. SDIRAs offer the same tax advantages as a traditional or Roth IRA, but with more investment options such as real estate, private equity, and precious metals. You would set up your SDIRA with an investment or trust company, and a custodian would handle your transactions, with you directing how your funds are invested.
Brandon Roth, Executive Vice President and Managing Director of Residential Lending at Cogent Bank, says “a self-directed IRA is like having your own investment fund and is great for people looking to diversify their investments while also gaining more control over their assets.”
“The main difference between a standard IRA is that in a self-directed IRA, you can control the investments, and you have more freedom in what you invest in,” Roth says.
Diversify Your Investments
Recent volatility in the stock market is an example of why many investors have elected to put some of their IRA in real estate. Someone could also further diversify their SDIRA by choosing properties in different areas. Roth notes that even when real estate has an unexpected downturn, such as during the 2008 financial crisis, the impact was felt differently in various parts of the country. Housing markets that saw record-breaking growth in the recent years were those that faced the steepest declines in the crisis. Even if a property doesn’t see as much appreciation in value as your other investments it could still generate rental income that provides a solid return to your SDIRA.
“The stock market is up a few hundred points and down a few hundred points and it’s like I don’t know what’s going on, whereas with real estate there’s more of a sense that I know I can rent this property and while I might not get as much appreciation in a specific market, I’ll get consistent returns on my money and the rent pays the mortgage down for me,” Roth says. “Each month, the rent comes into your SDIRA, and it’s being used to pay the mortgage and any other expenses, and, in the end, all the net proceeds in the SDIRA are then available to further invest.”
Maximizing Your Returns
An investor could also leverage their SDIRA funds and maximize their returns by using it as collateral to obtain a loan to invest in rental property, with the income flowing back to the SDIRA. Any profit from when the property is sold would benefit the SDIRA as well.
“Let’s say you want to buy a $300,000 house and you don’t want to use $300,000 of your SDIRA. That’s where we come in, your SDIRA could put $105,000 down, and we finance $195,000.” Roth says. “There are restrictions. It’s considered a business purpose, so you can’t use it for any personal use, such as letting your son or daughter live there. You can’t use it for a day or two for a vacation. It’s strictly for business purposes.”
Minimizing Risk
Another advantage is that under IRS rules, all SDIRA mortgages are non-recourse loans. If you defaulted on the loan, you would only lose the property that you used as collateral to secure the loan. The rest of your SDIRA funds would be protected. With a traditional mortgage, your personal assets could be at risk if you couldn’t keep up with the mortgage payments.
SDIRA Services
Cogent Bank provides SDIRA loans to purchase single-family homes, 2-4 units, townhomes and condominiums. There’s a maximum loan-to-value of 65%, a minimum loan amount of $100,000 and the self-directed IRA must have enough funds to cover the mortgage payments if the property is vacant. Both fixed and adjustable rates are available, with an interest-only option for 10 years. Cogent Bank offers non-recourse loans in all 50 states.
Roth says “real estate is attractive for many investors because it’s something they’re familiar with, and they want a tangible asset in a market they are comfortable in and with less volatility than they may find in the stock market. After all, if there’s a bear market on Wall Street that causes a significant draw down, some people might not be able to fully retire when they want.”
Your Real Estate Management Options
Many initial SDIRA real estate investors elect to have the custodian manage the flow of cash on their behalf while others also elect to hire a local property manager to oversee their property. Having an intermediary, such as a property manager, could help the owner avoid accidental violations of IRS rules, which could result in tax penalties. Something as simple as an account holder buying materials for their property and inadvertently paying for repairs with their personal credit card could be considered a violation.
Roth notes that another benefit of hiring a property manager is that it could result in fewer headaches for the owner and faster response times for their tenants. For example, if a property’s plumbing or air conditioning system needs repairs (requiring immediate attention), the account holder would have to ask the custodian to cut a check to cover the repairs. A property manager, on the other hand, would probably have a list of vendors who they rely on to handle such repairs and would pay directly with a reimbursement request being submitted to the custodian afterwards.
Another option more seasoned investors elect is to purchase real estate through a limited liability corporation (LLC) owned by the SDIRA. This offers an extra layer of protection for the investor and the IRA. Ownership through a LLC also gives the account holder more control over management of the property, for issuing and accepting payments on behalf of the LLC, limiting the number and frequency of transactions that have to go through the custodian.
“In essence, the custodian is the controller of the SDIRA funds. Just like with a standard IRA, you generally don’t have immediate access to funds. To get them, you have to request and often wait,” Roth says. “In a very similar way, you have to request the custodian to release funds and wait. In addition, to funds management, the custodian is the party who executes the purchase agreement, the note, the mortgage, and all the other closing documents, because they’re the actual controlling entity. With the LLC it’s different, because the SDIRA is the owner of the LLC, the account holder of the IRA is usually the manager, and therefore able to execute documents and checks immediately.”
Leveraging Your Investments
A typical SDIRA investor is someone who already has considerable retirement funds that they have transitioned into a self-directed IRA because they want more control over their investments. Many SDIRA account holders then choose to invest in real estate and leverage their existing funds to buy more properties with expectations of better returns.
“We’re really trying to help people grow their retirement funds in a way that provides diversification for their portfolios, through real estate investment. Instead of just using 100% cash and with our help they are able to leverage their retirement and invest more than they ordinarily could,” Roth says.
Similarly, if someone has already been investing in real estate in their SDIRA, and owns property without a mortgage, they could refinance and take cash out of the property to buy additional investment property. By leveraging a self-directed IRA, someone can build a larger real estate portfolio more quickly than using cash alone.
“If you do the math and say a person wants to buy a $300,000 home as an investment. They might use all their investment on one home, whereas if you leverage it, you could buy two or maybe even three homes with that same amount of money,” Roth says. “So, all of a sudden, you can turn one home into a budding portfolio of investment properties.”
Contact Us to Learn More about SDIRA Services at Cogent Bank
If you’re thinking of setting up a self-directed IRA, or have already done so, and would like to talk about a non-recourse loan, please contact us to learn more about how SDIRA lending works.
FDIC and Non-Deposit Product Disclaimer:
Cogent Bank, Member FDIC. Non-deposit products such as loans are not insured by the FDIC, not bank-guaranteed, and may lose value.
General Investment Disclaimer:
This material is for informational purposes only and is not intended as legal, tax, or investment advice. Please consult with your legal or tax advisor regarding your individual situation.
Credit Terms Disclaimer:
All loans subject to credit approval. Terms and conditions may vary based on borrower qualifications and market conditions.
