Private Lender Lending and renting are alternative approaches with intriguing similarities

/Private Lender Lending and renting are alternative approaches with intriguing similarities

Lending and renting are alternative approaches with intriguing similarities

By |2018-08-07T02:38:13+00:00January 31st, 2018|Business Strategy, Private Lender|0 Comments

As someone whose roots are firmly planted in the world of private lending, you may be ready to tackle the real estate market, even if you may not know it! The principles of asset management (and the income potential) can be very similar when comparing private lending and real estate.

For example, both investment strategies can be incorporated into your self-directed retirement plan. Doing so has helped motivated investors realize the earning potential of alternative assets, while garnering the tax-deferred or tax-free benefits of vehicles like IRAs, 401(k)s or health savings accounts (HSAs).

Comparing Strategies

There are certain distinctions between investments with personal funds and investments with retirement funds, and you may find these factors worth pondering, given the substantial tax advantages self-directed accounts offer.

When investing with a retirement plan, all income and expenses flow to and from the IRA itself and never to you personally. The account holder maintains arm’s length distance from the asset (which means no sweat equity in the case of real estate) and may not conduct certain IRA transactions with “disqualified persons.”

From the onset, all documentation is titled in the name of the IRA and never in the name of the IRA holder. This reflects the direct and legal ownership of the asset by the IRA itself, even though you, the account holder, would pull the strings. Self-directed retirement accounts give you the chance to review investments and pull the trigger on the one that’s right for you (and your IRA) as if you were allocating your personal money.

In the context of real estate, you as the account holder can identify the property (commercial, residential, etc.) and specific approach that suits your needs and begin putting them to work for your financial goals. By using a retirement plan, you can alleviate stress when the tax man calls and fatten your pockets in your golden years. “Pre-tax” contributions for retirement plans such as traditional IRAs or Simplified Employee Pension (SEP) IRAs (for the self-employed) allow plan holders to defer contributions from income for tax purposes. Distributions, or withdrawals, are taxed down the road, but only once the held assets have ideally generated huge profits over many years and the plan holder has possibly fallen to a lower income bracket. With “post-tax” contribution accounts like Roth IRAs, contributions must be included with annual income. Distributions, on the other hand, may be completely tax free after five years and once the plan holder reaches age 59 1/2.

Similarities

These attributes hold true for their respective retirement plans regardless of the assets they hold. As such, if you’re already well-versed in private lending, you’re also poised to expand your existing investment expertise into the world of real estate. Some real estate investments may involve unfamiliar practices (e.g., fix and flip, buy and hold, raw land development, etc.), but you may be surprised to find striking similarities between loans and rental properties. The relationship between a property owner and a renter mirrors that of a lender and a borrower in many notable ways.

Qualification // As a lender, you likely qualify your potential borrowers as a measure of satisfying your risk tolerance. Qualifying a potential renter can be a virtually identical process. You determine monthly rental dues and lease durations on behalf of your IRA in the same way you specify interest rates and loan terms. You may even solicit the same information and prerequisites, such as a credit check or first and last month’s rent (to serve as a down payment of sorts), before initiating the business relationship. Although you don’t secure a rental agreement with collateral the way you do with a loan, a security deposit—whose terms you can also decide on a case-by-case basis—can provide a hedge against tenants you deem risky but choose to work with.

Payment Collection // There’s no added drama in collecting rent payments versus collecting loan payments. Your retirement plan can accept checks, ACH transfers, or wires depending entirely on your preference. IRA providers are beginning to offer advanced platforms with free and user-friendly online bill pay functions to help simplify the process even further. As with everything else we’ve discussed, you would decide how to address late or missing payments.

Real Estate Financing // If you’re 100 percent disinterested in rental property but still want to claim your slice of the booming real estate market, you can keep your lender hat on while helping somebody else with his or her real estate initiative. You can issue loans to put families into their new homes or help blossoming new real estate investors get off the ground, with or without their retirement plans.

Plan-owned real estate is typically financed via non-recourse loans, meaning the personal funds or assets of the plan holder may not be attached as security. The investment property itself would be the only collateral in this model. As the lender, you may therefore choose to mitigate risk by asking for more money down, a higher interest rate, cash reserves or any other measures you feel are necessary. Your due diligence and talents as a lender can help you zero in on the right opportunity and reduce your overall risk. Bridge loans, construction loans, non-performing notes and more are all allowable assets for IRAs as well.

Success Stories

Resounding success stories continue to emerge from the rapidly growing self-directed retirement segment of the real estate industry. One investor demonstrated the true power of his retirement plan by investing $93,000 of his Roth IRA into an LLC that dealt in land speculation. Before long the $93,000 grew to $970,000, which netted the investor a tax-free profit of $877,000 and a less-than-a-decade return that other retirement investors would be thrilled to attain in a lifetime. Another plan holder didn’t have the retirement funds to acquire a property in full, but she used non-recourse financing to upgrade her purchasing ability. Her modest account balance became an entire property, and additional, more expensive properties became realities as well. The IRA eventually accumulated several pieces of real estate, all made possible through the power of non-recourse debt leverage.

A couple in their 40s grew their retirement plans in unforeseen ways, and they weren’t even looking for an investment property at first. They wanted a house near some of the world’s most beautiful beaches to call home during their retirement years. They targeted Belize because of its cheap raw land. They planned to develop a house by the time they reached retirement age. However, even with lower property prices, they didn’t have the personal funds to fulfil their dream. The homes in question would be even further out of reach once constructed, and they couldn’t rely on another opportunity presenting itself decades in the future.

Their bank accounts were light, but their retirement plans were flush despite having achieved tempered gains in the stock market. Once they learned a retirement plan could hold real estate, they liquidated their stock positions, rolled their retirement funds into self-directed IRAs, and each acquired half of an undeveloped property in Belize. You may be wondering, “As spouses, weren’t they both disqualified persons to one another?” Yes, under many circumstances, but not in their unique case. Each IRA held its own title to separate halves of the property, so as long as the money (income and expenses) remained evenly divided and IRA assets never commingled between IRAs or the holders themselves, their investment was perfectly compliant with the Internal Revenue Code.

The couple began renting the IRA-owned house once it was fully constructed. Their IRAs grew at such an incredible pace that they found themselves able to retire well before they anticipated. The couple then had a decision on their hands once their landlord days were behind them: They could sell the house and distribute the cash, or they could distribute the house itself. In addition to traditional cash withdrawals, the IRS allows plan holders to distribute physical assets without liquidation. The value of the assets would be reported as income and, upon completion of the process, would become the personal property of the account holder.

In the spirit of their original vision, they elected to distribute their dream home in kind. They had obtained their paradise in Belize at long last, all without having to empty their personal savings and while boosting their retirement earnings in ways they had never considered before. In this regard, self-direction gave this couple the power of control, both over their retirement strategies and over the individual asset they had their eyes on many years before.

This couple proved that a minimal background in self-directed investing can pay remarkable dividends. Their pool of retirement funds empowered them to pursue their real estate goals, expand their nest eggs with a lucrative alternative asset, and do all of it while yielding the significant tax benefits their IRAs provided. These people simply wanted an amazing home on the Central American coast, but they had to learn the real estate investment game from scratch.

If they can do it, you can do it. As a private lending professional, you’re already better equipped to harness the fruitful possibilities of real estate than our example couple was. Your existing business practices revolve around identifying quality opportunities and then managing your income, so why not put those skills to work in the exciting and expanding field of rental property?

 

By |2018-08-07T02:38:13+00:00January 31st, 2018|Business Strategy, Private Lender|0 Comments

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