There are many investors who are unaware that they can invest into alternative investments, of their choice, using their Individual Retirement Account (IRA) investment dollars.
Numerous sophisticated investors want to invest into alternative investments (such as individual real estate assets, REITs, private equity, etc.) in their IRA accounts but are limited from doing so because these investments are not available or offered on their financial advisors’ platforms. For investors who want to deploy their IRA capital into real estate and real estate alternative investments of their choosing and selection, an option for them is to open a Self-Directed IRA Account, outside of their traditional brokerage advisory account.
What is a Self-Directed IRA Account?
A self-directed IRA account (SDIRA) is an account that allows the investor/account holder to invest into many types of assets and funds, including alternative investments selected (SELF-DIRECTED) by the investor. SDIRA accounts are provided by Trust Companies who act as custodians for IRA accounts, the same way traditional brokerage firms custody their IRA accounts. The account owner chooses the investments that they are interested in funding, and then the Trust Company processes the investment as custodian. The benefits of using a SDIRA to make investments into real estate and real estate alternative investments is that in most cases, private real estate investments and REITs, are not available to investors via traditional brokerage firms and advisors because those firms do not want to deal with the processing of alternative investments, private funds, nor specific assets like a single office building.
Benefits of investing into Real Estate using an SDIRA
The concept of investing in real estate and using alternative investments, selected by the investor/account holder, in your Self-Directed IRA could be a new idea to many. The benefits of using a traditional IRA held at brokerage firm, and a SDIRA, are the same from a tax perspective. The big difference being the ability of the account holder to select investments that are typically not offered, nor serviced, at traditional brokerage firms. There are a number of benefits to investing into real estate via an IRA:
- Real estate investments may be used as an ‘alternative’ to traditional investments that are typically listed and traded on an exchange.
- Real estate alternative investments are not traded on exchanges, and thus the volatility of the capital markets typically does not play a short-term role in the valuation of a real estate asset or real estate alternative investment.
- Real estate income in Traditional IRAs is not taxed until the assets are withdrawn.
- Real estate assets are typically held for many years to attempt to achieve both income from the real estate assets and potential for gains from asset appreciation. The income and potential gains are not taxed until the assets are withdrawn from the IRA, thus allowing the cash flow to accumulate or compound over the long run in a tax advantaged manner. (This is similar to a traditional IRA held at a brokerage firm, the difference being that the investment that the investors has selected, cannot be purchased in a traditional IRA held a traditional brokerage or advisory firm.
Investing in Real Estate for yield and growth using a Self-Directed IRA
Everyone has different investment goals and strategies for their risk/return profile. Many investors and allocators have two buckets for investment allocations to real estate.
- Yield and income: target yield and return: 7%-10%
- Growth, Value-Add, Development: target IRR +15%
For a yield alternative to publicly traded fixed income instruments (bonds, preferred stocks, MLPs, mortgages, etc.) where rates and yields are relatively low, some sophisticated investors make investment allocations for their SDIRA into high-quality, stabilized real estate where the cash flow from the buildings, meets their investment targets and goals for current income. Real Estate Sponsor choice is just as important as choosing the region and specific asset. You may make a well thought out investment into a type of commercial real estate (Office, Multi-Family, Retail, etc.), in a good region, but the sponsor/asset manager should be a firm with an extensive track record of performance.
The two types of alternative investments that investors typically consider for the ‘Yield Bucket’ are:
- Private REITs with institutional quality buildings with existing cash flow, managed by an institutional quality sponsor.
- Credit funds that lend to specific office and multi-family properties. These properties tend to be of lesser quality than the institutional quality office properties in several institutional-quality REITs, and carry higher yields, as expected given the higher risk profile.
The ‘higher return target Growth bucket’:
- Direct investment into a specific CRE project that does not have current cash flow but the expectation of a higher return when the project is developed and comes online.
- Development projects
- Significant value-add projects
- Direct investment into a specific loan on a property that does not have current cash flow but will hopefully reach the goals of the sponsor to pay off the loan and pay the interest on that loan.
So, what is a Do-It-Yourself investor to do?
The business of Self-Directed IRA custody and administration is a relatively large industry, although not well known compared to traditional brokerage firms and their custody services. The reason for this is:
- Financial advisors and brokerage firms, in most cases, are limited in what products they can offer to clients and only offer products available and approved on the firm’s platform.
- Often these products are marketed and sold with a commission and / or fee built into the transaction to compensate the advisor and firm for the advice, recommendation, and execution of the transaction.
Educational resource for how to use a SD-IRA for investments into Real Estate:
There are significant participants in the SDIRA industry providing the service of custodian for a large number of alternative investments. Many of these SDIRA firms have extensive educational information available to investors to learn how to use their IRA dollars for investments into real estate and real estate alternative investment products. The article link below provides additional info on Self-Directed IRAs.
KBS Direct makes no representations as to the appropriateness of an investment in KBS Growth & Income Real Estate Investment Trust REIT for ERISA plan fiduciaries and IRA owners and no investment advice is being provided. ERISA plan fiduciaries and IRA owners should consult with their own advisors and counsel before making an investment in the REIT’s shares. This is not an offer to sell securities. Offers to sell, or the solicitations of offers to buy, any security can only be made through a private placement memorandum and other official offering documents that contain important information about risks, fees and expenses.