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Commercial Real Estate Investing with your Self-Directed IRA

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  |  By Chris Shanahan, CISP®

Given that stock market volatility is starting to feel more like a rule rather than an exception these days, retirement investors are looking for ways to diversify their savings by investing in alternative assets such as real estate.

According to a PENSCO survey, retirement investors plan to invest in more alternative assets to diversify their IRA holdings, and more than half of the survey's respondents said they are likely to increase their allocation to real estate. Those intentions are not surprising given that 32% of the new accounts opened at PENSCO in the first three quarters of 2015 invested in real estate.

One popular strategy among our self-directed IRA clients is residential real estate investing. The property is then leased to a tenant, allowing the IRA to benefit from the monthly income flow of a rent check and any potential asset price appreciation. Many PENSCO clients also use their self-directed IRA to invest in commercial real estate, such as apartment buildings, warehouses, shopping centers and industrial complexes.

According to National Real Estate Investor, commercial real estate price indexes have been on the upswing for nearly five years, reaching new heights with their January readings. The NREI graph below captures this upward momentum. (An interactive version of this graph is available on NREI’s website).

There are some similarities between residential real estate investing and commercial real estate investing:

  1. Tax Advantages: Using your IRA for real estate investing comes with tax advantages. When a real estate investor uses retirement dollars, in most cases, capital gains are avoided and taxes on income from return on investment are deferred until it’s time to take distributions. If you use a Roth IRA, in many cases you can avoid paying taxes on distributions or profit generated by the sale of the property entirely.
  2. Non-recourse Loans: Many investors do not have enough cash in their IRA to purchase property outright – especially when it comes to the capital outlay needed to buy a commercial property. If this is the case, you can work with a participating bank to take out a non-recourse loan to finance the investment property without the risk of sacrificing your entire IRA in the case of default.
  3. Prohibited Transactions: When investing in real estate in an IRA there are a few rules and considerations to be aware of – for example no personal use of the property is allowed, meaning you and your family cannot live or work in the property. These rules are referred to as prohibited transactions.

There are also a number of differences when it comes to commercial real estate investing:

  1. Numerous tenants: Typically when an investor owns a home in their self-directed IRA, they deal with one tenant or party. But owning commercial real estate means being prepared to deal with and collect rent from multiple tenants.
  2. Concentrated risk: Commercial properties tend to have a much higher cost of acquisition than a residential property. That means they could account for a larger percent of your IRA holdings, increasing your exposure to one asset class and decreasing your portfolio’s overall diversification.
  3. Pricing dynamics: The value of a single-family home is often determined by what similar properties are selling for in the neighborhood. The value of a commercial property can be much more dynamic and be closely tied to such things as the length and structure of each tenant’s lease, tenant suitability, and the future desirability of the building.

Given the complexities of commercial real estate investing and the potential tax implications of using retirement funds, we always recommend that you work with a professional who has helped other clients use their self-directed IRAs to purchase commercial property.

To learn more about the process for directly investing in real estate with your self-directed IRA, I’ve put together this blog outlining the key steps involved, including the paperwork needed and the custodian review process.

You can also download our guide on using your self-directed IRA dollars to invest in real estate, or reach out to us with any questions in the comment section below.

This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.

PENSCO Trust Company performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. Other than the Opus Affiliates, PENSCO is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.