Author Topic: Using retirement savings to purchase low-cost rental homes for cash flow  (Read 10909 times)

RetireAbroadAt35

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I'm still a few years away from reaching FI through frugality and investing in stock/bond markets.  I was remarking about this to a friend, and how I sometimes wonder about alternatives to trading my time for a salary to that end. 

His path is a bit different from mine.  We both live frugally and have decent-paying professional jobs, but he has been using leverage to invest in real estate over the last 10 years, whereas I've been dumping everything I could spare into stocks & bonds.

5 years from now, if we were both to retire and live off our investments, his monthly cash flow would be almost 3x mine (his mostly from rental income, mine from a 4% withdrawal from my investments).  His mortgages would be paid off and I'd be renting or starting a mortgage of my own.  My FI would be tight.  His would not.

So I'm intrigued.  Ignoring all the practical aspects of property maintenance and management, I'd like to learn more about the finances.

His strategy, after years of trying various things, is to purchase small houses, often in the $50,000 range, in a small blue-collar area near the city where he lives and rent them out.  There is enough local industry so that people are employed but it's not the sort of place where appreciation is likely.  This is all about cash flow.  He nets around $500 on each one (he does all his own maintenance & tenant management).

It got me wondering how I might do something similar.  For now it's a thought experiment.  Here's the plan:
  • Quit my soul-sucking full-time job and start working part-time or as an independent contractor.
  • Convert existing 401k/IRA to a self-directed IRA.  I don't know how to do this but I think it's possible.
  • Use the funds in my self-directed account to purchase investment real-estate ($50k homes)
  • Rent those homes, looking to net around $500 each
  • ???
  • Profit!

Some questions that come to mind: Is the self-directed retirement account feasible?  Are there any gotchyas in the rules for this sort of thing?  Could I live off the cash flow or would I be required to keep that in the retirement account?  Would I have to pay penalties and could they be avoided using things like 72t distributions or other means to access the cash flow?

If I could turn $200,000 of 401k into $2000 a month in cash flow, I'd be able to pay my bills and then some.  I could leave my non-tax-protected investments alone and work contracts to pay for big expenses.

Thoughts?
« Last Edit: July 08, 2014, 03:02:43 PM by RetireAbroadAt35 »

johnhenry

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Quote
   
1. Quit my soul-sucking full-time job and start working part-time or as an independent contractor.
2. Convert existing 401k/IRA to a self-directed IRA.  I don't know how to do this but I think it's possible.
3. Use the funds in my self-directed account to purchase investment real-estate ($50k homes)
4. Rent those homes, looking to net around $500 each
5. ???
6. Profit!


1. There's no need to make this an all-or-none proposition.  Research thoroughly, buy your first place and see how it goes.  If it goes well, use the profit/positive cash flow to do a second deal.  Repeat as often as desired.  If also desired, quit soul-sucking job.  Even owning several, even low-double digits likely won't cost enough of your time to "force" you to quit your job.

2. Not an expert here.  But I've read a few articles that suggest this strategy and even those that promote it make it sound like a complete bear to manage because every single closing cost fee, utility bill, etc must be paid out of the IRA account.  And I believe the articles all claim that self-managing any part of the "business" is not allowed.  I also believe that by holding inside of an IRA, you'll lose the ability to claim the expenses (including depreciation) on YOUR personal tax return.  Research further, but I'm guessing you'll nix this option quickly.  Please report back if that's not the case.

3. Same answer as #2.  Probably not the best WAY to buy.  If you are buying a $50K house and the bank requires 20% down, you only need $10K to get started.  I'd then work on building a small operating nest egg before buying second place.  If you want to start right away and can't set aside $10K in a non-retirement account, you could consider withdrawing from a Roth IRA, if you have one.  I'm not advising that.  I'd scrap together $10K in a taxable account first.

4.  Yes, if you buy one, you should rent it out :)  Be sure to accurately estimate your expected income, but more importantly all your expected expenses.  This forum in addition to your friend should be able to help out here.

5. Just run it like a business, that's what it is.  One won't take much time/effort at all except during the research/purchasing phase.  Tenants moving in/out and dealing with maintenance issues will happen.  If you can deal with owning the place you live, I'll bet you can deal with owning a rental.  Buy at a conservative price-point so if it doesn't work out you can sell in a year or two and not lose your shirt. 

6. Yes.  If you do decide that it works well for you, the cash flow (and tax-deferred savings from depreciation) will help fund the down payment for the second place.  Income stream from 2 places will put you in a position to buy a third even faster.  That's the beauty of investing for cash-flow.  You don't need to jump in with both feet at once by cashing in retirement accounts.  You'll be surprised how quickly multiple investments with solid positive cash flow will add up.  It's your choice how fast to ramp up your holdings or when to let the holdings sit and start providing cash-flow that you live off instead of reinvesting.  Controlling your leverage is another lever you can use to control your cash flow.

Just don't forget to put enough back for each property to pay utilities, repairs, some capital improvements, etc.

Edit: And research enough to fully understand the tax-benefits to investing.  Download a blank Schedule E and see what your taxes would look like.  Depreciation will help shield (defer) some of the realized income, which is a great thing.  Just don't forget to make an exit strategy, because selling outright, all at once will leave you with a big depreciation recapture bill.  Read up on 1031 Exchange.  It may be a part of your exit strategy if you don't just plan to hold till you die.  It's all in your favor.... you just have to make it part of your plan ahead of time.

hope that helps.  Get started, don't let your friend have all the fun!


« Last Edit: July 08, 2014, 03:54:06 PM by johnhenry »

Zoot Allures

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Sounds like you could split the difference between your friend's strategy and yours, and you'd have a nicely balanced approach. I'm very interested in real estate as well and am hoping to get started within the next year, but I'm leaving my retirement savings alone. My thinking is I'll continue to contribute to my 403(b) plan over the next 5-6 years and use whatever extra cash I have for down payments.

arebelspy

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I'm still a few years away from reaching FI through frugality and investing in stock/bond markets.  I was remarking about this to a friend, and how I sometimes wonder about alternatives to trading my time for a salary to that end. 

His path is a bit different from mine.  We both live frugally and have decent-paying professional jobs, but he has been using leverage to invest in real estate over the last 10 years, whereas I've been dumping everything I could spare into stocks & bonds.

5 years from now, if we were both to retire and live off our investments, his monthly cash flow would be almost 3x mine (his mostly from rental income, mine from a 4% withdrawal from my investments).  His mortgages would be paid off and I'd be renting or starting a mortgage of my own.  My FI would be tight.  His would not.

We can't tell if you or your friend has done better, simply because we don't know the contribution amounts of each of you.  You've amassed 200k in a decade, he's amassed a bit more (and will have higher returns), but we don't know what he put into them each year.  He's also put in a LOT more work (labor) than you have.

So it's an apples-to-oranges comparison.

Some questions that come to mind: Is the self-directed retirement account feasible?  Are there any gotchyas in the rules for this sort of thing?  Could I live off the cash flow or would I be required to keep that in the retirement account?  Would I have to pay penalties and could they be avoided using things like 72t distributions or other means to access the cash flow?

You cannot do any work on a property owned by your IRA.

All cash flow from it goes directly into the IRA - you don't get any of it.

You could access the funds the same way you would any other retirement account - with penalties or via 72t or Roth rollover pipeline.


If I could turn $200,000 of 401k into $2000 a month in cash flow, I'd be able to pay my bills and then some.

That's a 12% return.  Completely doable, especially if you are doing your own property management and repairs (i.e. your own labor would account for a decent chunk of that return).  I prefer to contract all that work out, personally, but if you enjoy it, and managing rentals and doing labor on them sounds like a good ER to you, go for it.

But not in your self directed IRA.  That all needs to be hands off.  You can screen tenants, and collect rent.  That's about it.  You can't even pick up a paintbrush or unclog a toilet without it all being subject to taxes and penalties.

Since self directed IRAs are so hands off, my favorite real estate investment for them is performing notes, as notes are a very passive investment in general (NPNs aside).

I prefer to hold rentals with taxable funds, so you can do whatever you please without worrying.

A 12% return without doing any labor, paying for a property manager, etc. is a lot tougher, and involves a lot more risk.
« Last Edit: July 08, 2014, 06:04:22 PM by arebelspy »
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If you end up with an NPN in a self-directed IRA, who does the foreclosure?  You or the custodian?

arebelspy

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If you end up with an NPN in a self-directed IRA, who does the foreclosure?  You or the custodian?

Legal team.  I'd handle it the same as I would not in a retirement account - handle someone in that state who does foreclosures.
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I was wondering where the line is drawn between what you can and can't do when the property is in a self-directed IRA.  The "checkbook" self-directed IRA's seem to give you the ability to act, where the more traditional self-directed IRA's seem to require the custodian to do it all.

arebelspy

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I was wondering where the line is drawn between what you can and can't do when the property is in a self-directed IRA.  The "checkbook" self-directed IRA's seem to give you the ability to act, where the more traditional self-directed IRA's seem to require the custodian to do it all.

Yeah, I prefer the LLC within SDIRA route for checkbook control, but either way a legal team is hired to handle the foreclosure, you just have the custodian cut the check versus you, I believe.

Of course, consult a professional on this (usually the SDIRA company itself is very familiar with the rules and can answer most questions), as the consequences could be dire. 

As an aside, I like how ominous that sounds!

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RetireAbroadAt35

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We can't tell if you or your friend has done better, simply because we don't know the contribution amounts of each of you.  You've amassed 200k in a decade, he's amassed a bit more (and will have higher returns), but we don't know what he put into them each year.
Just to be clear, this isn't my question.  I'm not asking anyone to run numbers or make any comparisons between my friend and I.  I mention it because it was the inspiration for me to investigate real estate.  The $200k thing is just an example.

Quote
You cannot do any work on a property owned by your IRA.
Are you sure about that?  The only restriction I read about is you can't reside in a property that you're working on, even for one night.

Quote
You could access the funds the same way you would any other retirement account - with penalties or via 72t or Roth rollover pipeline.
Right ... and I'm wondering if this is a good strategy to make funds accessible earlier/cheaper than leaving them in stocks/bonds.  $200k can yield a lot more cash flow in the form of rental income than the 4% safe withdrawal rate from stocks/bonds.

Quote
I prefer to hold rentals with taxable funds, so you can do whatever you please without worrying.
This is something I'd like to explore/understand better.  Any references?

johnhenry

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Quote
Quote

    I prefer to hold rentals with taxable funds, so you can do whatever you please without worrying.

This is something I'd like to explore/understand better.  Any references?

He just means use money that you've saved, but that is NOT in any type of retirement account. 

Quote
Quote

    You cannot do any work on a property owned by your IRA.

Are you sure about that?  The only restriction I read about is you can't reside in a property that you're working on, even for one night

Do you care to post the place you read that?   Everything I've read says trying to do this (hold and manage real estate rentals in any kind of IRA) will be a nightmare at best and clusterf*** at worst.  In addition to that, Rebs gave the restrictions as he understands them.  And I gave reasons, including losing the ability to claim the tax deductions and tax deferment (via depreciation) on your personal tax return, seem like big points against that strategy.  What's your reasoning for wanting to hold your investment inside your IRA anyway?  Other than, that's where your saving are at?  As I pointed out, you don't need much to get started investing with taxable funds instead and you avoid the hassle of trying to hold it in an IRA.



arebelspy

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You cannot do any work on a property owned by your IRA.
Are you sure about that?  The only restriction I read about is you can't reside in a property that you're working on, even for one night.

Yes.

Some people believe the IRS rules allow you to do work if  it doesn't improve the property's value.  This is a grey area (one I would personally not touch, given it's the IRS, and the potential consequences).  Others think you can't even do that much.  Think about how an "aggressive" accountant will skirt the line.  Ditto with advice you'll get on SDIRAs. I sure wouldn't want to be having to justify any work done on the property during an audit, and then have the whole thing disallowed and pay a bunch of taxes, penalties, etc. (sometimes nearly as much as the value of the property, depending on appreciation and such).

Everyone agrees though that you definitely can't do any rehabbing/remodeling, as that would improve the value and be prohibited, there's no controversy about that.

(Essentially the idea is you can contribute a maximum of $X per year to an IRA - by doing your own work, you're increasing the value of the property and allowing you to "contribute" more than the maximum - that's a big no-no.)

Like I said, my favorite real estate investment to hold inside an SDIRA is notes.  Loan the money to someone else doing real estate.  It's no work, all the money is collected into your IRA (you can use the normal tricks to access it), and you don't have to worry about crazy rules.

200k could probably yield you 1300-1600/mo.

Notes inside the IRA, rentals outside of it.
« Last Edit: July 09, 2014, 10:27:38 AM by arebelspy »
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RetireAbroadAt35

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What's your reasoning for wanting to hold your investment inside your IRA anyway?

$200,000 tied up in stocks/bonds has a lower SWR ($8,000 a year) whereas $200,000 tied up in 4 rental houses could result in $24,000 a year.  If using a 72t or other means to access IRA funds during ER, the rental investment produces more, earlier. 


arebelspy

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What's your reasoning for wanting to hold your investment inside your IRA anyway?

$200,000 tied up in stocks/bonds has a lower SWR ($8,000 a year) whereas $200,000 tied up in 4 rental houses could result in $24,000 a year.  If using a 72t or other means to access IRA funds during ER, the rental investment produces more, earlier.

Like I mentioned:
Quote
That's a 12% return.  Completely doable, especially if you are doing your own property management and repairs (i.e. your own labor would account for a decent chunk of that return).  I prefer to contract all that work out, personally, but if you enjoy it, and managing rentals and doing labor on them sounds like a good ER to you, go for it.
...[but you can't really do that inside an IRA]...
A 12% return without doing any labor, paying for a property manager, etc. is a lot tougher, and involves a lot more risk.

I think your 24k is reaching quite a bit.  24k on 200k of taxable money (i.e. outside a retirement account) is doable.  24k within is a lot tougher.  And you'll need 5 years expenses outside the IRA anyways to live on until the Roth pipeline kicks in.

Plus you need lots of reserve funds within an IRA - if something breaks, you cannot pay for it and get reimbursed, the IRA has to pay for it.  If it doesn't have the funds, you're *. So it won't all be invested, some will just be sitting idle. Meaning you're looking for more like a 12-15% return on the invested funds.  (And that's a passive return, since you can't do work on it).  Not going to happen.

EDIT: Let's run the numbers. You'll want probably 10-20k sitting as reserves if the HVAC goes out, roof needs repair, property is vacant and property taxes and insurance are due, etc. - though how much reserves will depend on the numbers, how big are the taxes, how many properties do you have, etc.  Let's say 15k, meaning you only have 185k invested.  24k annual on 185k is a 13% passive return.
/END EDIT

200k in cash generating that?  Sure.  200k inside an IRA, a lot trickier.

I think something more like 16-19k annual on 200k is feasible for a passive, SDIRA real estate investment.
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RetireAbroadAt35

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And you'll need 5 years expenses outside the IRA anyways to live on until the Roth pipeline kicks in.
I hear you but that's not an issue.  Assume for a moment that I have this covered, either through working part-time, taking the penalty, using taxable savings or maybe finding a sugar momma.

Quote
Plus you need lots of reserve funds within an IRA - if something breaks, you cannot pay for it and get reimbursed, the IRA has to pay for it.
Good point.  Let's assume the following:

Upfront:
* IRA contains $250k
* $200k is used to purchase 4 $50k homes outright
* $10k is spent on repairs and maintenance upfront
* $10k is spent on closing costs (no idea if that's realistic)

Ongoing costs:
* $4k in property taxes (taxes are cheap in this semi-rural area)
* $4k in maintenance (I think this is high?)
* $2.4k in property management fees (assuming 10% of rents)

Rental income:
* $2k per month, $24k per year

After the initial purchase, the IRA would have $30k reserve and would net around $13.6k a year after taxes/maintenance/fees, or 5.4% for the IRA.   This beats the 4% SWR for stocks and bonds but not by much.

arebelspy

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5.4% is probably low, the actual will probably be somewhere in between.

That analysis seems more reasonable, and thorough, though.
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johnhenry

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OP, have you checked with your current IRA custodian to see if they'll allow to hold real estate?  Or are you going to have to open a self-directed account?  Have you looked into what it will cost to open an account like that and hold real estate in it?

arebelspy

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OP, have you checked with your current IRA custodian to see if they'll allow to hold real estate?  Or are you going to have to open a self-directed account?  Have you looked into what it will cost to open an account like that and hold real estate in it?

Yes, they'll need a self directed IRA, but they're quite cheap.
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1. There's no need to make this an all-or-none proposition.  Research thoroughly, buy your first place and see how it goes.  If it goes well, use the profit/positive cash flow to do a second deal.  Repeat as often as desired.  If also desired, quit soul-sucking job.  Even owning several, even low-double digits likely won't cost enough of your time to "force" you to quit your job.

+1

The overall strategy of buying and renting cash flowing properties is sound, of course. And it's a great diversifier for your portfolio, plus an excellent hedge against inflation. Rental income will almost always go up with inflation, giving you a stable source of increasing income for decades to come. It can get you past the worries of the 4% SWR and what you will do when markets are down, because your rental income will keep coming despite stock market gyrations.

So I agree with the advice above to research and buy one property and see how it goes. If it suits you, keep going! I guarantee you will learn things along the way, and will become better at spotting and making deals and avoiding pitfalls.

arebelspy

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1. There's no need to make this an all-or-none proposition.  Research thoroughly, buy your first place and see how it goes.  If it goes well, use the profit/positive cash flow to do a second deal.  Repeat as often as desired.  If also desired, quit soul-sucking job.  Even owning several, even low-double digits likely won't cost enough of your time to "force" you to quit your job.

+1

The overall strategy of buying and renting cash flowing properties is sound, of course. And it's a great diversifier for your portfolio, plus an excellent hedge against inflation. Rental income will almost always go up with inflation, giving you a stable source of increasing income for decades to come. It can get you past the worries of the 4% SWR and what you will do when markets are down, because your rental income will keep coming despite stock market gyrations.

So I agree with the advice above to research and buy one property and see how it goes. If it suits you, keep going! I guarantee you will learn things along the way, and will become better at spotting and making deals and avoiding pitfalls.

Agreed.  My later purchases are much better than my earlier ones.  Jumping all in at once means you're not improving as you go.  And rushing in can lead to some big errors.

Start slow, learn a lot, and buy them and build up.  Real estate markets move slowly, you'll have months or years to develop your portfolio.
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If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
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RetireAbroadAt35

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Seems reasonable, though I wasn't thinking I would convert everything to RE in one go.  I'd decide on my asset allocation, set a target, and make purchases over time.

I probably would do this in conjunction with leaving my full-time job, however.   The current gig is 50-60+ hours, with weekends and travel too.  I'd go part-time or independent and start relying on y 'stache, freeing myself up to start investing in RE.  That's an issue for another thread though. 

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I, too, have thought that it would be great to use my retirement savings to pay for real estate.  Unfortunately, I have a 403b account and was told that the rules are much more restrictive.  Does anyone know if that is accurate?  (I was told that I cannot convert to a Roth, etc. unless I am terminated from my job.)  Is it even possible to have a self-directed account with this plan?
My recommendation to RetireAbroad is to buy the rentals with as little downpayment as possible using savings outside of your retirement account.  See how it goes, then you can decide how to proceed.  You may decide to wait and use your retirement account to pay-off remaining mortgages when you are old enough to access without penalty.  I think that is what I am going to do.

RetireAbroadAt35

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If the IRA were large enough to cover the price on the amount of real estate desired, and other investments were used to round out the asset allocation, why use mortgages? 

I also understand that getting a mortgage on a $50k property isn't always easy as many institutions don't want to lend amounts that low.  I also hear it is hard to get more than 4 or 5 mortgages at a time.

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If the IRA were large enough to cover the price on the amount of real estate desired, and other investments were used to round out the asset allocation, why use mortgages? 

Because mortgage interest rates are very low (even accounting for the extra 0.5% or whatever that they'll tack on for a tiny mortgage like $40k), there are far fewer rules to follow than if you use your IRA (and thus a far lower risk of getting embroiled in some IRS-related hell), and you can do work on the houses if you want.

I also understand that getting a mortgage on a $50k property isn't always easy as many institutions don't want to lend amounts that low.  I also hear it is hard to get more than 4 or 5 mortgages at a time.

Different banks do different things, so you have to shop around. Some banks don't do investment properties at all; some only do them for businesses (i.e. you form an LLC and borrow as that--total PITA, with higher interest rates and no fixed rate mortgages); etc.

As for the number of mortgages, I can't imagine why the mere number itself matters. What matters to banks in my experience is whether your income is sufficient to support the mortgage you're trying to get. That is, if they require your mortgage costs to be less than--say--40% of your income, they won't give you a new mortgage if you're already at 39% and the new one would push you over to 43% or whatever. That's true whether the new one is your second mortgage or your twelfth.

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Banks care because they sell the loans to Fannie and Freddie.  Fannie and Freddie buy something like 90 percent of conforming loans now.  The rules are Fannie and Freddie rules.

arebelspy

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I probably would do this in conjunction with leaving my full-time job, however.   The current gig is 50-60+ hours, with weekends and travel too.  I'd go part-time or independent and start relying on y 'stache, freeing myself up to start investing in RE.  That's an issue for another thread though.

If you're investing within the IRA, you won't need extra time.  Like I said, you won't be doing any work on it, so it should easily fit within your schedule already.

I, too, have thought that it would be great to use my retirement savings to pay for real estate.  Unfortunately, I have a 403b account and was told that the rules are much more restrictive.  Does anyone know if that is accurate?  (I was told that I cannot convert to a Roth, etc. unless I am terminated from my job.)  Is it even possible to have a self-directed account with this plan?

After you leave your job (quit, fired, laid off, etc.) you can roll it over to a self directed IRA.

If the IRA were large enough to cover the price on the amount of real estate desired, and other investments were used to round out the asset allocation, why use mortgages? 

Because you don't have the cash to buy it outright outside the IRA.  Getting mortgages is the only way you can get them outside your IRA. And by doing that you can actually do your plan to fix them up, leave your job to be a full time landlord, etc.  The plan to do it within the IRA just. doesn't. work.  You can't live off cash flow owned by a rental within your IRA.  You can't work on a rental owned by your IRA.  It's not legal.

You should read www.lackingambition.com - Mike on there FIREd off a few rentals he fixed up himself, very similar to what you want to do, he just did it with taxable money. 

If you have an existing 401k, you could take a loan against it and use that to buy taxable real estate now, and then start aggressively paying off that 401k loan, and then quit when you're done.  Then you'll have the best of both worlds: rentals outside retirement accounts providing cash flow to live on, and a decent chunk in your 401k (which you could rollover to a SDIRA at that point and invest in whatever, understanding that you have to jump through hoops to access the money, or leave it as is for continual compounding and later access).
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

RetireAbroadAt35

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If you're investing within the IRA, you won't need extra time.  Like I said, you won't be doing any work on it, so it should easily fit within your schedule already.
I suspect I would - just dealing with the IRA custodian, finding & purchasing homes, etc is a distraction.  I could probably pull it off with focus and a job change, but it would be a struggle and other things would fall by the wayside.  Maybe after the first year it would be closer to running on autopilot?  Not sure it matters.  This is all part of my "wind-down" strategy from full-time travelling office work.  Right now, for example, my home exists only on paper.  It's a garage where I have some things stored with a friend.

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Because you don't have the cash to buy it outright outside the IRA.
I would be able to but I would probably leave those funds where they were as they'd be easier to liquidate and use for other purposes.  I'm not set on this but my purpose in this thread is to explore the pros / cons of using the IRA to buy homes outright.

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Getting mortgages is the only way you can get them outside your IRA. And by doing that you can actually do your plan to fix them up, leave your job to be a full time landlord, etc.
I don't really want to manage/maintain them myself, except perhaps for initial fixes just after purchase.  That said, I could buy homes with cash from selling off taxable investments.  The IRA wouldn't be the only option available to me.

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The plan to do it within the IRA just. doesn't. work.  You can't live off cash flow owned by a rental within your IRA. 
Why not?  Cash flow can be accessed with penalties or other means to draw-down (72t, etc).  Doing so without penalties might take some time.  Simply paying the penalties is also possible and if the returns were good enough.

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You can't work on a rental owned by your IRA.  It's not legal.
As for the working on the property issue, I'm not yet convinced I care or that I'd be truly prohibited.  This seems to be a bit of a grey area.  In any event, even if I did have to let the IRA custodian contract out for maintenance, that would be fine provided that the numbers worked out (i.e. greater than 4% return).

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You should read www.lackingambition.com - Mike on there FIREd off a few rentals he fixed up himself, very similar to what you want to do, he just did it with taxable money. 
That's good stuff.  I've done some reading over there. 

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If you have an existing 401k, you could take a loan against it and use that to buy taxable real estate now, and then start aggressively paying off that 401k loan, and then quit when you're done.  Then you'll have the best of both worlds: rentals outside retirement accounts providing cash flow to live on, and a decent chunk in your 401k (which you could rollover to a SDIRA at that point and invest in whatever, understanding that you have to jump through hoops to access the money, or leave it as is for continual compounding and later access).
Interesting tweak.  I do have a 401k.  The majority of my tax-advantaged retirement savings are there.  I suppose I'd have to look at the interest rates on the loan and determine if that made more sense than buying properties outright (after paying capital gains from stock/bond sales).

My goal here is to put the 401k/IRA to better use than simply stock/bond returns.

Daleth

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Banks care because they sell the loans to Fannie and Freddie.  Fannie and Freddie buy something like 90 percent of conforming loans now.  The rules are Fannie and Freddie rules.

That's why banks care about your total mortgage payments being less than X% of your income. That's their proxy for "evidence that you will keep paying the mortgage rather than going into foreclosure." I continue to fail to see why banks care how many mortgage payments you have, so long as the total amount to be paid each month remains under X%.

Another Reader

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The 4 loan breakpoint and the 10 loan limit are Fannie and Freddie rules.  They have nothing to do with the bank originating the mortgage.  The maximum DTI is also not determined by the originator.

Some banks are actually more conservative.  They "overlay" their own set of rules on the Fannie/Freddie standards.

You can get more than 10 loans if you can find a portfolio lender that keeps the loans as investments rather than selling them to Fannie/Freddie.

Bobberth

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To address the financing issue and to throw out a different thought on purchasing lower priced rental properties: I have purchased all of my properties ($11k-$48k purchase prices) for cash and then once rehabbed and rented, I obtain a Line of Credit (LOC) on them from a local bank to get access to some of the money back (75% LTV).  I love that I can put all rents towards paying the lines down to save interest charges and still have access to the money when I need it.  If I had a mortgage with the same, or even higher, interest rate I wouldn't pay it down as the money would be gone but with LOCs I still have access to the cash.  This adds a new dimension to RE investing for me as it gives me 'access' to more cash that I can better utilize.  I firmly believe in and invest with the 50% rule.  But, since I don't always incur the incorporated expenses, I can use that money to pay down the LOCs instead of socking the cash away in a savings account paying very little to nothing (instead of putting 1/12 of property taxes in a savings account paying .5% in Jan, I can pay the LOC down by that amount saving myself 5.5% interest until I pull it out in Dec to pay the bill. More so with 1/20 of a new roof etc).  Interest rates are a bit higher (5.5%)  than a mortgage would be and there are renewal fees, but it's a small price to pay to have this flexibility and I only pay interest when I have purchased a new property that is making me more than that.  It also means that all new purchases are fully paid off until & unless I put a LOC on it and I would only need to do that to purchase another property.  In the coming year I should have enough room under the then existing LOCs that I won't need to obtain any more to keep expanding at my desired pace and all new purchases would be lien free.


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Hmmmm....you bring up an interesting idea.  I wonder if I could substitute HELOCs for mortgages on a couple of my properties.  I shifted an old high interest mortgage to the HELOC on my house, but it never occurred to me to make a substitution on other properties.  I'm over the 10 loan limit and can't refi, except the old Fannie loans that I did through HARP.

JoJoP

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I use HELOCs  as part of my FI strategy. 

 The beauty of a HELOC is that you can park money in it and take it back out.   So for IRS, real estate taxes, rainy day funds, vacation monies, etc, instead of tucking the funds into a low earning savings account, you can put them into your HELOC.  For as long as the money is in in the LOC, you are saving yourself the interest on those funds.   

We have a farm, and thus have a significant amount of money pouring in during harvest season, and then that money sits until it gets used up through the fall, winter and spring.  So the HELOC idea has allowed us to bank the funds and essentially have a good portion of the year with an interest free home loan.    It could work the same for another sort of windfall, such as an inheritance, sale of home, boat or vehicle, job bonus, etc. 

There's a company at www.tardus.com -- which I CONSIDER TO BE A SCAM, but has some interesting, out of the box ideas for using a LOC.  Once again... I BELIEVE THIS COMPANY IS A SCAM, so please don't consider the link above to be any kind of endorsement or recommendation, it's just a semi-good presentation of the concept.  They advocate rolling the money into P2P lending, but that, to me, is another risk level that I wouldn't take with borrowed funds.
« Last Edit: July 12, 2014, 09:23:00 PM by Jill P »

johnhenry

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Hmmmm....you bring up an interesting idea.  I wonder if I could substitute HELOCs for mortgages on a couple of my properties.  I shifted an old high interest mortgage to the HELOC on my house, but it never occurred to me to make a substitution on other properties.  I'm over the 10 loan limit and can't refi, except the old Fannie loans that I did through HARP.

Very good idea.... Many investors don't realize they can take out a second mortgage or HELOC on their primary residence, use the funds for purchasing rental property, and get to deduct the interest expense in full on their Schedule E.  This often makes sense because of favorable rates on the primary residence.  And for those of us with mortgage interest on our primary residence not getting us anywhere close to the standard deduction... it makes perfect sense to use the primary residence at collateral to fund the rental property.

johnhenry

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I use HELOCs  as part of my FI strategy. 

 The beauty of a HELOC is that you can park money in it and take it back out.   So for IRS, real estate taxes, rainy day funds, vacation monies, etc, instead of tucking the funds into a low earning savings account, you can put them into your HELOC.  For as long as the money is in in the LOC, you are saving yourself the interest on those funds.   

We have a farm, and thus have a significant amount of money pouring in during harvest season, and then that money sits until it gets used up through the fall, winter and spring.  So the HELOC idea has allowed us to bank the funds and essentially have a good portion of the year with an interest free home loan.    It could work the same for another sort of windfall, such as an inheritance, sale of home, boat or vehicle, job bonus, etc. 

There's a company at www.tardus.com -- which I CONSIDER TO BE A SCAM, but has some interesting, out of the box ideas for using a LOC.  Once again... I BELIEVE THIS COMPANY IS A SCAM, so please don't consider the link above to be any kind of endorsement or recommendation, it's just a semi-good presentation of the concept.  They advocate rolling the money into P2P lending, but that, to me, is another risk level that I wouldn't take with borrowed funds.

Hey Jill, I farm some too.  Never knew there were any other farmers on the forum.  If there's one thing successful farmers know how to do, it's manage rolling debt! And those who have been doing it more than a generation, respect the detrimental power of leverage as well as it's positive power.  I must admit I know just enough about this to be dangerous.  Please forgive me.  When you use proceeds from grain sales, etc. to "pay down" the balance of line of credit.... are those funds held in a separate account?  Or does your LOC balance get paid down?

I've worked with Farm Credit organizations that allow a "funds held" account for deposits just as you described.  The interest charged is calculated on the amount borrowed on the LOC minus the balance in the "funds held" account, which has the net effect of ensuring that your "liquid saving" or "operating cash" is paid the same rate that you borrow at through the LOC, basically avoiding the normal opportunity cost.  That's huge!  I've known other Farm Credit branches to offer the same setup, but with a 1% spread in their favor.  Still a great resource.  Obviously, the "funds held" account is not allowed to exceed the amount outstanding on the LOC.

But rules and rates can change.  I was curious how your LOC worked?  When you make a deposit is it "held" in a different account?  Or does it just pay down the LOC?

Another Reader

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Actually, I was wondering if I could get HELOCs on a couple of the rentals in place of their old, higher rate mortgages.  I already moved a high interest rate rental mortgage to the HELOC on my house and I'm busy paying that off.  If I could get a 5 year fixed rate HELOC to replace the mortgage on a couple of others, I could pay down the principal substantially before the rate adjusts.  Anyone been able to do that?

Bobberth

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Talk to some local banks, most likely their commercial dept.  My LOCs are 1 year terms but I do have 5 year commercial loans on 2 properties.  They are 20 year amort with 5 year fixed rate.  Technically they are balloon loans but even in the worst of things, the bank didn't call any balloons in as long as people were paying on them. 

Commercial lenders have a lot more products and options than just your traditional mortgage broker so go meet with them and see what they can do.  These are what I use but I also buy properties under $50k.  You may have more options with higher values.  My properties are in the city so that helps the bank with certain ratios regulators use for making sure banks aren't 'red-lining'.  Commercial lending is a whole new world.

Another Reader

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Commercial lenders would want a rate close to what I have now, charge high fees, do at most a 5 year fixed with a 20 year amortization and demand I cross-collateralize.  Some lenders throw in loan covenants that are difficult to meet.  That's not for me. 

Think they won't foreclose if you can't refinance at the end of the 5 years?  History says otherwise.  If a foreclosure won't make them money they may do a work-out.  Otherwise a problem with one property could cost you your entire portfolio.  The B 2 R and First Key folks are basically commercial lenders.  I don't think they are really in the business of lending money as much as they are looking for new acquisitions through foreclosure when the borrowers find they can't refinance.  Win-win for them - above retail rates today and a good shot at the collateral down the road.

I'm looking for a way to replace individual mortgages in series with lower rate HELOCs and pay them off.  Otherwise I will drip them out over a longer time.

DoubleDown

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Actually, I was wondering if I could get HELOCs on a couple of the rentals in place of their old, higher rate mortgages.  I already moved a high interest rate rental mortgage to the HELOC on my house and I'm busy paying that off.  If I could get a 5 year fixed rate HELOC to replace the mortgage on a couple of others, I could pay down the principal substantially before the rate adjusts.  Anyone been able to do that?

I was able to do exactly that around 2009 with a rental property I had (I did it with PNC Bank, if it matters). I think it was a 15-year HELOC, and I got an outstanding rate and terms compared to the traditional mortgage I held. I had far fewer rental properties than you have, though, so I'm not sure if you'll run into difficulty on that front.

RetireAbroadAt35

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Another piece of this puzzle that I'm struggling to understand is, what is the division of labor between the IRA owner, IRA custodian and property manager?  How passive could this really be?

Regardless of whether we're talking about purchasing through an IRA or with cash/mortgage, I see some real-estate folks in this and other forums say they used to do their own management/maintenance but now they hire it out.  The more I plan my wind-down towards retirement, the more likely it will be that I'd be using both work and rentals to generate cash flow for a period.  I'd like to reach a point where I only need to spend a few hours a month dealing with real-estate matters.  How realistic is that? 

My friend that does his own maintenance and management is doing something related to real estate/rentals almost every weekend.  At least at first, I'd like real estate to be more passive than that.

johnhenry

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I think the best advice is the advice that's already been given.

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I'd like to reach a point where I only need to spend a few hours a month dealing with real-estate matters.  How realistic is that? 

Start out by buying one property, outside of an retirement accounts.  This is going to be the only way to get a sense of what's realistic.  Not only in terms of your time, but whether it performs financially like you expected.   The only alternative I can think of that requires less commitment is to talk more to your buddy who's in the business.  Offer to help him with his weekend rental projects at no cost so you can chat him up and get a feel for what it's like to be in the business. 

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Another piece of this puzzle that I'm struggling to understand is, what is the division of labor between the IRA owner, IRA custodian and property manager?  How passive could this really be?

If you still haven't ruled this out (buying within a retirement account).....  While you are learning the ropes managing your first investment, you'll have time to research this in more detail.  You should start by identifying the potential custodians and property managers to cull them and understand the fee structure and the division of labor structure they advocate.  But you'll be able to ask better questions and demand better answers if you've been in the business at least a little while.

If I had to guess, this is probably like most things involving the IRS rules/interpretations.  Your advice from those custodians/PMs will vary.  The ones I would choose would be those who could convince me they have the policies, procedures and experience to not only help me avoid an audit, but successfully navigate one.  There's a lot of good advice on this forum, but at some point it makes sense to get that advice from the company that will be involved if/when you get audited. 

RetireAbroadAt35

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The only close contact I have in the business is a huge proponent of DIY / sweat equity.  He's the opposite of what someone like arabelspy does (outsourcing / delegating).  But I am learning from him as I go.

Given that my steps into real estate may happen while I'm still full-time employed (lots of proponents of that approach on this board), I suspect I can bring in a lot more income by staying employed and outsourcing management/maintenance. 

I'm seeking to understand the roles and responsibilities of the absentee landlord vs the hands-on landlord.
« Last Edit: July 21, 2014, 08:56:21 AM by RetireAbroadAt35 »

JoJoP

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I use HELOCs  as part of my FI strategy. 

 The beauty of a HELOC is that you can park money in it and take it back out.   So for IRS, real estate taxes, rainy day funds, vacation monies, etc, instead of tucking the funds into a low earning savings account, you can put them into your HELOC.  For as long as the money is in in the LOC, you are saving yourself the interest on those funds.   

We have a farm... <snip>

Hey Jill, I farm some too.  Never knew there were any other farmers on the forum.  If there's one thing successful farmers know how to do, it's manage rolling debt! And those who have been doing it more than a generation, respect the detrimental power of leverage as well as it's positive power.  I must admit I know just enough about this to be dangerous.  Please forgive me.  When you use proceeds from grain sales, etc. to "pay down" the balance of line of credit.... are those funds held in a separate account?  Or does your LOC balance get paid down?

I've worked with Farm Credit organizations that allow a "funds held" account for deposits just as you described.  The interest charged is calculated on the amount borrowed on the LOC minus the balance in the "funds held" account, which has the net effect of ensuring that your "liquid saving" or "operating cash" is paid the same rate that you borrow at through the LOC, basically avoiding the normal opportunity cost.  That's huge!  I've known other Farm Credit branches to offer the same setup, but with a 1% spread in their favor.  Still a great resource.  Obviously, the "funds held" account is not allowed to exceed the amount outstanding on the LOC.

But rules and rates can change.  I was curious how your LOC worked?  When you make a deposit is it "held" in a different account?  Or does it just pay down the LOC?

Hey, good to meetcha!    That sounds like a great set up for you.  You should be sure to explore/exploit all of the opportunities that such a loan presents.  You appear to have the opportunity to borrow/pay/borrow with out the hassle or expense of refinancing repeatedly.   You have some great opportunities to minimize RE debt for a good portion of the year, or borrow a down payment from yourself early in the season and get a good jump on a rental property for 5-8 months until you need the money.

We currently do not have any ag loans of any type on property.   They are all conventional mortgages, Heloc's with National Banks, or owner carry financing for purchases.  Getting conventional loans has been an epic adventure (not a good one!), but we do have a couple of them.  I  think we farmers really have to be resourceful financially, since lenders are so biased toward paycheck income and they basically freak out when income varies by 100% from one year to the next.  Our Helocs were from the days of handing money out in the RE boom of 2005/2006.   I'm not sure if we could get any more, but, if I could, I'd put a token First TD on a free and clear rental, and get a HELOC 2nd TD to buy some more.    Our Helocs were on Free and Clear properties-- so they became First Trust Deeds, and, in hind sight, that was a mistake that would be easy to remedy. 

Good luck with it.  Sounds like you've got a good opportunity there.