A Guide to Investing Retirement Funds in Real Estate

By the Realty411 Team with
Mark Robbins, J.D., CEO

The Debut of the Non-Recourse Loan

The ability to purchase real estate with an IRA or other retirement funds has been in existence for many years. However, until 2004, banks in the United States would not lend money to the investors without requiring the investors to guarantee the loan.

If an investor wanted to buy real estate with retirement funds, they had to pay in cash. In 2004, a little-known bank in the mid-West became the first residential lender to create what today is known as a non-recourse residential loan.

This program was originated to allow for the purchase of real estate with various retirement funds, such as: Self-directed retirement accounts (SDIRA), Roth IRA, Solo 401K, an IRA/LLC account, or other trust accounts with retirement funds.

With this type of loan, the non-recourse loan, the investor can obtain leverage with a mortgage to buy one to four-unit properties. Today, it is now a highly-acceptable and useful way to invest one’s retirement funds.

Many of the better-known retirement fund custodian companies such as Pacific Premier Trust [Formerly Pensco Trust (Denver)], Equity Trust (Ohio), uDirect IRA (Irvine, Calif.), IRA Services (San Bruno, Calif), New Direction Trust Company (Colorado), and other retirement management firms, have passed the word on to their investors that they can use a non-recourse loan to invest their retirement funds in real estate.

In addition, a few banks have cropped up since the first pioneering bank in 2004 to provide non-recourse financing for all different types of residential properties.

Lending Resources Group (LRG) has become a well-known expert in non-recourse lending. The company, owned by Mark Robbins, J.D., CEO, has been counseling investors since 2004 about the “ins and outs” of investing retirement funds in real estate.

Robbins has established long-term relationships with many of the custodial companies as well as the lenders in this unique lending arena. His experience and knowledge with the non-recourse loan will offer the borrower the best recommended procedures in determining the appropriate lenders and their respective lending for the investor’s property to be financed.

The Non-Recourse Loan

As mentioned in the beginning of this article, prior to 2004 no banks issued non-recourse loans for the purchase of real estate, let alone the purchase of real estate by an IRA, as opposed to an individual.

The fact of the matter is this: The IRS does not permit the IRA investor to personally guarantee a loan when the investor is using their retirement money, along with a mortgage, to purchase real estate with their retirement funds. Why is this the case?

Answer: Because these retirement funds haven’t been taxed by the IRS. These funds are tax-deferred, and the IRS doesn’t want the investor commingling his personal assets and/or personal obligations with the property subject to the purchase with the IRA or other retirement funds.

Under a normal, conventional, personally-guaranteed loan, if the mortgagor (property owner) cannot, or does not, meet their payment requirements of the mortgage, the bank can use whatever legal means at its disposal to obtain payment from the mortgagor. The bank can sue the property owner and obtain that individual’s personal assets to satisfy the mortgage debt, if necessary.

As a result, most banks will not lend money to purchase real estate through a retirement-funded account because they cannot obtain that personal guarantee from the borrower.

With a non-recourse loan, the only recourse the bank has is the property and the rental revenue that the property generates. The bank cannot even go after the retirement account’s other funds or assets. Hence, this is a protective measure for the investor. The result of this stringent requirement is some fairly strict guidelines by the banks to issue these non-recourse loans.

Non-Recourse Loan Requirements

That brings us to the “how to” of making an investment in property with your IRA. The first step in this process is to establish your IRA account with a custodian/trust type company that specializes in handling retirement accounts for investments in real estate with IRA’s such as the SDIRA (Self-Directed Individual Retirement Account), or a Roth IRA, or an IRA in an LLC, or a Solo 401K, or individual trust.

This is necessary for several reasons. Again, the IRS does not permit the owner to handle any financial transactions in respect to the ownership of the property. The custodial company must pay all bills and receive all rents associated with ownership of this real estate with exceptions of a Checkbook LLC or a solo 401K. Nevertheless, one still needs a custodian to make sure the investment rules are being followed.

Once you have established an account, the time is right to find a property worthy of your investment. In order to identify the right property to invest in, there are a few important things for you to know.

First, you will need to have enough money in your retirement account to make a minimum down payment of 40% of the purchase price. Depending upon the type of property and the lender, you might need to make a greater down payment. This is usually dictated by the lender for the transaction.

Second, you will need to find a property that is either already rented or will be easily rentable once you own it. The property being purchased by your retirement account must be an investment property. It cannot be a primary or secondary home.

The third thing you need to keep in mind is the rent the property will generate should be 120% of the property’s total expenses, which include the mortgage payment, taxes, insurance, any HOA dues, a vacancy factor of 7%, and a management fee if the investor is going to have a property manager. Some investors opt to manage the property themselves, which is usually permitted.

If you find your property is not generating enough rent to exceed these collective expenses by a minimum of at least 20%, then the loan will almost always be rejected.  The one thing that can offset an imbalance in the income-expense relationship is if the borrower has plenty of reserves in their respective retirement account. A lender that otherwise likes the property and the investor’s overall financial strength will make an exception when the debt ratio falls below that 20% margin.

So, make sure your retirement account has sufficient assets to cover any deficit for a long period of time.

At the time the lender analyzes the respective property for a loan, the lender needs to see that the borrower will have 15% of the loan amount in their retirement account as reserves.

Some lenders require only six months of mortgage payments, taxes, and insurance. It depends on the lender and the property’s cost. In either case, the investor must maintain some level of reserves. The lender will audit the investor’s account at year end to make sure they comply with this requirement.

What Property Types Do Non-Recourse Lenders Consider?

Most non-recourse lenders are very particular about the types of properties to which they’re willing to grant a mortgage. Generally-speaking, lenders will consider single-family homes, condominiums/townhouses, duplexes, triplexes, and fourplexes.

Most of the better-known, non-recourse lenders do not lend on commercial properties, although there are a couple that will consider multi-family properties up to 15 apartment units, and some that will consider business properties such as offices or industrial warehouse types.

There are only a couple of lenders that can be depended upon for these types of properties in general. Once the investor seeks a commercial property, there are other dynamics to the loan process and the mortgage arena that can be discussed with the author.

When it comes to 1-4 unit properties, most lenders do not want to lend on properties that cost less than $200,000 because they don’t want to lend amounts less than $120,000. Knowing that the down payment required for these loans is 40% oftentimes precludes many properties from being attractive to these lenders to issue a mortgage.

The majority of lenders also do not like to work with properties that were built more than 70 years ago. There are properties known as row houses which are common in certain cities such as Philadelphia. Lenders generally steer clear from lending on these properties. Vacation rentals can also be troublesome because they don’t necessarily produce a steady stream of income to ensure the monthly debt will be covered.

The borrower needs to present a compelling story to the lender as to why this particular property will maintain or exceed the debt ratio requirements discussed above. Lenders also require the property to have a minimum square footage of 700 square feet or greater to issue a non-recourse loan.

To Learn More:

To learn more about using non-recourse loans for retirement funds’ purchases of real estate, contact Mark Robbins, J.D., CEO of Lending Resources Group (LRG) at (415) 309-1803, or by email at mark@lendingresourcesgroup.