An IRA asset
By Beth W. Orenstein Special to The Morning Call
Congress created Real Estate Investment Trusts in 1960 to give more people the opportunity to invest in commercial real estate.
Today, there are about 183 publicly traded REITs in the United States with assets totaling $375 billion, according to the National Association of Real Estate Investment Trusts.
There are several types of REITs. Equity REITs own and operate income-producing properties.
Properties can range from residential and office buildings to shopping centers and industrial buildings.
Mortgage REITs lend money directly to real estate owners and their operators or indirectly through the acquisition of loans or mortgage-backed securities.
REITs also can be hybrids, owning and operating properties and making loans to owners and operators.
According to NAREIT, publicly traded REITs saw an average 12.91 percent annual return from 1971 to 2003. That compares with an 8 percent return on the Dow Jones Industrials; 9.37 percent on the Nasdaq Composite; and 11.45 percent for the S&P 500 over the same time period.
Institutional investors — organizations such as pension funds — routinely include REITs in their portfolios.
According to NAREIT, 8 percent of the nation's 401(k) plans offer participants the opportunity to invest in real estate stocks. Individuals with self-directed Individual Retirement Accounts also can invest in REITs.
Leona Robinson, a partner of Robinson & Robinson in Allentown, says REITs are often a good way to invest in real estate market without the hassles of being a landlord.
Deborah Harry, 57, owns a three-bedroom, 21/2-bath twin home in Womelsdorf, Berks County, that she rents to a family of three.
Nothing unusual about that. Lots of people own rental properties.
What is unusual is that Harry's investment property is part of her retirement portfolio. She bought the house in March for her Individual Retirement Account, which means the money she earns on the investment grows tax free.
The investment strategy is not well-known and the rules are complex. However, individuals can own real estate in an IRA just as they can individual stocks, mutual funds, certificates of deposit or other more traditional investments.
Indeed, direct investment of IRA assets in real estate is hot and getting hotter.
According to the Investment Company Institute, the percentage of retirement investments in real estate has more than doubled in recent years. In 2002, it says, 1 percent of the $2.45 trillion in IRA assets was in real estate. Today, a little more than 2 percent of the $3.01 trillion in IRA assets is in real estate investments.
Carl Fischer, manager of Entrust CAMA in Spring House, Montgomry County, attributes the growth to the Internet. Individuals have been able to invest their self-directed IRA money in real estate since the government established the accounts in 1974, he says. (Self-directed IRAs are those in which the investor can choose his or her investments.)
However, originally, only the very wealthy took advantage of the real estate investment option, Fischer says. Since the advent of the Internet in the early '90s, he says, more people have been learning about how to invest in real estate for retirement.
Over time, real estate also has proven to be a good investment, Fischer says. ''With real estate, people like the returns that they see, and want to use that money to fund their retirement.''
Also, Fischer says, more people are trying to diversify their investments. ''Baby boomers figure they have to protect themselves because the government isn't going to do it,'' he says.
Leona Robinson, a partner in Robinson & Robinson Inc. in Allentown, an investment firm, agrees that diversification is critical to any investment strategy. However, she believes that investing retirement funds directly in real estate is too complicated and too risky for most people.
''The problem with real estate,'' she says, ''is that it's not always liquid. If you want to get out of the real estate market, you can't always do that.''
Also, Robinson says, when individuals reach 701/2 years of age, they are required to make withdrawals from their IRA. Calculating the mandatory amount of those withdrawals would be complicated, she says.
Robinson says she can see the allure, especially with the increase in property values owners have seen in the last few years. However, she says, those who want to invest in real estate would be better off choosing a Real Estate Investment Trust, a company that manages a portfolio of real estate to earn profits for its shareholders. ''With a REIT,'' she says, ''you can get into real estate without being a landlord.''
Fischer says those who want to invest in property for their retirement must carefully follow the rules or be subject to tax penalties.
Almost all real estate is eligible — raw land, commercial property or residential rental property. However, investors can't buy the property from themselves or a relation, including their spouse, children or parents. ''You can't use your IRA to purchase your own residence or a vacation place or an office for your business,'' he says.
An IRA custodian must manage the real estate investment. Custodians may not be easy to find. Only about a half-dozen companies offer IRA custodian services. Entrust, which has 32 offices across the country, is one. Its office in Spring House opened about 21/2 years ago.
Rental properties need managers to collect the rent, make repairs and oversee it. Rent is deposited to the IRA while costs for repairs and maintenance are withdrawn from the IRA.
Some advisors believe it is best to start with at least $50,000 in the IRA if investing in real estate. Others, including Fischer, say it can be done with as little as a few thousand dollars because the real estate purchase can be financed.
However, obtaining a mortgage on a small residential investment property generally requires a larger down payment — 30 percent to 35 percent — than a traditional mortgage, says Harry, who owned a commercial real estate and property management firm, Sheltered Assets Real Estate, in Allentown from 1982 to 1993.
The mortgage on an IRA investment property has to be a non-recourse loan, which means if the borrower defaults, the lender can only seize the mortgaged property and has no other recourse against the IRA or the investor's other assets, Fischer says.
Not all local banks offer non-recourse loans, which can make them difficult, but not impossible to find, Harry says. It is easier, she says, to find lenders who offer non-recourse loans on larger commercial property investments such as office buildings and shopping centers.
Typically, investors who are buying real estate for their IRAs find their own properties.
Entrust doesn't recommend properties to buy because it would be a conflict, Fischer says. ''We don't recommend any deals. We say go to the experts.''
It seems that a lot of his clients interested in this opportunity are real estate agents who find their own deals, Fischer says. Many buy fixer-uppers because they can get them for less and turn them around at a profit.
Harry bought the house in Wolmesdorf for her IRA because it's near a property that she bought a few years earlier for her son. ''I contacted the agent who sold me my son's house and said I was looking for a townhouse or duplex property in that area that I could buy for under market value. I didn't care if I had to fix it up,'' she says. ''The agent said she had something right away.''
It turned out, Harry says, all she had to do was paint and install new carpeting. ''But I was prepared to do major renovations to a property, if necessary, because I can analyze what something could be worth when I was done. With my training and experience, I am able to take the price, closing costs, renovation costs, mortgage/tax payments, and potential rental value into account to determine if something is a good investment candidate.''
Harry, who lives in Elverson, Chester County, says she wanted her investment property to be in Wolmesdorf because ''you can still buy at prices that make the numbers work on residential rental properties there. The community is a desirable place to live. In many ways, it is similar to the Emmaus area. Home values in Chester County have gone out of sight.''
A commercial real estate agent with Weichert Realtors in Haverford, Montgomery County, John Steele, 60, of Villanova, Montgomery County, has been investing in real estate for 30 years. He recently bought a single family home in Norristown that he is using for his IRA.
Steele says he's comfortable investing in real estate for his retirement ''because I'm in the business and I like investing in something I know something about.''
Entrust collects the rent and handles the lease for him, he says. But because he has other investment properties, he uses his handyman crew to take care of any maintenance that is necessary.
Typically, IRA custodians charge fees for establishing the account and annual fees for maintaining it.
Entrust charges $300 a year for each real estate asset if it is in a 401(k) plan and $250 per asset if it's an IRA. Fischer notes that some 401(k) plans allow their investors to invest in real estate and some do not. The custodial fees are fixed and are not related to the value of the investment, Fischer says. The property can be sold at any time, Fischer says. ''The money from the sale would go into your IRA — all of it. No taxes and no 15 percent capital gains.'' The money would be taxed as ordinary income when it is withdrawn if it is in a traditional IRA and tax free at withdrawal if it is in a Roth IRA. The idea behind the IRA is that the owner will be retired when he makes the withdrawals and in a lower tax bracket than when he was working. Withdrawals can start at age 591/2.
If the property is still inside the IRA when the investor reaches age 701/2, the property has to be appraised each year to determine how much needs to be withdrawn, Fischer says. The owner must deed a percentage of the property to himself each year or take the annual distribution in cash if there is enough there.
Fischer isn't concerned about real estate investing given that the housing market is starting to slow. One of the reasons it is slowing is that mortgage interest rates are rising. That could be good news for real estate investors, he says, because higher interest rates mean fewer eligible buyers and more renters who need homes.
''With a real estate IRA, you control your investments,'' says Harry, ''and that's ideal for someone like me who understands real estate and the power that owning real estate offers as an investment tool.''
Beth W. Orenstein is a freelance writer.
Real Estate Editor Eloise DeHaan
eloise.dehaan@mcall.com
610-820-6167
Copyright © 2006, The Morning Call
