Many investors are looking at real estate as a hedge against inflation. However, not all real estate is created equal. A recent Wall Street Journal article warns investors about commercial real estate. Real estate remains the most popular asset for Self-Directed IRA investors. It’s important for investors to know what they’re getting into before using retirement funds to invest.
- Real Estate has long been a hedge against inflation
- Residential real estate is much better than commercial as a hedge
- Using retirement funds to invest in real estate offers enormous benefits
Why Real Estate?
As we’ve talked about here on the blog, real estate has always been a great hedge against market volatility. The COVID-19 pandemic has led to tons of government spending. At some point, we have to pay that money back. Generally, inflation is the next step. Many financial analysts say the period mat be short as people start resuming normal buying patterns, however, no one knows for sure how long the inflationary period may last.
With uncertainty abound, investors are looking past the markets, as they typically fall during times of tumult. On the flip side, real estate remains strong and usually outpaces stocks and other assets. The simple concept of supply and demand have driven real estate prices through the roof. Because of the pandemic, working remotely has become the norm for many industries. Bosses and employees alike have realized not everyone needs to work in an office. Because of that, many Americans are looking for quieter, and perhaps safer, places to live. All of this leads to a strong residential real estate market that investors are trying to capitalize on.
What About Commercial Real Estate?
As the WSJ article points out, “landlords who are unable to raise rents can suffer during periods of inflation.” Further, “Inflation only leads to higher prices for products that people actually want.” As we alluded to already, companies are ditching the traditional office space, which leaves many buildings near (or completely) vacant. The demand for that space is not as great as it once was. Plus, the leases of retail and office space are generally longer. If there’s no way to raise the rent because of inflation, the owner/investor will see less of a return.
As the country reopens and more people return to work, there may be an influx of new businesses. But, will those be brick and mortar? Can you expect to charge a high enough rent to make it worth the investment? One can argue the supply of commercial real estate will be much more than that of the demand. Quite the opposite story of the residential space. Of course, there are always exceptions, so if a commercial property fits the bill, it may be worth the risk. As always, you should consult with a financial advisor and real estate experts before making any investment. Plus, be sure to do your own research, especially if you are considering using retirement funds to invest.
Using Retirement Funds to Invest
If you self-direct you retirement plan, you can invest in just about anything. With residential real estate seen as a hedge against inflation, now may be the time to step up your game. Using a Self-Directed IRA will allow you to buy, sell and rent real estate in a tax-advantaged account. Remember, any investment held inside a retirement account is not subject to annual taxes. Your investment grow tax-deferred, or tax free in the case of a Roth account. You only pay taxes once you withdraw the asset from the plan (or never in the case of a Roth!).
Residential real estate comes in all shapes and sizes, from single family houses to multi-family apartments, land, vacation properties, short- or long-term rentals and even fix-and-flips. Depending on your goals and risk tolerance, there is a property out there for you.
Again, with more people working remotely, they’re moving further away from the big cities, which expands desirable neighborhoods. Plus, as summer is on the horizon and the country is getting “back to normal,” you can expect a strong demand for vacation destinations. VRBO and Airbnb are two popular options among vacationers. It would be great to finally have a steady stream of income, all within a tax-advantaged account.
Bonus for the Self-Employed
The one drawback of using a Self-Directed IRA to invest in real estate is the UBTI tax. We talk about not having to worry about taxes with an IRA investment. However, when you borrow funds (i.e. for a mortgage), you will be subject to Unrelated Business Taxable Income. Essentially, the percentage of the purchase price that is borrowed will be taxed on the income the property generates.
If you are self-employed, you can open a Solo 401(k) plan, which has an exemption for UBTI. For whatever reason, the IRS has stated that you don’t owe the tax when you leverage real estate with a 401(k) plan. Experts are still baffled why the tax applies to IRAs and not 401(k)s. Obviously, you can take full advantage of the tax code, but you must be self-employed.
Residential real estate is a hedge against inflation, while commercial properties may not be. That’s not to say that that’s true for every single property out there. As an investor, you must do your own due diligence, and decide what’s right for you. Plus, using retirement funds to invest may be the best way to hedge, because of the tax-advantaged nature of the system. To learn more about real estate investing, feel free to reach out to us @ 800.472.0646!