According to a recent CNBC article, 2019 will indeed become a buyer’s market. The rise in mortgage rates have caused an influx of available properties. Though the price of homes for sale are still higher, they’re not as high as they could be amid concerns of potential buyers not having the funds to afford a new house.
The real estate market generally boils down to supply and demand, in addition to the economy. With stock markets down in 2018, concerns have been raised about making an investment in a new home. While that’s not good news for potential buyers, it’s not as bad for investors. Investors see an opportunity to get real estate properties at a discount.
What Does a Buyer’s Market Mean for You?
First, let’s talk about the individual or couple looking to buy a home for themselves. Since there’s such a large supply of homes on the market, buyer’s can be choosy when it comes to finding their dream house. They can negotiate a better price for the home they’re considering. However, with higher interest rates and a volatile economy, it still might not be enough to convince some people to buy. After all, a house is the biggest investment a person can make. This is not as big of a concern for those who have been saving and can afford a hefty 20% down payment. The last thing a new home buyers wants to be, is “house poor.” It’s imperative to make sure you are financially stable enough to buy a home.
Next, we will take a look at the real estate investor. Typically, an investor has enough funds too utilize to get the best interest rates possible. Better rates translate to bigger profits. A boon for investors could be the potential growth in the rental market. If more people are worried about buying, they will end up renting. This may create a shortage of available rental properties, which would increase monthly rent for tenants. Flipping houses is another lucrative business for a real estate investor. If a “flip” property can be had for cheap, there’s plenty of money to be made on the sale. If costs are kept down, a profit can be made, even when selling the house for cheaper.
Using Retirement Funds to Invest in Real Estate
Savvy investors already know about the tax advantages that come with retirement plans. What they may not know is that they can use their retirement funds for a variety of investments. This includes real estate, among a slew of other things. If your plan is at a traditional financial institution, you are limited in what you can invest in (typically stocks, bonds, mutual funds, and the like). However, Self-Directed IRA investors know they can invest in just about anything (not including life insurance and certain collectibles).
A Self-Directed IRA is a regular Individual Retirement Account that allows for alternative investments. However, not all Self-Directed IRAs are the same. They may be opened at larger financial institutions, but again, they limit your investment opportunities. This is why you need a special IRA custodian, such as IRA Financial Trust, that will never tell you what you can invest in. They’re simply there to make sure all the rules are followed and that your plan remains IRS-compliant.
Setting up a Self-Directed IRA has never been easier. If you have a retirement plan already (such as an IRA or 401(k) plan), you can transfer the funds to your new custodian. An LLC will be created and the funds will be invested in it. You, as the manager of the LLC, can now use it to make an investments. You will now have complete control, also known as “checkbook control”, to make the types of investments you want, when you want!
Now, when you want to make a real estate investments, you can use your new SDIRA and reap all the benefits a retirement plan affords you, including tax-deferred gains/income on your investments. Another option is the Self-Directed Roth IRA, where withdrawals will be tax-free, since these plans are funded with after-tax money.
Three Things to Know About Using IRA Funds to Invest in Real Estate
- First, you should never mix personal funds with IRA funds in an investment. If you have $200,000 in your IRA, you should not look to buy a property worth $250,000 (even if you have the difference outside of your IRA). Further, any associated expenses should come from the IRA as well. For example, if you purchase a fixer-upper, the renovations should be paid for by the IRA as well. If you have a rental property, all rent should flow back into the IRA and if you need to fix something, that should also come from the IRA.
- Secondly, you should be aware of the prohibited transaction rules. We mentioned earlier that you can invest in almost anything with your retirement funds. This is true so long as you follow the rules. The main prohibited transaction is one that involves a disqualified person. They main persons you should not deal with are yourself and lineal ascendants and descendants of yourself, such as parents, grandparents and children. For example, you cannot use your IRA to purchase a property from your father. Although, you may purchase it from your cousin. This differs from partnering with a disqualified person. You are allowed to make an investment with an otherwise disqualified person. For example, you can go 50/50 in a rental property with your son. Your Self-Directed IRA would own half and your son would own half. The two of you would split all expenses and income.
- Lastly, be aware of the pros and cons when using leverage to purchase a property with your IRA. Your IRA cannot personally guarantee a loan (it is a prohibited transaction). If you wish to borrow money to make an IRA investment, you must use a “non-recourse” loan. Only the property is used as collateral, not the IRA itself, when using a non-recourse loan in a Real Estate IRA investment. Moreover, any property your IRA invests in using leverage will be subject to Unrelated Business Taxable Income or UBTI. For example, if you take out a loan to purchase a rental property, rental income will be considered taxable under the UBTI rules.
Is a Possible 2019 Buyer’s Market Right for You?
The answer to this question will vary based on your particular situation. We can’t speak to those who are looking to buy a home for themselves. However, for a real estate investor, the market is ripe to jump in on. The most important thing is to do your research. A buyer’s market will offer you tons of inventory to dissect to find the perfect investment for you. If you plan on using retirement funds to make the investment, it’s just as important to have proper guidance to navigate the complexities of the IRS rule book.