Retirement investment in real estate has evolved as a lucrative source of retirement income over the years. Real estate investment for a retiree can be highly profitable as it serves as an additional source of passive income that provides certain tax benefits. Moreover, smart retirement investment in the inflation-proof real estate market helps a retiree to enjoy great rental returns and property value appreciation. However, retirement investing today goes farther beyond stocks and bonds and traditional retirement plans like 401(k)s and IRA. Retired investors can now diversify their portfolio by investing in private or public traded REITs, crowdfunding, direct ownership, real estate mutual funds and stocks, etc.
How to execute retirement investment in real estate?
- Publicly traded REITs
With REITs, an investor does not purchase the actual property. A Real Estate Investment Trust (REIT) is an investment in real estate development companies that own multiple properties and other real estate assets. Publicly traded REITs act like mutual funds. This is because they own a collection of various property types or mortgage securities. Hence, instead of stocks and bonds, public REITs finance or operate commercial, residential, or industrial properties and generate income. Investors can earn a substantial amount of income from sold or rented properties. In the case of a mortgage company, investors receive payments against loans in mortgage-backed securities.
Publicly traded REITs are the most generic way of implementing retirement investments in real estate. This is because they produce capital gains and their special tax status requires them to pay at least 90% of their income to their shareholders as dividends.
Some dividend stocks pay their shareholders’ quarterly dividends and hence they are a reliable source of income for retirees.
Moreover, public REITs make investors passive. As they won’t own property directly, they won’t require to actually manage a physical property. Also, since REITs trade like stocks and bonds, retirees can invest in a pool that invests in a collection of REITS.
Hence, this allows more diversification as the pool owns multiple assets. Furthermore, REITs are liquid, which makes them easier to buy and sell than actual properties.
However, like various other fixed-income investments, REIT prices can fall with the falling of real estate values. For instance, as a result of the pandemic, commercial and residential properties are witnessing high vacancy rates. In addition, when newer mortgage securities generate higher yields, REITs face losses and affect their shareholders subsequently.
Retirees can invest in a REIT with an IRA, 401(k), or a pension plan. This is helpful for investors because these accounts are tax-favored. This means REIT investments within a retirement account allow investors to preserve the full income of their investments without paying an annual income tax.
However, IRA or an employee-sponsored 401(k) does not offer a wide range of self-directed investment opportunities. In case of a limited range of investment opportunities with a 401(k), a retiree can opt to open either a traditional or Roth IRA to invest in real estate.
However, investors wanting to pursue self-direction in real estate investment, have to conduct proper due diligence for identifying a self-directed IRA administrator. Furthermore, an investor needs to learn the tax implications and limitations of maintaining an IRA or 401(k) simultaneously.
- Private REITs
Retirees can also execute retirement investments in real estate via non-traded private REITs. These are just like publicly traded REITs. They must also distribute at least 90% of their taxable income among their investors. They are relatively riskier than publicly traded REITs. However, they help an individual investor to gain access to a non-public real estate asset. Under ordinary circumstances, an individual investor may not have access to such real estate assets.
However, with a retirement fund from a self-directed IRA, retirees can invest in a real estate asset and enjoy the benefits of a passive income in their retirement account. A rental income from a real estate property would also be non-taxable if it remains in the IRA or a Roth account. Some REITs even allow investors to reinvest their dividends back into the REIT. This, in turn, helps the investors to generate compounded returns.
Notwithstanding the benefits of a Private REIT, such REITs are of lesser appeal to humble retirees. This is because they have a much higher investment minimum and are, therefore, only accessible to accredited investors. Moreover, they are not registered with the SEC ( Securities and Exchange Commission) and are not exchangeable. In addition to this, there is limited disclosure about such REITs. This makes it difficult for the investors to gain information regarding the REIT’s performance. Being private, they are highly illiquid in nature as compared to publicly traded REITs.
- Crowdfunding
Crowdfunding as a way of facilitating retirement investment in real estate has recently gained momentum. It involves the pooling of funds by a number of investors into a real estate project. Such type of funding makes an investor a part of an actual real estate project, which makes them both active as well passive investors. This is because the investor can directly select suitable real estate properties from a list of projects.
Real estate experts evaluate and screen these properties carefully, along with their estimated incomes, capital gains, and value in the future.
These properties include any type of real estate asset ranging from industrial, and commercial to multifamily apartments that were previously only accessible to accredited investors.
Crowdfunding makes such large-scale properties available to humble investors. They can make equity and debt investments in such properties after conducting proper due diligence. While equity investments yield higher returns, debt investments generate monthly profits based on the loan amounts.
As a result, before investing in a crowdfunding platform, an investor must evaluate the pros and cons of the investment. It is noteworthy that equity investments involve greater risks. This is because they involve locking up the investment amount for the entire duration of the property life cycle until it is sold.
On the other hand, debt investments provide greater security for retirement account investors. Hence, retired investors must make investment decisions after analyzing their needs and requirements.
The minimum amount of investments in a real estate crowdfunding platform is much lower than that of individual investments. This is because, in crowdfunding, investors purchase and own only a small share of an individual project.
Hence, it is a great way of diversifying the retirees’ portfolio and simultaneously dispersing the risk among various projects.
As a result, instead of investing in a REIT mutual fund, investors can purchase a part of actual real estate property. This makes a retiree an active investor in a large-scale property.
Furthermore, professional managers will undertake every task related to terms of property management, tenant screening, or direct ownership of a property. Hence, retirees will retain a passive role in terms of property management, which can often be cumbersome and time-consuming. Plus, crowdfunding provides attractive returns on investment, sometimes often exceeding 15%.
For such investments, a retiree can use their self-directed IRA funds. Such funds provide flexibility to retirees to undertake alternative asset investments.
- Direct Ownership
If someone wants to invest his entire retirement account in a real estate asset, it is a more active and riskier approach. However, if the investor is fully aware of the ramifications of such an investment approach, direct ownership can be rewarding to the investors.
- Self-Directed IRA
To invest their IRA funds directly to own a real estate property, the investors have to make sure their fund is a self-directed one. This means that their IRA administrator ( the financial institution or company with which the investor has opened the IRA account) allows and accepts alternative investments.
However, the investor needs to have a sufficiently high balance in their IRA account to go through with such a costly investment in a real estate property. Moreover, the investor needs to maintain the fundamentals of purchasing a real estate property with an IRA fund. Some of the basics of such a purchase are:
- If the property faces loss and fails to generate any rental income, the investor can’t get tax breaks and nor can they claim depreciation.
- They can’t mortgage the property.
- The investor has to reimburse any expense related to the maintenance or repair of the property.
- The investor has to deposit the rental income in the IRA account.
- Any kind of ‘self-dealing’ is prohibited in such situations. This implies that the investor cannot use the property for their own personal use. Furthermore, they also can’t purchase, lease or sell the property from or to any person the IRS deems ‘disqualified’. These include spouses, children, parents, or any other family member. Any service provider of the IRA or any entity that owns more than 50% of the property is also ‘disqualified’.
The income from the property that is deposited in the IRA account of an investor is not taxable. However, the tax benefits are only deferred until the investor makes any withdrawals. In the case of a Roth IRA, the investment gains accumulate tax-free in the account.
The investor can withdraw the money from the account without paying any tax as well. Active investors can also buy, flip and sell the real estate asset without affecting the tax-free status of the IRA account.
Nevertheless, if a retiree investor has past experience in buying, flipping, and selling rental real estate, IRA is the perfect choice for them. But novice investors may find IRA investments in real estate overwhelming and riskier with the lack of diversification and liquidity in such projects.
- Solo 401(k)
The IRS (Internal Revenue Service) created the Solo 401(k) or Self-directed 401(k) to help self-employed individuals and small business owners to make traditional as well as alternative investments in real estate. Such individuals can borrow up to 50% of the solo 401(k) account to finance real estate investments. The IRS prohibits using personal finances for such investments.
The investors can however open a bank account in their solo 401(k)’s name with ‘checkbook control’. Here as well, an investor cannot purchase, lease or sell a property from or to a family member (‘disqualified person’). The investor has to make sure that he/she is purchasing the real estate asset from an unrelated third party.
With a solo 401(k) plan, all the investment income and gains are deposited back into the solo account. Investors can also generate tax-deferred or tax-free income, which helps them to save faster.
Solo 401(k)s are also free from UDFI (Unrealized debt-financed income). Moreover, contrary to the SDIRA funds, solo 401(k) funds do not need a custodian to act on the investor’s behalf.
In addition to this, investors can use a non-recourse business loan to purchase or partially fund a real estate investment. This helps investors to protect other investments and funds from bankruptcy and lawsuits if one property fails.
However, directly purchasing a real estate property requires the investors to be active with property and risk management. Furthermore, they should be acquainted with the legal and financial implications of borrowing against retirement funds for real estate investment.
Three steps to retirement investment in real estate
- Plan
The first step to retirement investment in real estate is identifying one’s goals. Then they should formulate a realistic, achievable plan to attain those means. The investor should evaluate his/her financial goals in long term as well as the short term. Depending on when he/she retires, the investor’s plan will vary in length and nature.
- Locate
It is undeniable that when it comes to investing in real estate, location is the most important deciding factor. With extensive research and financial wisdom, an investor should identify an affordable and convenient property. Before investing in a real estate property, an investor should research the market performance of the asset.
The investor should also research its rental income, occupancy rates, etc. By further comparing different property types in different markets, the investor can then shortlist and eventually select the asset best suited for an optimal investment opportunity.
- Finance
Financing a retirement investment in real estate is the final step in the process. After a careful analysis of the various retirement accounts and their allowance and limitations regarding alternative investments, and their financial status, the investor should finance a real estate project.
Whether it is a crowdfunding platform or direct ownership, retirement investment in real estate is generally aimed at generating a positive, monthly cash flow through rental incomes.
Conclusion
There are many available opportunities for retirement investment in real estate today. Real estate is an ever-flouring market that provides a stable investment post-retirement. Being inflation-proof, self-funding, and tax-friendly, it provides a perfect opportunity for retirees to generate a healthy stream of cash flow and secure their future.