Archives for May 2014

Buying Investment Property With Your IRA

Are you a candidate?

A unique subset of property investors are those that comprise the niche utilizing their Individual Retirement Account (IRA) to fund new property acquisitions. This subset is made up of very savvy investors, who are unafraid of the risks of IRA investing in real estate, simply because they know all the inherent risks. They also check with their tax advisor (as should you) before attempting to use IRA funds to purchase investment property. They know that this is the best way to protect yourself before beginning any program of investing in real estate using your IRA funds.

Self-directed IRA’s

The actual vehicle used to purchase investment real estate with an IRA is called a self-directed IRA. It differs greatly from a traditional or Roth IRA in that it is set up specifically to fund outside investments (be they real estate or otherwise). The chief benefit? Naturally, deferring paying tax on your positive rental income, of course! And like all other forms of investment property, you can leverage them to increase your real estate portfolio. The double benefit of tax deferment along with the ability to leverage makes a self-directed IRA a very attractive financing tool for savvy property investors.

Passivity – the integral part of the plan

In order to retain the tax advantages afforded you by a self-directed IRA, you’ll need to make sure the investment is “passive” income. This means you can only use the investment to rent to others. It can’t be used for yourself, or other family members either. Each tenant has to rent from you in an “arms-length” way. In addition, and this is a real kicker, you must never comingle your own personal funds with the rental property you’re buying with your self-directed IRA. That also means, only funds from that IRA can be used to pay expenses on the building, over and above your rental income from that same building. The rent that building throws off should be used exclusively to pay for all your property manager fees, renovations, repairs and basic maintenance expenses on that building. You can’t mix the funds with any other building you own that was not bought with funds from your self-directed IRA!

Taking funds out at any time? Nope.

Using self-directed IRA funds to purchase investment property also means you must abide by the rules of the IRA at all times. This includes the provision that you cannot take funds from your investment property out at any time. While the money earned is yours, it must stay in the IRA, and there are set time frames for removing funds (IRA withdrawals) as well as distributions. In order to keep the tax advantage of the IRA, you must stick to these rules. Otherwise, you will lose your IRA status – and all of its tax advantages as well.

Some key elements to remember

There are several important things to remember when acquiring investment property using a self-directed IRA. Foremost among them is the fact that all costs incurred with the acquisition of the real estate investment must come exclusively from the IRA. Don’t even think of comingling funds with other assets. Any deposits or binders on a property need to be coming directly from the IRA. In addition, you’ll need to leave a large amount of reserve capital within the IRA. Any new (and especially unexpected) expenses that arise with your new property acquisition have to be borne exclusively from the proceeds of the IRA, and not any other personal funds. As mentioned above, always check with your tax advisor before undertaking any property investment using your IRA funds.

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Commercial Property Leasing Tips

Major differences in commercial versus residential leases

When evaluating commercial investment property, it’s best to take into account the major importance the property’s leases play in determining overall value of any given property. Commercial leases differ in several key ways from residential leases, and greatly affect the market valuation based on these differences. Here are the key elements that differentiate them, and why they play such a major role in property value…

Viability of tenant

In commercial property investing, always consider the credit capacity of any prospective tenant. While this is important in residential property management as well, it is more crucial in commercial investments, where longer-term leases come into play. You’ll need to feel very assured that the tenant you’re installing on a long term agreement has the capacity to pay you regularly each month. With tenants that have little or no track record, you, as their landlord, will need to ask for some form of personal guarantee to back up their lease agreement.

Length of lease term

In residential real estate, a one year lease is pretty standard. Two years would be rarer. But in commercial property investing, terms usually start at three years, and can extend many years out in many cases. Additionally, lease options allow prospective tenants to renew at certain years in their overall lease contract. Sometimes rent bumps are included as part of the overall lease. Sand sometimes rent bump options are included. As a landlord, anything you can do to lock a tenant into as long a lease term as possible is most beneficial to your bottom line. You’ll also want to keep the number of renegotiation periods (in the guise of rent bump options) down to a minimum. Not only will this help you be able to count on a set revenue stream down the road, but you won’t have the need to renegotiate at a future date with the same tenant either.

This also has a major effect on the total valuation of your commercial property. The more long term leases you can lock tenants into, without options, the more “set” you property will be for the future – especially when it comes time to sell your investment. Any new prospective investor will look at all your leases, see how set in stone they are, and a market valuation based on non-negotiable terms will be much easier to arrive at. And remember, the less future negotiating that’s required, the less turn over, with all its concomitant time, energy and fees (like commissions and repair costs) associated with installing new tenants.

Lease arrangement factors

Most property investors in commercial real estate want to try to negotiate triple net (NNN) leases with prospective tenants. In a triple net lease, a base rent is negotiated, and tenants are required to pay for all operating expenses associated with their premises. These long term leases tend to also build in rent bump increases pegged to some inflation average. This helps the landlord avoid future negotiations with his tenants. As mentioned above, it also helps “set” the future market value of any given commercial property.

Allotments for options

Commercial tenants and landlords tend to be diametrically opposed on the key issue of allowances for renewal options. While tenants like them for the ability to reevaluate their expense and space needs every few years, landlords want to ensure that tenants stay in place as long as possible, with rent increases set in stone in terms of regular inflationary bumps. So commercial landlords tend to be very stingy with requests from prospective tenants for any form of lease term option. Keep in mind that this may not always be a good decision on the part of a commercial real estate investor.

While locking tenants in is great on one hand, it also can be damaging on the other, in the fact that a landlord must then live with his decisions for a very long time. If he wanted to change the make-up of his commercial building to attract a different class or type of business operation, he would not be able to do so if he had no options built in to the original lease with his tenant. This could also affect future valuation of his property if a landlord finds, down the road, that he is lagging behind in collecting current market rents. So sometimes, locking a set of tenants into no-option style leases can be ultimately damaging to a commercial property investor.

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Buying Investment Property For No Money Down

Myth or reality?

Ah, if it were only that simple…the most often-asked question in property investing has to be: can you actually purchase investment real estate for no money down? Well, I certainly have not. Nor have I heard of any other investor I know doing so. That said, in theory, there are ways to limit your own financial exposure in any investment property acquisition. Just don’t expect to find a situation where you can buy property completely for no money down. Investors tend to get pretty scared when they see you have no proverbial skin in the game. And then they either run away, or jump ship.

OPM made simple

Using other people’s money (OPM) is a tried-and-true formula many experienced investors have honed to a fine craft. Some ways of doing so involve seeking out owner-financing for a piece of investment property that’s on the market for sale, asking for greater loan to value ratios from your lender, asking for relatives and friends for unsecured loans for any given project, and partnerships (also known as joint ventures) where your partners take on partial ownership responsibilities with you (though not necessarily project control, or even any hands-on participation in the process).

Owner-financing

This is where most investors will begin in their efforts to reduce the amount of money they actually invest in any given piece of investment real estate. Finding a “desperate” seller is a good way to locate investment property where you can have the seller take back a large amount of the financing in paper supplied by them. The mortgage may be for a short-term, but if you work out a long-term amortization schedule (say, 30 years), your cash flow will be greatly improved. Most short-term mortgages given by sellers tend to be in the 3 to 5 year range. Afterwards, you can look to convert the mortgage to a standard one with your usual bank/lender that you have a relationship with already.

Also, keep in mind that sellers don’t necessarily have to be desperate to give owner-financing. If you “give” in price a little bit off of your negotiated amount, and pay a little extra, you may find that a seller is willing to offer paper in return for the increased price. Paper they had no intention originally of giving…

Greater LTV’s

Another option to lessen your actual cash outlay is to ask your lender for a slightly greater loan-to-value ratio for any given investment property. Most times a lender’s standards for investment property may be a top LTV of 70%. But if you shop lenders, you may find you can do a little better. In addition, consider buying a property where you become an owner-occupant. So, for example, if you purchase a three-family house, you can live in one unit and rent out the other two. In this scenario, since the property is also your home, you can apply for a mortgage under owner-occupied LTV ratios – which can be much greater than 70%.

Unsecured loans from family and friends

If you’re comfortable with this arrangement, consider borrowing funds for down payments and/or repairs and renovation from your family and/or close friends. You can download any number of promissory note blank forms online, see which makes the most sense for you, then ask your family member or friend to sign with you. The note will usually be for a specified amount of time, with a set rate of interest, with both principal and interest due at the end of the term.

If you give your relative or friend several points above what they could get from a bank, both you and they will be quite happy with the arrangement. Let’s say you offer them an interest rate of 5% on their unsecured loan. They’ll be happy receiving such a high return, and you’ll be ecstatic obtaining an unsecured loan at such a low percentage. A good deal for both parties. Keep in mind that you rather obviously better not default on your payout of the principal and interest – or Thanksgivings could become pretty icky in the future. So make sure you know your relatives and friends well enough to not mess with them in any financial sense. This rather obviously involves the utmost trust on both your parts. So make sure you know yourself and your relatives or friends very well before undertaking this scenario.

Partnerships

Lastly, consider partnerships (or joint ventures) with other investors. Some may not want the headache of being responsible for al the work that’s required once you’ve purchased the property. Some don’t want to be property managers. Others don’t want to do property renovation work. So they let you handle it – in return for a share of the operating and future sale profits, since they will become part-owners with you.

Counting the ways

All these ways of financing investment property are designed to lessen your overall cash outlays in any given project. You can use one or several of these techniques to help you keep you overall exposure down. Will you be able to totally pay for an investment property with no money down? Not very likely. But you can lower your total cash cost – and in so doing, lessen your own risk, as well as substantially increase your return on investment (ROI). Obviously, the smaller your own cash amount invested in a property, the greater your leverage – and the greater your ability to reap larger ROI’s on your minimal cash investment.

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Property Investing Safe Haven

Commercial property alternatives

It’s sometimes easy to get too staid as a property investor. If you’re used to residential investing, you tend to stick with it, thus placing most all of your real estate eggs in one basket. If you’ve been doing this for a while, you might want to consider a safer haven for part of your nest egg….commercial property. And by commercial property, it can run the gamut from office and retail space to more niche-oriented, but relatively safe property investments, such as medical office space, hospitals and nursing homes. The entire medical care industry is a safe bet for tenancy in the mid to long term periods.

Building your safety net

You’ll soon discover that locking up tenants for long term leases is a whole lot safer and more predictable, let alone less expensive to administer, than finding tenants each year for every one of your residential rental units. The time factor of not having to constantly be advertising, screening, doing financial and background checks, and dealing with a multitude of residential tenant emergency issues makes renting to commercial tenants a great boon as an alternative.

Office buildings, for example

Consider the benefits of office buildings, where many leases with a wide range of tenants over multiple lease terms helps to increase their overall return on investment, relative to residential property. When one tenant in an office park leaves, the effect will be minimized on the overall performance of the building, compared with residential rental unit buildings, especially smaller multi-family dwellings with less units than apartment houses.

In addition, if you own commercial property, you’ll certainly be negotiating for longer-term leases than only one year. Typical commercial leases will range between three to five years on average. Some, a lot longer, depending upon how much remodeling work a business has to do prior to moving in. The more upfront costs they have to incur to get their store ready, the longer the lease they’ll be looking for, in order to help them amortize the total cost of their renovation in your building. On the other hand, a two year lease in residential property would be considered long. And then you have to spend the time replacing any tenant when they leave.

The upshot of the longer term leases in commercial property? Simple…you’ll be able to plan better, as well as realize a greater degree of security and consistency of cash flow by having longer-term tenants. The steadiness of the income stream is one of the chief advantages of commercial property over residential investments.

Other benefits of commercial property

There are several other key benefits of investing in commercial property relative to residential investing. Consider that commercial real estate offers a wonderful buffer against inflation. This is because most tenant leases, since they are mid-to-long term in nature, have bump-up increases in yearly rents. This acts as a hedge against inflation. This helps build in increased valuation for your commercial property over time. In addition, there tends to be less market volatility amongst commercial buildings. Especially ones that are at or near capacity for rentals. Relative to residential buildings, commercial property will show a much flatter growth line, with fewer sharp spikes or dips.

Lastly, commercial real estate offers the ability for certain tax breaks that may not be available for residential property. For example, if building or renovating in a central city a municipality may be offering commercial property owners certain tax-deferred tax breaks to spur construction in their city. This is just one type of tax benefit that may be available to commercial property owners relative to residential investors.

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