Invest in Real Estate With a IRA

Marilyn  fed up with her financial planner. He had invested the 57-year-old’s Roth IRA in stock mutual funds that tanked in 2008, and then he put it in bond funds that yielded next to nothing. So in late 2009, Cotterman, a quality assurance manager at a printing company in Brownsburg, Indiana, decided to move the $40,000 she had with her planner into a self-directed IRA so she could invest in mobile homes.

Today, Cotterman says her investments yield double-digits and her portfolio is a multiple of that initial $40,000. Because her self-directed account is still a Self Directed Roth IRA, her gains and income accrue free of taxes. “We bought a $6,000 mobile home and fixed it up,” she says of her first IRA real estate purchase. “We found someone who wanted to buy it for $10,500. We sold it to them but held a promissory note on the home so that they have to pay us $215.34 a month over a six-year period.” After factoring in costs, Cotterman says she's earning 15 percent on her $10,000 promissory note.

While most retirement accounts let you buy only paper securities, self-directed IRAs offered by companies such as Equity Trust (the company Cotterman uses), Guidant Financial and The Entrust Group allow individuals to invest directly in hard assets such as real estate and gold bullion. Such IRAs, which have annual account fees ranging from $125 to about $300, have become increasingly popular. “Our asset growth rate has normally been about 15 percent a year, but this year it’s 25 percent,” says Hubert Bromma, chief executive of the Entrust Group, custodian for $3 billion in self-directed IRA assets.

Today's hot real estate markets are distressed ones in Florida, Nevada, Michigan, Arizona and California. Many of the sellers are people who got ahead of themselves in the housing bubble and now wind up renting in the same neighborhood. That makes the rental market stable while the housing market is depressed -- the ideal scenario for a real estate investor. “In every major metropolitan market, you face the same issues,” says Jeff Desich, chief executive of Equity Trust. “There are people now who need to rent and can’t get credit any more to buy, so there's a pool of homes that have been reduced dramatically in price.”

Tax twists

Self-directed IRAs are complex legal structures that, if managed incorrectly, can lead to stiff penalties from the Internal Revenue Service. The primary mistake is any appearance of self-dealing, where you benefit financially or otherwise from the property in the account before the minimum distribution age of 59 1/2. That means if your IRA owns real estate, you or any immediate family members can’t live in it or get any rental income from it directly. Otherwise, you could invalidate the status of your IRA account and be subject to a 10 percent tax penalty for the account’s value.

Moreover, all repairs, management and property tax costs must be paid with the IRA’s funds. So you must either have a buffer in the account to pay for unforeseen expenses, or hope that the annual maximum allowable IRA contribution, currently $5,000, will cover costs. You can’t even make repairs by yourself without your own “sweat equity” being considered a contribution to the account. Desich recommends that investors keep 5 percent to 10 percent of their property’s value in liquid securities such as cash or bonds to cover future repairs.

Nor can investors employ a traditional mortgage to finance IRA properties. An IRA account doesn't allow its owner to be held personally liable for any unpaid debt. The only permissible loans are so-called non-recourse loans that use the property itself as collateral. These have higher interest rates than conventional mortgages, and any income earned with the portion of the property owned with this leverage is considered outside the IRA and fully taxable. “Such loans aren't always easy to find,” says Bromma. The rates he sees range from 5 percent to 7 percent.

All-cash deals

As a result, most self-directed IRA real estate deals tend to be all-cash. For most people, the lack of easily available leverage creates concentrated portfolios of a handful of properties. That's why experts recommend multi-family rental properties with two to four apartments, instead of single-family rental homes; if you lose one tenant, you still have a second apartment rented. Las Vegas realtor Kirby Scofield, of Cosmopolitan Real Estate, has been selling such properties at prices ranging from $20,000 to $30,000 per apartment. Annual rental yields after expenses run from 12 percent to 25 percent at current prices, he says.

Cotterman has investments in 20 mobile homes, 10 of which are in her IRA. She prefers dealing with buyers because she feels they have more respect for her property than renters do. With her promissory note, she essentially becomes their mortgage lender and is still able to earn hefty yields because her properties are cheap and the value of the loans she offers is small. “Buyers don’t care about the interest rate, just the total monthly payment,” she says.

Her strategy has additional perks. Since her properties are in mobile home parks, the park managers do a lot of screening for her as to the credit quality of the buyers. Residents also have to pay lot rent to be in the parks. If they default, they often default on both their lot rent and Cotterman, so the park does the evicting for her. She’s had six defaults, but says it isn't a problem because of the low cost and high turnover. “You just turn around and sell the property to someone else,” she says.

Avoiding scams

Perhaps the biggest risk of self-directed IRAs isn't tenants bolting or tax twists but what you choose to put into it. Self-directed IRAs allow you to invest in things that aren't normally regulated by the SEC. Since companies like Entrust are just custodians, they don't check the legitimacy of what you buy. This lack of oversight is a magnet for scam artists with promises of easy returns. That's why in August the North American Securities Administrator's Association issued an Investor Alert citing these risks.

Entrust offers seminars that try to teach people how to avoid common scams. The most important thing is simply to make sure any deal is completely legit. "As people reach retirement age, they get desperate because they haven't saved enough," says Bromma. "They invest in things they know nothing about in an attempt to generate big returns. Unfortunately, there are so many bad people out there operating Ponzi schemes, trying to rip people off. Due diligence is the biggest thing people aren't doing.

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How to Play a Real Estate Game

For investors, the real estate roller coaster ride continues. They made billions -- probably trillions if you add it all up -- flipping houses, leasing offices and constructing condo towers. Then the real estate market collapsed, throwing the U.S. into the 2007-2009 recession.

Now the prognosis for real estate investments is looking much better, though it's anything but simple. Some commercial real estate has rebounded, with investors craving income that real estate provides, while residential real estate -- particularly single-family homes -- may be at once-in-a-lifetime bargain prices.

Bloomberg.com asked four top experts for their take on the the opportunities and potential pitfalls facing real estate investors in the coming years. Edited excerpts of their interviews follow:

Jim Sullivan, managing director of REIT research, Green Street Advisors

Every diversified investor should have some exposure to commercial real estate, and REITs [real estate investmenttrusts] provide a terrific, transparent and liquid way to get that exposure. Operating fundamentals in most property types range from good to great, with good being the shopping center business and industrial business and great being the apartment business. The economy is not doing great, but the silver lining for commercial real estate is how little new supply is coming on the market. Too much new construction is typically what puts a halt to real estate recoveries. This time around, it's just not an issue.

REITs tend to be specialized by property type. You can pick and choose, depending on what your economic outlook might be. If your forecast is a little rosier, you'd want to be in property types that respond well in economic recoveries -- hotels, for example, or REITs that own shopping centers with lots of small tenants. If you wanted to be a bit more defensive, health care REITs are a terrific place to be.

The question of whether REITs are cheap or not depends on what you compare them to. If you're thinking about selling bonds and buying REITs, that looks like a good trade. If you're thinking of selling some of your S&P 500 [stock funds] to buy REITs, that's a trade that doesn't look as good today as it might have a year ago. I have to throw out a warning that there's a whole world of REITs called "non-traded REITs." Unlike publicly traded REITs, the valuations are hard to discern and there are a ton of fees for individual investors.

John Burns, chairman and president, John Burns Real Estate Consulting

The biggest opportunity is buying distressed single-family homes, because that market has been completely beat up. The next biggest opportunity is buying land because very few people have been focused on it. If you have a long-term view, you'll probably see a significant multiple return. Buying land is a complicated business, though. Mom-and-pop investors should not be buying land.

Investing in apartments has gotten very expensive in gateway cities like New York, San Francisco, Los Angeles and San Diego. I'm not going to say those are bad investments, but you're paying a premium to get in those markets. There are opportunities for B- and C-class properties in the non-gateway cities like Phoenix, Dallas, Houston and Chicago. Renters are in for a rude awakening over the next three years. They're going to get significant rent hikes, which is going to cause far more of them to start looking at home ownership.

Lauren Pressman, director of investment research at wealth management firm Aspiriant

The U.S. is in a period of sustained but very slow growth. Job reports are huge factors for real estate, because jobs create demand for housing, for offices, for travel and at retail establishments. We're wary of things like retail and office, except in very unique circumstances. Multifamily real estate (apartment buildings) arguably had all the tail winds at its back to do the best of all asset classes. However, be careful. There is so much capital chasing multifamily, and that can lift prices beyond a point where your return is commensurate with risk.

Our overriding philosophy now is to look for opportunities that don't require a strong recovery to make money. So, for example: debt. Instead of bidding on apartment buildings, funds will provide debt for a new apartment owner. They can provide it at fairly high interest rates because debt is very hard to come by these days.

We're very cautious. You need to choose the right asset with the right manager with the right business plan. If you go and buy something because you think rents are going to go back to 2007 levels, that's not a good strategy.

Jack Chandler, global head of real estate, BlackRock

We're very focused on cities we think are going to compete for jobs. As opposed to 2000 to 2006, when there was job growth everywhere, it's much trickier. There is going to be a much bigger spread between the performance of winners and the losers. So the New York, San Francisco, Washington markets are pretty fully priced. Secondary assets in secondary locations -- especially in areas that have not seen job growth resume -- have seen a very small amount of interest from the capital markets.

We like mezzanine debt [a form of debt that is riskier and thus pays higher interest rates than more senior, secured forms of debt]. In debt, as they always say, your upside is you get your money back. If you think equity is going to earn 6 to 9 percent over the next three to five years, and debt's earning 7 to 12 percent (while the debt has a more senior part in the capital structure), that's a compelling risk proposition. You give up the potential upside for the extra yield.

Forecloses in black,Latino neighborhoods get little maintenance

Foreclosed homes in heavily-black and Latino neighborhoods are far more likely to be left with inadequate maintenance than those in majority-white neighborhoods, according to a recent investigation by the National Fair Housing Alliance.
Investigators from the group looked at more than 1,000 foreclosed homes in nine major metropolitan areas around the country, including Gary Indiana,Detroit,Atlanta, Baltimore and Oakland and found patterns of unequal treatment of the foreclosed homes across the country.
"While REO (real-estate owned) properties in predominantly White neighborhoods were more likely to have neatly manicured lawns, securely locked doors, and attractive "for sale" signs out front, homes in communities of color were more likely to have overgrown yards littered with trash, unsecured doors, broken windows, and indications of marketing as a distressed sale," the report concludes, "REO properties in communities of color generally appeared vacant, abandoned, blighted and unappealing to real estate agents who might market the unit to homebuyers."
The alliance argues that not maintaining these homes will hurt minority neighborhoods, both discouraging people from buying the foreclosed homes, and driving down the value of other residences in those neighborhoods.
The report is the latest illustration of the damage caused by the foreclosure crisis, particularly among Black Americans.

Man Buys Texas Home For $16

Kenneth Robinson of Texas used an obscure law known as adverse possession to get the rights to a house for sixteen dollars

Propose Plan to Address Government Bank owned Properties

Radar Logic plans to publish a response to the government’s proposal to sell pools of foreclosed homes to investors to rent.

Federal agencies, including the Federal Housing Finance Agency (FHFA), HUD, and the Treasury Department recently issued a Request for Information and will be accepting proposals for how best to deal with the large inventory of foreclosed homes held by Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA).

While the current thinking is that selling pools of properties to investors under the condition that they rent them for a specified period of time – thus keeping them off the market in the short-term – is ideal, federal officials are accepting alternative proposals.

In its RPX Monthly Housing Market Report for August, Radar Logic expressed concerns that selling homes in bulk to investors might negatively affect home prices in the broader market.

“[U]nless careful steps are taken to prevent it, we fear that bulk sales of REO properties could have an adverse effect on the appraised values of homes, and therefore home sales,” Radar Logic states in its report.

Radar Logic believes the REOs sold in bulk to investors will come at lower prices than if they were sold individually – prices much lower than non-distressed sales, and these low prices could lead to low appraisals for other homes on the market.

“Even if local appraisers do not use the bulk-sale properties as comps, there are many automated valuation models (AVMs) that would likely incorporate the prices of those homes unless there was some way to designate them as bulk-sale properties,” Radar Logic states in its report.

Radar Logic also expressed concern that the bulk sales would translate to large losses on Fannie Mae’s and Freddie Mac’s books – losses that ultimately would be absorbed by taxpayers.

Radar Logic will present its two-step strategy of reducing the GSEs’ REO inventory to FHFA next month.

First, Radar Logic proposes there be no more foreclosures. Instead, all distressed mortgages would be restructured.

Distressed mortgages would be replaced with bundles of debt and equity securities, which would be distributed to investors.

Secondly, the GSEs would rent their REOs through private-sector property managers. The GSEs would continue to own the properties rather than sell them to investors to rent.

California Officials Take Down Foreclosure Rescue Fraud Ring

California’s attorney general and the state’s Department of Justice have taken down a fraud ring of legal firms and attorneys that officials say swindled thousands of homeowners out of millions of dollars by convincing them to take part in mass lawsuits against their lenders.

Attorney General Kamala Harris has sued Philip Kramer, the Law Offices of Kramer & Kaslow, two other law firms, three other lawyers, and 14 other defendants who are accused of working together to defraud homeowners across the country through the deceptive marketing of “mass joinder” lawsuits. Mass joinder lawsuits involve hundreds, or more, individually named plaintiffs.
Kramer’s firm and other defendants were placed into receivership on August 15. The legal actions were designed to shut down a scheme operated by attorneys and their marketing partners, in which defendants used false and misleading representations to induce thousands of homeowners into joining the mass joinder lawsuits against their mortgage lenders.
Defendants also had their assets seized and were enjoined from continuing their operations. Nineteen special agents from the California Department of Justice participated as the firms were taken over on August 17, along with 42 agents and other personnel from HUD’s Office of Inspector General, the California State Bar, and the Office of Receiver Thomas McNamara.
Fourteen office locations in Los Angeles and Orange counties and 16 bank accounts were seized in the massive sweep.
“The defendants in this case fraudulently promised to win prompt mortgage relief for millions of vulnerable homeowners across the country,” said Attorney General
Harris. “Innocent people, already battered by the housing crisis, were targeted for fraud in their moment of distress.”
It is believed that at least two million pieces of mail were sent out by the defendants to victims in at least 17 states. The defendants’ revenue from this scam is estimated to be in the millions of dollars.
“The number of lawyers who have tried to take advantage of distressed homeowners in these tough economic times is nothing short of shocking,” said William Hebert, president of the State Bar. “By taking over the practices of four attorneys accused of fraudulent marketing practices, the State Bar can put a stop to their deplorable conduct as part of our ongoing effort to protect the public.”
The California attorney general’s office says the defendants led homeowners to believe that by joining these lawsuits, they would stop pending foreclosures, reduce their loan balances or interest rates, obtain money damages, and even receive title to their homes free and clear of their existing mortgage. Defendants charged homeowners retainer fees of up to $10,000 to join as plaintiffs in a mass joinder lawsuit against their lender or loan servicer.
This mass joinder scam began with deceptive mass mailers, the attorney general’s lawsuit alleges. Some mailers, designed to appear as official settlement notices or government documents, informed homeowners that they were potential plaintiffs in a “national litigation settlement” against their lender.
No settlements existed and in many cases no lawsuit had even been filed, Harris says. Some consumers lost their homes shortly after paying the retainer fees demanded by defendants.
The Department of Justice has seized the practices of the following non-attorney defendants: Attorneys Processing Center, LLC; Data Management, LLC; Gary DiGirolamo; Bill Stephenson; Mitigation Professionals, LLC; Glen Reneau; Pate Marier & Associates, Inc.; James Pate; Ryan Marier; Home Retention Division; Michael Tapia; Lewis Marketing Corp.; Clarence Butt; and Thomas Phanco.
The State Bar has seized the practices and attorney accounts of the attorney defendants: the Law Offices of Kramer & Kaslow; Philip Kramer, Esq; Mitchell J. Stein & Associates; Mitchell Stein, Esq.; Christopher Van Son, Esq.; Mesa Law Group Corp.; and Paul Petersen, Esq.