Best Investments For an IRA (SDIRA)?
Investor · New York City, NY · Member since 2015 · 808 posts · 417 votes
I have recently been evaluating what to do with my IRA. I first thought I would use it to do crowdfunding investments but I believe they gives you part of depreciation deduction in most cases so I lose that valuable deduction (though the gain on sale would be tax free). As such, I am not sure it is the most efficient investment and the same applies for owning homes in the IRA, not to mention the headaches with UBTI and other issues (doing work yourself etc.).
The other option most people talk about is note investing but the amount I have is less than $100K so the people I know that do notes and HML at greater than 15% returns won't take me. I know you can't lend the money to yourself. I could obviously lend but rates are coming down and 12% is a decent return but I could defiantly find better uses for the money.
Does anyone have any better ideas for using SDIRA money? Or am I mistaken about my analysis above?
The best use of your IRA is the asset class that provides you with the best mix of security and return. That can mean different things for different investors based on their experience, age, network and location.
@Daniel Dietz Makes an excellent point that I often make myself. Where there are limitations or potential tax implications internal to the IRA - while something you surely want to understand - should not distract from the real analysis of what is the net return to the IRA.
The IRA money is what it is, and is treated differently than after-tax money in all investment scenarios both in and out of the stock market. Comparing IRA investments in real estate to after tax investments in real estate is comparing apples and oranges.
If you can get 12% on notes, is that better than other things that you could invest the IRA into? If not necessarily superior in overall return, is it a good, consistent return relative to other riskier assets?
Same for rental property. The net return you can expect from cash flow (with appreciation being a bonus if you get it) should be compared to other investments the IRA could make with respect to risk-reward. A deed to real property does not evaporate when the news gets into hype mode over the small economy of a country 1/2 world away.
Leverage is a powerful component of IRA investments into real estate. You cannot leverage in the stock market with an IRA. You cannot leverage into the purchase of notes (easily anyway), but you can leverage the purchase of real estate with a non-recourse mortgage. This does introduce a tax implication with Unrelated Debt-Financed Income (UDFI) but the tax cost is generally pretty low and your IRA should certainly receive a higher cash-on-cash return than with an all cash purchase of the same property.
If you search some of my older post you will see that I have given my opinion (for what it is worth) extensively on this subject, mostly from a buy and hold rental perspective in SDIRAs.
A summary would be, that at least in my area, and in my case - 90%+ of my liquid assets are in my IRA Accounts, that is DOES make sense to use a SDIRA for real estate investing.
Lets say you can get a 15% return without the benefit of depreciation on a cash flow basis, and maybe 20% with appreciation thrown in. Is that a return to turn down *just* because you loose the deprecation benefit? I would say no, at least to me.
IF you leverage a buy-n-hold in your SDIRA, where taxes *might* come into play, then depreciation *also* comes into play, so that at least 'on paper' (just like outside of the SDIRA) it often looks like there is no 'profit' for there to be a tax on. Returns can run 15-20% without appreciation factored in and up to 30% when the appreciation is factored in (I figure 2.5-3% in my area).
I am just starting to look at Note Investing which is foreign to me (I work construction so know housing etc...) but seems attracktive due to the passiveness of it.
Looking forward to see what others say here too.
Dan Dietz
I would not say its a small portion of my net worth but its also not a big part of it. So yes if I did not have a good amount more there would be no choice but assuming I can do other strategies outside the IRA the question is really more what is the most efficient use of the IRA assuming you are well funded elsewhere but like everyone else can always use more funds and in this case are diversifying strategies (syndicated deals, flips and buy and holds)
The best use of your IRA is the asset class that provides you with the best mix of security and return. That can mean different things for different investors based on their experience, age, network and location.
@Daniel Dietz Makes an excellent point that I often make myself. Where there are limitations or potential tax implications internal to the IRA - while something you surely want to understand - should not distract from the real analysis of what is the net return to the IRA.
The IRA money is what it is, and is treated differently than after-tax money in all investment scenarios both in and out of the stock market. Comparing IRA investments in real estate to after tax investments in real estate is comparing apples and oranges.
If you can get 12% on notes, is that better than other things that you could invest the IRA into? If not necessarily superior in overall return, is it a good, consistent return relative to other riskier assets?
Same for rental property. The net return you can expect from cash flow (with appreciation being a bonus if you get it) should be compared to other investments the IRA could make with respect to risk-reward. A deed to real property does not evaporate when the news gets into hype mode over the small economy of a country 1/2 world away.
Leverage is a powerful component of IRA investments into real estate. You cannot leverage in the stock market with an IRA. You cannot leverage into the purchase of notes (easily anyway), but you can leverage the purchase of real estate with a non-recourse mortgage. This does introduce a tax implication with Unrelated Debt-Financed Income (UDFI) but the tax cost is generally pretty low and your IRA should certainly receive a higher cash-on-cash return than with an all cash purchase of the same property.
True assuming everything I said ( I can, do and will participate in all those activities just a matter of where) and adding that I am in my early 30s with decent experience (or at least the ability to trust those that have it) I think that due to the rules and tax implications around the IRA and various strategies I would assume there are more efficient and less efficient ways to use your IRA and I would imagine someone like you has seen the better uses and the worse uses.
Your point is correct. We have seen clients experience good results in rental property, flipping, hard money lending, tax liens/deeds, venture capital and a whole array of other investment classes. We have also seen clients struggle in the same range of assets. Success will really depend on expertise, effort, network, focus, etc. regardless of the asset class.
Generally speaking with regards to real estate, folks who know what they are doing can achieve excellent results in leveraged real estate with the right properties. This takes a higher level of education, tax/legal support, and time commitment.
Notes are a good asset class for those who want a simpler, less time-intensive approach. Of course, within notes there are easier and more difficult approaches such as buying up performing notes from an investment provider (turn-key) to shopping for discounted, non-performing notes.
In a perfect world, one would create a portfolio that has a nice balance of different properties and notes of various types in different markets to achieve diversity - as well as perhaps some traditional equities/funds, maybe some precious metals as a hedge, etc.
A budget of $100K could most likely be placed into one or two key investments. One factor to consider in addition to risk/reward is liquidity. As you accumulate earnings, you may want to be able to roll forward into bigger and better deals - or more separate deals. Notes will generally provide more liquidity or quicker turnover than property - but that depends very much on how you invest in either class.
Despite working with thousands of IRA investors for the last 10 years, I would not be in a position to say, "Notes are always better than rentals" (or any similar statement with different asset classes), for example. Results vary for different investors. Economic cycles also come into play, so what may work well now might not be the strongest choice 2 years from now. In 2010 when property values were in the tank but rental rates were strong, we did see a stronger preference for rentals vs notes, for example. Today I would probably put them as about equal, but with different advantages and disadvantages to each. We have been in a window of about 2 years where flipping is a solid opportunity in some markets, but that might stall out in another 12-24 months depending on what the economy does.
I know the above is not an "answer", but perhaps a means to ask the questions that will lead you towards what is best in your situation.
My preference is to invest in notes or options only, not real property. Keeps things very simple.
I prefer to hold notes in my retirement account and property in my personal name for the tax benefits. However, everyone's situation and investments are different and there might be cases when it would make sense to own real estate in a retirement account.
Here is my example: couple years ago I came across really good deal on a rental property and I didn't have the ability at that time to acquire it in my personal name, but I had funds in my 401k so I purchased it in my retirement account. My annual return on investment is over 20% so it made perfect sense to me in that situation.
The key piece is that retirement accounts such as solo 401k plans and IRAs are tax shelters and are meant to be used for long-term savings. Once these two items are understood, the next key concept is to understand the importance of diversification and to be aware of ponzi schemes since IRAs and solo 401k are often a target of since they are long term investment vehicles. Therefore, just because someone is offering a 12% or more return doesn't mean that at the end of the day your retirement account will benefit. As such, it is best to diversify your retirement account into an investment mix such as physical real estate, precious metals, equities and annuities, to name a few.
@Charles Worth, look forward to our chat, I just might have some ideas for you...