Hugh Bromma, CEO of The Entrust Group, an administrator of self-directed IRAs, knows from his own experience how important it is to maintain adequate reserves.
"I have two Florida houses in my IRA and I was getting $1,300 a month on each of the properties; I had a slight positive cash flow," he says. "But then both tenants moved out, and in Florida the real estate tax rates almost doubled, so I got a double whammy. My slight positive went negative because, when the tenants moved out, I still had to pay the mortgages. Fortunately, I had $10,000 extra in each account to pay for that eventuality which came to pass."
While Bromma is prepared for the downside of real estate investing, he cautions that many people aren't, and they should think twice about risking their retirement fund.
"A lot of people have gotten into real estate and thought they couldn't lose because the real estate market will go up forever. They bought property thinking it would appreciate, and a year later it's upside down and they have a real problem. It's not like buying a stock and thinking it will go up. You probably have more confidence in publicly traded assets and having an adviser who can say this company has a good track record, here's its performance, etc."
Not everyone thinks self-directed IRAs are a great venue for buying real estate. "I tell people to not use third parties in any real estate transaction," says real estate expert Lucier, who is firmly opposed to the concept. "You're going to get your best deal dealing directly with sellers and buyers without a middleman. (The custodian and property manager) are unnecessary layers that are stripping away money that should be coming to you. It's going to kill any positive cash flow in a lot of cases."
As with any investment, consumers should know how much risk they're willing to tolerate and whether they have the financial wherewithal to withstand any market downturns and the possible loss of their money. This may be especially critical when using a retirement fund. Some people may be better off limiting their real estate purchases to
real estate investment trusts, or REITs, or mutual funds that specialize in real estate.
Even if you plan to use someone to help you find properties, it's best to educate yourself about the various real estate markets that interest you. You should also speak with an IRA custodian to understand which types of transactions are allowed and which are prohibited.
If you're going it alone, Rice advises that in addition to a custodian, you should have a financial planner who will help you set goals; a real estate broker who will find properties; an attorney who will draw up leases, purchase contracts and the like; an accountant who can review all the numbers, and a title company.