Choose an account type
August 8, 2018
Traditionally owners of self-directed IRAs or Solo 401ks have invested in real estate using just the funds in their accounts (meaning, without any financing); and the type of real estate purchased by these investors has primarily been residential (meaning a 1-4 unit property: a single-family residence, a duplex, a triplex, or a quad plex). An alternative that should be given thoughtful consideration is investing in commercial real estate (meaning an office, warehouse, or retail building which can each be single tenant or multi-tenant, or an apartment building), and this can be done using financing, which should also be given thoughtful consideration.
The main reason that more investors have not purchased commercial real estate is because the price point of such investments is so much higher than buying residential properties (say $1,000,000 for commercial real estate compared to $100,000 for residential real estate). The way that an investor (or a group of investors) could approach doing this would be to create a Limited Liability Company (“LLC”) that will hold title to the commercial real estate that will be purchased. This LLC could be owned by one or more self-directed IRAs or Solo 401ks. Each investor should certainly discuss the structure with their legal/tax advisor and/or self-directed IRA or Solo 401k administrator, but the general idea is that a handful of investors pool their resources that will provide the down payment and closing costs needed for the purchase of commercial real estate and an LLC serves as the owner of the real estate and as the borrowing entity.
An investor might consider using financing because it allows the investor the ability to purchase larger assets and benefit from its growth and income, all with a comparatively small out-of-pocket capital outlay. Another reason is because it can help an investor diversify their investment portfolio; both in product type (meaning they could invest in residential and commercial properties), and in quantity of assets (meaning that an investor could own more properties using leverage than they might be able to own using only their own funds).
The loan to finance such an investment (whether it is to buy commercial or residential real estate) must be what is called non-recourse. This means that the loan is one in which the self-directed IRA or Solo 401k account holders are not liable for repayment of the loan. The security instruments (meaning the loan documents) allow no recourse against any individual account holders or the balances of their self-directed IRA or Solo 401k funds. Using the LLC structure outlined above, in the event of default/foreclosure the lender can only look to the borrowing entity and to the property serving as collateral as the sole source of repayment. A non-recourse lender cannot pursue any owner of an IRA or a Solo 401k or pursue other assets owned by those account holders. So, the only recourse the lender has is to whatever the LLC itself has (and they are typically set up as single asset entities just to own a subject property) and to the real estate that is serving as collateral for the loan, and any income that said real estate may generate (this is because the primary loan documents that will be executed for this type of loan are just a promissory note, a mortgage, and an assignment of rents and leases, and no guarantee agreements).
Non-recourse loans are not common and even less common in which the borrowing entity (the LLC) is owned in part or fully by a self-directed IRA or Solo 401k or several of them. As such, the terms of such a loan will be more conservative (to protect the lender) than a loan that is not non-recourse (meaning that more money will have to be put down, the interest rate and fee may be higher, the interest rate lock period the term and the amortization may each be shorter). Keep in mind that while the down payment required for a non-recourse loan may be more than for a loan that is not non-recourse that only non-recourse loans are allowed when self-directed IRAs or Solo 401ks are involved, and the down payment is a lower capital outlay than if an investor just paid all cash, without any financing.
In addition to requirement that the loan being non-recourse, another thing to consider when financing a purchase is whether a tax may be due on the profits from the leveraged real estate. An investor should consult with their tax advisor and/or IRA or Solo 401k administrator.
The investor should find out from the lender several things such as:
To recap, using an LLC is a good vehicle for investors to use to purchase commercial real estate and the funding of the LLC can come from monies in a self-directed IRA(s) and/or a Solo 401k(s). If an investor wants to leverage their purchases, then they should find an experienced commercial real estate lender that has made non-recourse loans before that is also a good communicator and prides themselves on managing people’s expectations.
Authored by Tim Hendricks,
Vice President/Commercial Real Estate Lender with Citizens Bank of Florida.