Retirement Accounts & Real Estate How to Invest in Real Estate with your IRA : Case Study


Prepared for: Davis Real Estate Investments (DREI)


Prepared by:  Douglas  Wolf (senior advisor to DREI)



What caused me to create this case study is the excitement I have enjoyed since using my IRA funds to invest in Real Estate. To illustrate the power of investing in Real Estate I would like to share with you my own personal story. To take you back, the timeframe was the fall of 2007. At the time, I had over 85% of my retirement funds sitting in cash earning a paltry 4% interest or less. Mutual funds took up 10% and the other was stocks & bonds.



I was extremely frustrated because based off of my stock market charting knowledge and based off of where I saw the economy going, I accurately predicted the stock market was going to go down.  I did not want to lose my money, yet I couldn't find anywhere to invest. My wife and I spoke with several financial planners. One successfully convinced us to purchase an annuity with a small portion of our IRA. But, as soon as we got the paperwork back, we could see the annuity was not going to earn what the financial planner claimed it would.



When I read the fine print of the annuity contract, the way they calculated the annuity rates of return was different than what we were told. Yes, we could have cancelled the policy right there and gotten our money back. But, we were so frustrated from the process we just threw up our hands in disgust. We figured we would at least collect the 20% bonus the insurance company was adding to the premium of the policy.



Time will tell if that investment will ever pan out, but I am not betting on it. So back to cash we went. That was until I saw an article on Yahoo! Finance. That article discussed how you could diversify your IRA by purchasing Real Estate.  I thought... "Can I really do this?" So I researched it and researched it. I practically lived on Google for several days, reading article after article. I must have visited hundreds of websites.



I then talked to my accountant. I talked to a Real Estate lawyer. Finally, I called potential IRA custodians that specialized in Real Estate.



At the end of the day, I discovered... Yes I can buy Real Estate in my IRA. I was so excited. You see, Real Estate had just gone through one of the rare periods in time when prices actually did come down so there were some great buys out there.  My wonderful friend and mentor Andy told me how he had just bought this house in Southwestern Illinois just outside of St. Louis. He got a great deal from the builder and he was going to rent it out. Being near Scott Air Force base there was a big need for rental homes and not that many rental homes existed at that time.



Additionally, Andy told me how he found this great property management firm who specialized in renting out homes to military families. And best of all, this firm charged a very reasonable management fee to find renters, collect the rent, and make repairs when necessary to the home.



So, the first weekend of the year in 2008, my wife and I packed up the kids in the minivan and we drove to St. Louis to check out this subdivision. The builder had three homes left to sell in the subdivision and they wanted to move them fast.  Each home was almost 2,700 sq. ft. and each had a slightly different set of upgrades. The one I really liked had a brick front and an upgraded master bath. The list price of the home was just south of $200,000. Several of the models of this house sold in the subdivision for as high as $210,000.



The builder, because they wanted to unload the house in a tough market, dropped the price to $169,900. Even at that price, it would have been a great deal. But we negotiated further. A lot of people don't realize you can negotiate with builders just like you can with existing homes.



After negotiating further and securing additional concessions, I wound up purchasing the house for a net price of $163,800. This was for a home that others in the subdivision had paid up to $210,000 to purchase. I don't know about where you live, but compared to the Chicago area, to be able to purchase a brand new 4-bedroom, 3-bathroom home for under $164,000 was a great deal.  Since I was using my IRA, I was able to buy it with cash. That is the whole beauty of buying Real Estate in your IRA. By paying cash for the property, it significantly strengthens your negotiating capability and also reduces the pain if the property doesn't rent out for a while.



In my case, I wanted the home to rent quickly. My goal is to build up enough rental income in my IRA to where I could put down a nice down payment on a second rental home and try the whole process again. So I priced the rent out at $1,295 per month. After about a month and a half, the house did not rent out.



So, I went to the website of the property management firm I was using to see what other houses were renting for in the area. I saw that even though I was at the low end of the market, there were a few homes renting out for $1,275 per month. I thought to myself, well $20 a month is not that big of a deal to me, but maybe it is to someone on more of a fixed income. So I lowered the rent to $1,275 and gave two free weeks of rent to anyone that moved in during the month of April. Within a week of lowering the price and doing the promotion, the property management firm rented out the house. Success!



So let's take a look at the numbers. After closing costs, I basically purchased the home for $165,000 in out of pocket expenses using money from my IRA. I am earning $1,275 per month, actually $1,295 a month because they have a pet and there is a $20 per month pet rent. So I am earning $1,295 a month on $165,000. That comes out to 9% per year in income. Now, mind you that is gross income.



To protect the house, I needed insurance on the house. That was around $750 per year. Plus, I have to pay the property management firm their fee. Also, I also have to pay property taxes on the house. Then, of course there is normal wear and tear on the house that will require maintenance from time to time. And finally, it is not a given that the house will be rented out all of the time. In fact, it took me almost two months to rent it out the first go around so that is lost income.



Thus, if you look at it, at the end of the day, after you figure in all of the added costs both physical and opportunity costs my average rate of return was around 5%. That was about 2% more than I could earn sitting in cash at the time this book went to print as interest rates decreased further at the time. And, that rate of return will increase as I increase the rent over time.



You might not think an initial return of 5% is a great return. However, I left out one big thing... anticipated price appreciation. Just as I predicted, as soon as the builder sold the final house in the subdivision, even in arguably a terrible Real Estate market, the listing prices of the existing homes in the subdivision increased.



Just a few months after I bought the house, in one of the "worst" housing markets in history, the cheapest house for sale in the subdivision was listing for over $20,000 more than I paid for the house or over 12% higher. Over time, if Real Estate performs according to the typical rate of 1.5% more than inflation as quoted by the National Association of Realtors, then I should see some great appreciation above and beyond my initial 12%.



In fact, depending on what industry experts you believe, the value of a home doubles in anywhere from 7 to 15 years. In my case, I purchased this home as a retirement vehicle so I expect to hold it for at least 15 years.



So let's say, on the conservative side the house does double in price by the time I want to sell it. That means it would be worth over $330,000. But, on top of that, I will have collected rent for a good portion of that time. And, the rents I collect should increase and keep up with inflation.



To be conservative, let's say for every one year lease I sign, it takes two months to rent the house. That would mean over the course of 15 years, I will have rented it out for about 13 years of that time. So even if the rent never went up, which it will, in today's dollars I will have accumulated over $202,000 ($1295 x 12 months x 13 leases) in rental income. Subtract property tax, insurance and maintenance and I should still have about $120,000 in the most conservative scenario. And that doesn't count any interest received on that money. So that means my $165,000 investment in 15 years, very conservatively should be worth at least $330,000 + $120,000 or $450,000. If this holds true, that means my investment will have darn near tripled in value in the time I held it. And, that doesn't count investing the rental income which could easily take the account to well over $550,000 in value.



Not bad! And, please note, I am being very conservative here. In my calculations, I assumed a very modest rate of appreciation and I assumed no appreciation in the rent I can charge, I assumed 2 months of vacancy for every one year lease and I assumed earning 0% interest on the rental money I had coming in.



So, if you look at it, if I invest the funds properly from the rental income, if the house appreciates a little more than I stated and if I rent it out faster than my assumptions, it is very possible that my investment could even quadruple in 15 years.



Buying Real Estate is a great way to diversify an IRA


I certainly don't want to sit here and tell you to put all of your retirement money into Real Estate. Nor, do I want to try to tell you I am a genius. All I am trying to convey here is that the best way to retire wealthy is to have a diversified portfolio of many different kinds of investments including Real Estate.





Just bought my first investment property! Possession Oct. 7th! Thanks for being so inspiring and willing to share your knowledge Meshawn."

Stacey Jackson,  Regal Inc

“Meshawn has helped me in a number of different ways regarding real estate investing. She has opened my eyes to and taught me creative real estate investing, such as using a $2 deposit. Meshawn has been through many deals, has a lot of personal stories and many people have sought her advice. 

Brett Quilalang, New Real Estate Investor