Challenges in Self-Directed Real Estate Investments

A small percentage (4%) of Kiplinger survey participants said they, or someone in their household, had previously invested in Real Estate through a self-directed IRA. According to these experienced investors, top challenges include:
  • Finding property with value potential
  • Obtaining financing
  • Picking a property manage


Asset sponsors such as Growth Equity Group specialize in helping investors overcome these kinds of obstacles. Read on for a brief discussion of the solutions GEG offers to identify great properties, obtain non recourse financing and manage properties in compliance with the rules for self-directed IRAs.


Identifying properties

When it comes to investing in real estate in general, eight out of 10 Kiplinger survey respondents say that selecting properties with valuepotential is the most challenging part of the process. Survey participants also identified two major elements of the value proposition: ensuring a consistent income stream and planning or accounting for capital improvements.


Growth Equity Group is an expert at identifying markets with value potential. “We’re constantly scanning the nation for three specific types: urban markets, college towns, and emerging markets,” says Despenas. “The point is to identify the right time in the cycle to buy into a market that is going through exponential growth, has a solid
existing tenant pool, or has a growing millennial population, the majority of which are renters.”
GEG’s pursuit of investments in the state of Virginia is a great example of how their acquisition strategy pays off. “Virginia has been a big market for us the last 18 months for two reasons,” says Immel. “The really huge indicator was the $6 billion Panama Canal expansion. Over the past 25 years, ships have gotten increasingly bigger. They are so wide that they can’t fit through the existing locks.” That’s why a new, wider lock is set to open by the end of 2015 or early in 2016.


Because of the expansion, an opportunity exists: “There’s only one port in the United States that’s wide enough and deep enough to allow for these box and container ships, and that is the Port of Virginia. “It’s incredible what’s happening in this area,” he says. “Population is expected to double. They say it’s going to have a $60 billion impact on the economy.”


The other reason is the abundance of growing college towns in Virginia. “We did a deal in Williamsburg, right down the street from William & Mary,” says Immel. “And we just completed a deal in Harrisonburg, six blocks from James Madison University.”
Over all, GEG has purchased 292 units to date in Virginia because of the unique opportunities available statewide. It ensures the value proposition of these properties (as well as others) in two critical ways:


  • Securing a consistent income stream. Every property that GEG sells comes with a Rental Assurance guarantee. “We do extensive due diligence,” says Immel. “For example, if we buy a 177-unit building, we look at the five-year trailing rent roll to see the trends within the complex. But we also realize that it isn’t fair if out of those 177 units … 176 of them are great, but one of the tenants loses a job two months into it. So we’ve implemented a program where we cover tenant occupancy for the first year of ownership. We want consistency across the board.”


  • Planning for capital improvements. GEG rehabs all investment properties that aren’t new construction. Thus, investors can reasonably expect that major expenses become limited in the short-term. “If you intend to hang on to the asset for 20 plus years, then you can build up the cash flow as a fund to update the unit down the road,” says Immel. “But if you’re hanging on to this for five to seven years, you shouldn’t need to be making major expenditures inside the units.”

Securing financing

Most Kiplinger subscribers who had purchased real estate through a self-directed IRA struggled to secure a nonrecourse loan. In fact, only 6% of these investors reported having no trouble.
As mentioned previously, nonrecourse financing is required for SDIRA real estate purchases because the buyer cannot extend his own personal credit on a property held in a SDIRA. This is part of the requirement for arm’s length separation.
Nonrecourse loans, however, can be difficult to obtain. “There really are only a couple of nationwide banks that provide nonrecourse financing for individual investors, and they’re very small institutions,” says Despenas. As a result, the organizations can be very selective.
“They’re only funding a fraction of the hundreds of deals that come to them each month,” explains Immel, “at interest rates between 6.5% and 8.5%. So their money is very expensive. Outside of that, the only non recourse money available is hard money [from private investors], which is going to cost anywhere from 9% to 14%.”
Buyers who cannot secure nonrecourse financing often must pay all cash for the property, which results in losing out on one of the biggest benefits real estate investing provides. “We developed a chart (with actual numbers on a property one of our clients recently purchased) that demonstrates the impact of leverage on potential returns,” says Despenas. See “Cash vs. Leverage” on page 14.
This loss of potential is why GEG proactively secures nonrecourse financing, with excellent terms, for investors on all properties it sells. The firm’s ability to secure affordable asset-based loans stems from a combination of factors:
  • A history of buying, developing and managing millions of dollars of real estate investments nationwide.
  • Prior relationships with lenders who are familiar with the way GEG selects and develops its properties.
  • Bulk buying power which results in significant equity positions for the end buyer.
  • A reputation for securing phenomenal assets in phenomenal markets.

Managing the property

As discussed in the previous section, to avoid improper use of the IRA, self-directed real estate investors may not manage the property or make repairs themselves. They must hire independent third parties to perform those functions.
“Many investors mistakenly believe that loopholes exist allowing them to circumvent these rules,” says Despenas. “Some think it’s OK as long as they don’t get paid or as long as they have set up a limited liability corporation (LLC). A few simply believe that they won’t get caught,” he adds.
Another problem is that many investors lack the experience necessary to identify a good property manager and contractor. Even if you find a good manager, buying properties outside your area can make it difficult to communicate effectively. “It’s hard to keep your finger on the pulse of your property from far away,” says Immel.
Growth Equity Group helps minimize these difficulties in several ways. First, it only sells new construction properties or units that have been recently renovated. That decreases many of the repairs a real estate investor typically would face in the first years of the investment.
Additionally, there’s always an experienced, locally based property man agement team in place. And investors have access to an online tool called GEG Manager® that helps them monitor activity on their properties. The tool makes it easy to check monthly statements, view work orders, and download documents. It all becomes as simple—and as passive—as tracking an online investment account.
To further minimize risk, GEG offers a thorough tenant screening process which includes background and credit checks, rental history verification, as well as verifying prospect financials. “As property managers, we’re not just collecting rent,” says Immel. “We’re here to preserve, protect, and enhance the owner’s investment.”

Embracing alternative investments

Even some sophisticated investors can be reluctant to use retirement money to invest in alternative assets such as real estate. While a majority of Kiplinger survey respondents say they are aware it is possible to invest in alternative assets within an IRA, only a small percentage had ever done so.
What’s holding them back? For some, it’s the perceived hassle of avoiding improper use and prohibited transactions. “We completely understand that,” says Immel. “ERISA says that you have to be passive in this investment, so our investment is extremely passive. The fact is that we’ve never had an investor who had trouble with compliance on one of our properties.”
Others stick with traditional investments because of comfort with the status quo—even if it means foregoing potentially higher returns. Both Immel and Despenas, however, say this reluctance is fading. It will continue to erode as more people hear of friends and family who have experimented successfully with self-directed IRAs.
What’s more, GEG is committed to educating its investors about the potential of self-directed real estate investments. “I think the true difference between us and any competition out there is the amount of time that we spend educating our clients about the nuances of the process, even just individual prospects that are looking at the strategy,” says Despenas.
“We don’t sell real estate and say good luck,” agrees Immel. “Whatever our clients’ goals are, whether they want to pay off the investment and retire with it or sell it within three to four years, we’re with them through the entire investment period.”
Learn about the types of properties we have available
Leave a Reply

Your email address will not be published.