Does the "R" in IRA stand for real estate? If you know the ropes, it just might. Though most investors are unaware of it, Internal Revenue Service rules surrounding IRAs allow for a broad range of investments beyond traditional stocks and bonds. These include both developed and undeveloped real estate, gold and platinum bullion, and tax-lien certificates.
Why hadn't you heard of this before? It's fairly simple: Most investment companies that administrate IRAs don't sell these types of investments, so they're not interested in promoting them. Thus, though they often still refer to their accounts as "self-directed IRAs," typical brokerage firms won't offer these investment choices -- be they discount firms such as Ameritrade (Nasdaq: AMTD ) or full-service brokers such as Merrill Lynch (NYSE: MER ) or Citigroup's (NYSE: C ) Smith Barney.
However, a small but growing number of companies offer custodial services for truly self-directed IRAs -- ones that allow the alternative investments mentioned above in addition to all the traditional ones.
What does all of this mean? Say you've been driving around town and you see a piece of waterfront property that's selling for $250,000. (And for those of you thinking, "Yeah, right, where on God's green Earth are you going to find waterfront property for 250 grand," it's just an example, so stay with me here.) You're already quite familiar with the area, so you check the public records available on the Internet and note that this same property has changed hands five times over the past 20 years and the price has jumped 100% each time. In your estimation, the property is still comparatively undervalued, and even if it isn't, you believe you could well double or triple your money again over the next 10 years.
Though you recognize that stocks have historically doubled one's money every 7.2 years or so, that hasn't been your experience, and you feel a lot more comfortable with something that you know -- something you can see and feel.
You, of course, want to be able to buy this type of investment, rather than watch your tech stocks fall through the floor. And moreover, because it's long-term in nature, you'd like to be able to buy it within your IRA.
So far, you have $300,000 sitting in your IRA that's done nothing over the past five years, and again, you'd be much more comfortable buying land you're familiar with than stocks you know nothing about.
Well, it's your lucky day. A truly self-directed IRA will not only allow you to purchase this property with your IRA assets, but, for a fee, it will also administrate the closing process and ensure that you don't run afoul of the highly complex IRS rules surrounding these transactions. Even if you think you can handle this solo, you can't do so without an administrator because IRAs are technically separate legal entities and must be held by a custodian. You can choose the custodian, though.
There are a handful of prominent firms, but my favorite is Trust Administration Services Corporation (TASC), a subsidiary of California banking firm First Regional (Nasdaq: FRGB ) . As with most investment options, you have a combination of services and fees from which to choose. TASC offers custodial services for IRAs of all kinds (i.e., regular, Roth, SEP, and SIMPLE), allows any investment not prohibited by the IRS, and charges significantly lower fees than competing custodians. Given the relatively few providers in this arena, fees have a broad range and in many cases can add up to thousands of dollars per year. However, TASC offers the best range of services at the lowest price point I've seen.
I recently had the pleasure of chatting with TASC president and CEO Jim Wagner, who impressed me with his knowledge, candor, and commitment to his growing customer base. According to Wagner, his company has "no interest in hoarding assets in order to charge customers percentage-based fees." He added, "Our only interest is in establishing long-term relationships with our IRA customers and providing them with outstanding service at a reasonable price. Basically, we navigate our clients through this complex arena, and we do so fairly and equitably." He also pointed to the growing popularity of real estate as an IRA investment choice, saying that more of the company's new account holders are choosing to invest in real estate and that real estate makes up 65% of its new account assets.
Average fees for a "real estate IRA" at TASC can total several hundred dollars per year, which is a good deal better than the thousands per year charged by some competitors. In my cursory search, I found TASC's fees to be anywhere from 25% to 75% less than comparable custodians, particularly for larger account holders.
You can't leave your house nowadays without hearing how someone made a gazillion dollars flipping investment properties. Success stories aside, however, investing in real estate isn't for everyone. It takes exactly the same expertise to make consistent, low-risk profits in real estate as with any other investment -- namely, extensive knowledge of both the investment and its market.
The bottom line is that real estate can be a great investment, but you must use the same prudent approach in this sector as you would with any other asset. After all, we're talking about your retirement, and being forced to pitch a tent on one of your investment properties won't exactly light up your golden years.
Beyond that, I would be quick to point out that this is simply a cursory view of what can be a complicated field. In other words, if you think this is something for you, great, but do your own research, and do a lot of it.
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As one who has recently taken the plunge into waterfront property, Mathew Emmert feels your pain. Of course, the only flipping he'll be doing is off his dock. Mathew owns none of the investments mentioned in this article, but he is the advisor of Motley Fool Income Investor. The Fool is real estate owners writing for real estate owners.