Minimize risk in real estate investment
Non-recourse loans can shield borrowers’ other assets after default
In a recent column, we considered how an expensive waterfront property could be viewed in the eyes of the purchaser. While many consumers would consider the $12 million mansion the ultimate in comfortable living, it’s possible the place will not serve as the owner’s shelter, but rather solely as an investment.
Savvy investors buy assets because they foresee significant potential. Often, the “upside” is considerable, be it an undervalued stock, unpopular bond or unknown baseball player waiting for an opportunity to help a new franchise.
While you cannot purchase a baseball player with an individual retirement account, you can buy stocks, bonds and real estate. In fact, you can even finance a real estate IRA if you have a sizable downpayment and can document monthly income from tenants.
The challenge with real estate IRAs has been lack of funds to make a meaningful purchase. Historically, real estate IRAs have been purchased with cash, and the trust then held the property free and clear. One way to crack a huge financial nut was to get several investors to buy shares in one property.
Now, some banks are discovering the real estate IRA niche and granting a “non-recourse loan” to the trustee for specific properties. Non-recourse means if the loan goes into default and the lender needs to foreclose, the property would be the only asset the lender could claim. It’s similar to a non-judicial foreclosure, where the property becomes the lender’s only focus.
Seattle-based Pacific Crest Savings Bank is one local lender offering loan programs specifically designed for non-recourse financing requirements for purchases and refinances of rental properties. Representatives from the bank say they continue to get requests for customers seeking financing to purchase investment properties, allowing for diversification without tying up other retirement funds.
According to Larry Enselman, a non-recourse loan specialist at Pacific Crest, the bank provides mortgages for single-family homes, multifamily dwellings, commercial properties — even an RV park. Raw-land loans are problematic because there is no income from monthly rents.
Non-recourse loans typically are available for both purchasing and refinancing properties — including “cash-back” refinances that are structured to pull money out of one property for investment in another. Fixed-rate loans are the most common, yet three- and five-year adjustable-rate mortgages also are available.
The IRA-leveraged loan is made to the IRA or plan, not to an individual. Rules preclude an owner from using his or her personal credit to influence the loan. Since the loan is “non-recourse,” the lender can seek relief only from the secured property in the event of default and foreclosure.
The owner’s other assets cannot be claimed — similar to a “non-judicial” foreclosure.
The only advantage generally associated with judicial foreclosure is that it may be possible to obtain a deficiency judgment against the owner if the proceeds from the sale of the property are insufficient to satisfy the debt. A judicial foreclosure is usually more costly and time consuming because it requires court proceedings.
The typical customer of an IRA-leveraged loan usually has significant other assets. However, the lender is not making the loan to an individual; it is making it to the IRA. It’s a different twist, with different possibilities and guidelines.
Where the loan absolutely makes sense is with a small, traditional investment property like a duplex, triplex or fourplex in a good location. Unlike a vacation destination, income is not dependent upon seasons.
Rents would flow to a self-directed program administrator who would then make the monthly mortgage payment to the IRA-leveraged loan lender. The administrator also would make payments on taxes and insurance.
As mentioned previously, you cannot use IRA money to buy your own residence or any other property in which you live. It has to be an investment property. But when you retire, you can direct your IRA to turn it over to you as a distribution at the current market value.
Tom Kelly’s book “Cashing In on a Second Home in Mexico: How to Buy, Rent and Profit from Property South of the Border” was written with Mitch Creekmore, Â senior vice president of Stewart International. The book is available in retail stores, on Amazon.com and on tomkelly.com.