WSJ Experts say your retirement Should include Real Estate Investments
By Karen Hube
From The Wall Street Journal Online
It seems that many retirees have a bit of Donald Trump in them these days.
In recent years, older investors have been increasingly buying second homes, land and commercial properties to shore up their nest eggs. While stocks were going nowhere after tanking in 2000, real-estate prices logged their biggest rise on record between 2001 and 2005, with an average annual 9% gain. Some markets, such as Las Vegas, Southern California, Phoenix and Miami-Dade County saw double-digit returns of at least 20%, according to the National Association of Realtors.
But with mortgage rates climbing and home prices in some markets falling, is there still a chance to make money in real estate? Or is the retirement and pre-retirement crowd better off stashing its dollars in a traditional mix of stocks and bonds?
The answer, according to financial planners and real-estate analysts, is that most retirement portfolios should still include some real estate.
That’s because land and property are “loosely correlated to the stock market,” says Seth Pearson, a certified financial planner in Dennis, Mass. In other words, the value of real estate tends to rise when stocks are going down.
At the same time, though, real estate should be a relatively small part of most nest eggs, no more than 20% of your overall portfolio, Mr. Pearson advises. And investors with dreams today of making a killing in residential and commercial property need to lower their expectations — sharply.
“You can’t figure on returns being what they have been, or you’ll be very disappointed,” says Christopher Cordaro, a financial planner in Chatham, N.J.
If you’re thinking about jumping into the real-estate game, or already have purchased a property or two, consider the following stories of three real-estate investors who followed differing strategies with varying degrees of success.
Buy, Fix and Flip
Flipping is the tactic that received the most attention — and notoriety — during the real-estate boom. It’s when an investor buys a property with the intention of selling it quickly — usually in less than a year — betting simply that the demand for, and value of, the property will increase significantly in that brief period.
Risky as it sounds, flipping became wildly popular in some markets. In 2005, short-term investors in parts of Florida, Nevada and Southern California posted annualized returns of more than 50% on average, according to First American Real Estate Solutions, a research firm in Santa Ana, Calif.
In one of the hottest markets in the Miami area last year, investors who flipped properties within three to six months scored an average annualized return of 150%.
The problem: Flipping today isn’t as lucrative as it was only a year or so ago. Given that many communities are now buyers’ markets, “it’s a lot harder to make money,” says Christopher Cagan, an analyst at First American. And the process isn’t as easy as it looks, especially because buying and selling real estate carries high transaction costs.
Terry Bryan, age 53, is a flipper. A retired stockbroker in Colorado Springs, Colo., Mr. Bryan decided to try his hand at real estate investing in 2001, after the stock market tanked. For the most part, his bets have paid off.
“I don’t get excited over a 10% return for the year,” Mr. Bryan says. “I put $10,000 down on a property” and walk away with $20,000. “That’s a 100% return, and I do that in six months.” He adds, though, that his real-estate investments are “really my full-time job.” He buys two or three properties a month, typically single-family homes or apartments.
Mr. Bryan says he has learned several lessons that help him steer clear of trouble in a cooling market. First, he buys a property only if he can get it for less than market value. The way to do this, Mr. Bryan says, is “to look for motivated sellers — such as someone going through a divorce or who has to move quickly — or properties in foreclosure.”
While that might sound simple, Mr. Bryan has had to build a network of close contacts, including trusted real-estate brokers, mortgage lenders, real-estate attorneys and members of local real-estate clubs. His goal: be the one they call when they hear of a great deal.
That’s what happened in August, when Mr. Bryan got a call from a Realtor he knows who told him about a home in foreclosure. “The owner had passed away and left the property in a trust, but the trust couldn’t keep up with the payments,” Mr. Bryan says.
He bought the home for about 30% less than its value; after paying transaction costs and maintenance and doing some work on the property, he estimates he will make about 10% on the deal.
If you think you might want to try your hand at flipping, one of the most important rules is to “have an exit strategy,” says William Bronchick, author of “Flipping Properties: Generate Instant Cash Profits in Real Estate.”
“If you can’t flip the property, will you rent it? Lease with the option to buy? Know the answers before you buy.”
Let Your IRA Do The Buying
Last year, James Burns, a 60-year-old lawyer in Bath, N.Y., considered buying real estate purely as an investment. But Mr. Burns faced having to sell some of his investments to free up cash to buy property. And he didn’t want to get stuck with a large capital-gains tax bill.
His solution: buy a property through his individual retirement account.
And he’s far from alone. IRAs have become increasingly popular vehicles for real-estate purchases in recent years. “That’s where many people hold most of their assets, and they haven’t wanted to miss the real-estate boom,” says Jaime Raskulinecz, chief executive officer of Entrust Northeast LLC, a retirement-plan administrator in Verona, N.J.
To buy property through your IRA, you need an IRA custodian that specializes in real-estate purchases. Typical IRA custodians — banks and mutual-fund companies, for example — buy stocks and bonds, but they generally don’t get into real estate because it’s more labor intensive to add to a portfolio and manage.
Mr. Burns sold shares of a stock index fund in his IRA and used the cash for the real-estate purchase. This avoided an immediate tax bill because all taxes incurred in an IRA are deferred until funds are withdrawn.
And when he sells the property, “I’ll be able to make money without paying taxes right away,” Mr. Burns says.
Once your IRA owns a property, you may not use the property for your benefit. “It must be considered an investment only, meaning you and relatives — parents, children, grandchildren — can’t live in it or rent it,” Ms. Raskulinecz says.
What’s more, you must pay for maintenance, upgrades or any costs related to the property with funds from your IRA.
Likewise, if you rent your property, income must go directly into your IRA.
But keep in mind that the rules governing this kind of transaction are complicated. One wrong move and you risk losing your IRA’s tax-sheltered status. That would mean owing income taxes on all of your account’s assets and a 10% penalty if you aren’t yet 59½.
Mr. Burns figured that raw land was the perfect IRA investment, “because there’s not much in the way of expense and not a lot of insurance to carry,” he says.
His 8.5-acre property on Lake Keuka, in New York, “is wooded, with a couple of streams running through it,” Mr. Burns says. “If I had bought a building, I’d have to generate income on it because the taxes and
insurance would be higher.”
Paul Zelnick wanted to buy a second home to use for a few months of the year in retirement. But the 64-year-old retired financial analyst from Chappaqua, N.Y., had a tall order: He wanted a charming home in a vacation hot spot that would appeal to renters and be a good long-term investment — all for no more than $400,000.
In the U.S., where properties in the hottest markets fetch closer to $1 million or more, that would be a pipe dream. But Mr. Zelnick found what he was looking for — in San Miguel de Allende, Mexico.
Like Mr. Zelnick, many retirees are looking to foreign markets for properties that are not only their dream homes, but sound investments as well. Among some of the hot spots with good deals: Panama, Honduras, Malta, Thailand and Malaysia.
But investing abroad comes with its own set of difficulties, says Tim Leffel, author of “The World’s Cheapest Destinations: 21 Countries Where Your Money Is Worth a Fortune.”
“You have to realize that things work differently in markets outside the U.S.,” he says, “and you have to play by different rules.”
Mexico has attracted numerous Americans like Mr. Zelnick because of its proximity to the U.S. But near as it is, its business practices are vastly different.
“Most real-estate transactions go off without a problem, but you have to be careful or you could end up losing everything,” says Raoul Rodriguez Walters, a financial planner in San Miguel de Allende. “For example, Mexico doesn’t have a real-estate board to regulate brokers, so you can get caught up in unprofessional situations.”
That’s what happened to Mr. Zelnick. Months after paying cash for a $365,000 property, he still hadn’t received the deed. Such delays are common enough in Mexico for Mr. Zelnick to be unconcerned, so he proceeded with some $50,000 of construction on his property, “knocking walls down to create bigger rooms, putting in new, bigger windows and creating two extra bedrooms upstairs,” he says.
But partway through the construction, he learned that five Mexican charities had laid claim to the property, and a judge ordered all work to halt.
As it turns out, the former owner had two wills: one in the U.S. and one in Mexico. The will in Mexico cited the charities as the beneficiaries of the property. Mr. Zelnick bought the property from the owner’s nieces in the U.S., who were named heirs in the U.S. will.
To make matters worse, one of the attorneys from the Mexican realty company that Mr. Zelnick worked with absconded with the cash.
“It’s all a huge mess, and it’s costing me,” says Mr. Zelnick, who purchased the property in late 2003, and had been looking forward to renting it out for some extra income. “Now I have to work through all of this, and it could be another couple of years before it’s all resolved.”
Check for our Articles on Investing in Real Estate inside Your IRA.
Brian with www.REISkills.com