The current real estate market presents significant opportunities for entry into the world of real estate investment. With prices lower than in years past, smaller investors are able to build a portfolio of residential rental properties with far less capital investment, while others are looking to the still-profitable apartment industry for their financial gain.

The trouble which smaller investors face, however, lies in the fact that financing the acquisition of investment properties is more difficult. Lenders are wary of outlaying their funds on more real estate (especially single family residential real estate) and the passive investors who were involved in the prior real estate boom are investing elsewhere these days. These two factors have led to an increase in an often misunderstood method of financing real estate investment: the self-directed IRA.

Ask many attorneys, CPAs and financial advisors the question “can I buy real estate through my IRA?” and the answer you hear oftentimes is “no”. That answer, however, is the result of a lack of understanding of how the IRA rules work and/or a concern that answering truthfully could lead to a loss of business (such as a loss of assets under management).

A “self-directed” IRA is an IRA where the IRA owner directs how the IRA funds are invested. The IRA is administered by a custodian who handles the inflow and outflow of funds from the account. There are several companies throughout the U.S. that serve as custodians for self-directed retirement plans. These companies do not give investment advice; to do otherwise would make them fiduciaries. Instead, they recommend to their clients qualified advisors that understand self-directed investments – attorneys, CPAs and financial advisors – and who can provide the necessary advice.

Self-directed real estate investing works best when it is done through a limited liability company (“LLC”) funded by IRA funds. A qualified attorney sets up the LLC, the custodian signs the contribution agreement on behalf of the IRA which is the owner of the LLC. Use of a LLC allows a separate bank account to be created and IRA funds to be deposited into the account. The LLC manager then can write checks for expenses related to the properties and deposit rent checks and the like. Ask most custodians and they will tell you that they prefer the use of the LLC as it eases the time and burden placed upon them for their clients’ investment activities.

Use of self-directed IRA funds, however, is not without its pitfalls. Owners must be aware of the Internal Revenue Service’s regulations on IRAs, particularly the self-dealing provisions. These rules prohibit transactions between the IRA and certain disqualified persons (the IRA owner, his/her spouse, parents, children, siblings, spouses of these persons and/or entities in which they are owners). For example, an individual cannot set up an IRA LLC and hire (and pay) a management company owned by the owner’s spouse to manage the properties.

In addition, investors who use self-directed funds are not permitted to engage in some actions that would otherwise be permitted absent the use of IRA funds. An IRA owner cannot perform work on properties which are owned through the IRA (whether they be owned directly through the IRA or by an IRA LLC). Similarly, IRA owners are prohibited from personally guaranteeing loans made to the IRA LLC.

Why all the restrictions? Because when an IRA owner takes distributions before age 59½, significant taxes and penalties are applied. The “prohibited transactions” referenced above are deemed by the IRS to be distributions and hence engaging in these types of transactions defeats the very reason why an individual would establish a self-directed IRA as an alternative to liquidation of their traditional IRA.

The use of self-directed IRA funds is not just limited to individual investors acquiring property. Multi-owner LLCs can be created which allow several investors to pool their self-directed funds to acquire larger-scale properties such as multi-unit apartment buildings or income-producing commercial properties.

Self-directed investing is a concept that is gaining widespread acceptance, especially in light of the current difficulty in using more traditional financing methods for acquiring real estate investment property. However, this financing method requires proper planning and careful consultation with qualified professional advisors in order to navigate the myriad of restrictions placed upon IRAs.

In my first post, Real Estate Investment Series Part 1, I explained some basic information about buying your first investment property. While its not completely impossible, in most cases, being a landlord is not just simply collecting a rent check. Are you ready to leap out of bed at three in the morning when a tenant calls to say that the bathroom in the apartment above is now flooding his bedroom? Are you ready to interact with potential renters, deal with screening them, managing your cash flow?

I client of mine has been investing in real estate for several years. He is good at it because he has a business sense and he is extremely careful. He’s been burned in the past by not putting enough time and energy into his properties.

One of the most common mistakes first time landlords make is not properly screening potential tenants. You need to be willing to do your homework. Getting a credit check on tenants is very inexpensive. Also make sure to get rental references and actually call to verify them. Even though a tenant has a good credit history, does not mean they haven’t had issues paying their rent or didn’t damage property in the past. You have to be willing to take the time to do the research.

If being a landlord is not for you, you can hire a property management company to do it for you. Property management companies often charge a percentage of the rent or a flat fee. That will make life easier for you however this will also take a cut at your profits. Anything you can do yourself will put more money in your pocket. But if you can’t handle doing it, don’t. It will cost you more money in the end.

You will also need to educate yourself on landlord-tenant rights. Small mistakes in paperwork due to lack of education will cost you big time. Every city/state has its own requirements. In Minnesota, you can find some information here.

This may seem a lot to take on but if you do your homework. To many, this is the perfect time to get into it. If you do it right, you will be able to enjoy being a landlord and be able to build your wealth at the same time.

The old saying in real estate that it’s “location, location, location” is not necessarily the last word when it comes to commercial real estate transactions. Whether it be a buyer or a lender, the key to a successful commercial transaction is oftentimes the income stream the property generates, particularly from its tenant or tenants. Thus, a commercial tenant has a more significant role vis-à-vis third parties with whom the landlord wishes to do business than in the residential leasing context.

Commercial leases typically address the tenant’s role in commercial transactions with a paragraph such as this:

Within ten (10) days after written notice from Landlord, Tenant shall provide an estoppel certificate to Landlord and such other party as is directed by Landlord certifying: (a) that this Lease is in full force and effect and that it has not been assigned, modified, supplemented or amended in any way (or identifying any assignment, modification, supplement or amendment); (b) the date of commencement and expiration of the Term of applicable Renewal Term; (c) that there are no defenses or offsets thereto (or stating those claimed by Tenant); (d) the amount of Base Rent or Additional Rent that has been paid in advance and the amount of security that has been deposited with the Landlord; (e) the date to which Base Rent or Additional Rent have been paid under this Lease; (f) that any Tenant improvements have been completed in accordance with the requirements of the Lease; and (g) such other information as is reasonably requested by Landlord. Tenant hereby irrevocably appoints Landlord as its attorney in fact to execute such a certificate in the event the Tenant shall fail to do so within ten (10) days of the Landlord’s notice.

Estoppel certificates are an essential component to any commercial real estate closing, be it a sale or a loan. Prospective buyers and lenders want assurances that nothing looms on the horizon to interrupt the income stream which they are buying or lending on, as the case may be. With a paragraph such as the one above, a commercial landlord has a means of inducing its tenant to provide such assurances (assuming of course, that none of the issues referenced in the certificate do, in fact, exist).

Came across this article the other day in the Wall Street Journal in regards to real estate investing about triple net leases being a hot deal with the surging commercial real estate market.

The article reflects some of the same things that we are seeing here in the Twin Cities area. Investors whether single or pooling money together are starting to jump back into the local market.

Why? Higher cap rate returns and small businesses growing into new spaces.

From the WSJ:

Are you overlooking a commercial real-estate boom?

If your definition of the category is limited to splashy office parks and shopping malls, both of which took a pounding during the financial crisis and haven’t fully recovered, then you probably are.

But think a little smaller—like fast food-restaurants, convenience stores and gas stations—and the returns get bigger. Such ventures, known as triple-net-lease properties, are “the best-performing sector of the commercial real estate marketplace,” says David Bailin, head of global managed investments for Citi Private Bank, which serves ultra-high-net-worth clients. “It is the sector that lost the least value [during the recession] and rallied the quickest.”

Triple-net-leased properties or NNN in short are leases where the tenant typically pays for everything associated with the property. For instance: rent, maintenance, taxes, et al. NNN leases some times also require longer terms in the amount of years for the lessee.

Since the property is relative low maintenance for the investor, all they really have to do is collect a rent check.

Let us know if you are a commercial real estate investor and want to update your Triple Net Lease Property Portfolio, we’d be happy to help.

flickr photo cred: jessica @ flickr of Starbucks