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Bite of Real Estate

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09-14-2005

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by Stacy Delo, Market Watch

STACY DELO, host: In San Francisco, I'm Stacy Delo with MARKETWATCH. Everyone these days seems to want a bite of the real estate market; it's been quite hot. And one option that you may not have considered is putting individual retirement accounts--retirement account or IRA dollars to work in real estate.

And joining me to talk a little bit about how that works is Hugh Bromma. He's CEO of the Entrust Group and also author of his book "How to Invest in Real Estate and pay Little or No Taxes." Thanks for being here, Hugh.

Mr. HUGH BROMMA (Entrust Group): Thank you, Stacy.

DELO: So let's start a little bit of exactly how this works; you can actually buy real estate property with your IRA dollars, correct?

Mr. BROMMA: That's correct.

DELO: So tell me how that works. What are you buying? Are you buying residential, commercial?

Mr. BROMMA: You're buying residential primarily; it's all going to be investment property. You can't live in it; neither can your relatives. But residential, commercial property, small commercial property, it can be leveraged or you can have an undivided interest with other people in it.

So you can have groups of people buying the same property, and that now goes into an individual retirement account or a 401(k) for that matter, and then all of the profits come into the plan. And any expenses go out of the plan.

DELO: So let's say I'm 31 years old and my IRA might not be able to purchase a property in the Bay area, but if I were to collect a number of people, then I could team up with them and buy property? How does that work?

Mr. BROMMA: Exactly right--that's exactly right. That or you can get what's called a non-recourse loan, and there are some non-recourse lenders that will lend you the money, or your IRA the money, and you can use that as a methodology as well.

DELO: What's the risk involved there, though, if we've heard all the speculation that we may be at the end of the housing boom here? Is it unlike investing in stocks or mutual funds where you're taking a risk? It's a different kind of risk, though, when you're investing in real estate.

Mr. BROMMA: That's correct, and real estate has its risks related to it, depending on where you are in the market. So one really has to know the marketplace, and one of the things that we are very, very much in favor of is people getting an education, really knowing what they're buying and seeing where they are in the market.

And also that, if it is debt financed or encumbered, that they're able to rent that particular property out to cover at least a mortgage payment.

DELO: So because it is an IRA, you're not paying taxes on the appreciation that you would make on the property, but you are paying taxes on the property. Correct?

Mr. BROMMA: That's correct. So there's no tax on the appreciation, or if you sell it, there's no tax on that; or income, there's no tax on that. But your regular property taxes do have to be paid from the individual retirement account or the 401(k).

DELO: So does that make this a more expensive investment then? I would imagine you're also playing--paying maintenance fees and other types of property things that come up, that you have to get a new heating system, or something like this. You're responsible for that because you own it.

Mr. BROMMA: That's right. Your IRA owns it, so the IRA has to pay for that. So you have to make sure that you have enough income in the IRA to make sure that the payments are covered. So from the point of view of an investment, think of it as a long-term investment, that there is appreciation and also that if it is debt financed, you do get some income tax advantage for that particular portion.

DELO: OK so one thing I thought was interesting was that you can actually, and correct me if I'm wrong but you can actually take the house as a distribution after age 59 and a half. You could take the house and live in it then?

Mr. BROMMA: Yes, you can.

DELO: OK.

Mr. BROMMA: And at that particular time, if you took the whole house as a distribution, then you'd have to pay tax at your ordinary tax rate at that point. So you're going to have to be very careful to evaluate at what point in your life do you want to take it or do you want to sell it. And just take the cash that you have from it.

DELO: OK.

Mr. BROMMA: It's a matter of personal choice.

DELO: Well how much money are they generally coming to you with? Are they people closer to retirement age? Are they people just out of school? What types of people are you finding attracted to that?

Mr. BROMMA: Well the mean age is 49 so that's pretty late, all things considered. Considering you can start taking it out at 49- or 59 and then at 70-1/2 if it's a traditional, not a Roth IRA.

DELO: Right.

Mr. BROMMA: Again, at that particular point you must take mandatory distribution. The Roth IRA, that's the tax free one that we really like and those individuals have come to look and appreciate the value of what it is that they have in their market at an earlier age than most people. Most people are a little over 50 that get into their IRA's for the first time.

But we have individuals as young as 19 and people as old as 70 who are getting into that marketplace. Dollars are anywhere from $10,000 to $6 million. So we have a broad range.

DELO: OK.

Mr. BROMMA: The net asset value is about $68,000 in equity that people have in these types of accounts.

DELO: I see. So what's the benefit then or the difference of investing in say a REIT where you would have somebody else who owns the portfolio of properties handles all of the maintenance and pays the taxes, what not? Who makes the investment decisions and you just own a share of that and benefit from any upside?

Mr. BROMMA: And REIT's are wonderful and a lot of our customers, about 8,500 of them are involved in those kinds of private investments. So the REIT is a hands off, trusting somebody else, knowing what the REIT is. There are private REIT's that are smaller REITs that have a little bit more control or understanding. Those are great vehicles that people do use.

If you want hands-on, you actually by the real estate itself, along with partners and business associates or with leverage.

DELO: So if we are to get a dip in the housing market and people have put their retirement dollars to work in these types of IRA's, real estate, individual retirement accounts, how do they protect themselves from losing their shirt, so to speak? Especially if they've taken out adjustable rate mortgages or put something down with little to no down payment?

Mr. BROMMA: Yeah, that's a real interesting good question. And when you have an adjustable rate mortgage, you really have a lot of risk. So one has to really carefully evaluate the marketplace and the risk, whether or not they want to have an adjustable rate mortgage. That may be very, very good in a market where they tend to flip the property, in other words, sell it right away.

But if somebody's saying I'm going to have this for my retirement in ten to fifteen, twenty years from now, or even 40 years from now, then there's less risk with today's mortgage rates than having a fixed rate mortgage say for 30 years. So it's really a matter of evaluating what you want to do with your portfolio and when you want to sell it or get out of it or trade it because you can trade these properties.

So an individual must be involved in the actual purchase of that asset and know what they're buying. Buying at the top of the market as you suggest with an ARM with very little down is not a good idea if you plan to buy and hold. But it can be an effective strategy if you're going to flip it in the next 90 days.

DELO: Be interesting to watch what happens if we do get a dip in the housing market.

Mr. BROMMA: That's right.

DELO: What would you do then?

Mr. BROMMA: Well at that point, if you have a buy and hold strategy you're in the right place.

DELO: OK. Just like any other investment, you should know what you're doing.

Mr. BROMMA: That's exactly right.

DELO: Thanks for dropping by Hugh.

Mr. BROMMA: Thank you.

DELO: Nice speaking with you. I've been speaking with Hugh Bromma, he's the CEO of The Entrust Group. I'm Stacy Delo with MarketWatch.