I should have taken advantage more of sitting at home for most of 2020 by writing more. This topic has been on my mind lately as the stock market has been going in all different directions. To provide a refresher on this topic here is a link to my original post from 2013 on this subject. Let’s follow the journey from my 2013 transaction and see where it has gotten my client today in 2020.
If you have not gone back to read my post from 2013, I’ll give you a quick summary. Sometime around the end of 2012 a friend of mine had changed employers. He had roughly $131,000 in his retirement account. Somewhere along the way he discovered real estate investing through IRAs. To make a long story short, he formed a LLC, got an attorney to draft some paperwork and he was off to self directing his IRA into a real estate investment. He put about 60% down on a four bedroom 2 bathroom home in Clovis. We got it under contract for $177,000 and he was able to borrow about $77,000 against the home with a non recourse IRA loan. Non recourse means that if the loan defaulted or foreclosed that he wouldn’t get any negative impacts to his personal credit report. These loans function more like a commercial loan where the rents or rental survey justifies the loan amounts. So when you put enough money down, banks will lend on the investment if the Loan to Value ratio is low enough for them to accept the risks of having to foreclose, etc.
Fast forward to today and the loan that he took out in 2013 has been paid off by the tenants in his rental property. If I remember correctly it was a loan that was amortized over 10 years and he paid it off about 3 years early by contributing more towards the mortgage payments every month than what was required. So in 7 years time, my client turned $131,000 in retirement savings into roughly $300,000 in a paid off single family residence in Clovis. How did he get there so fast, more than doubling his money in 7 years? He got there by tenants paying off his loan balance and by property values increasing over the past 7 years. He was able to accomplish this gain in his retirement account over the past 7 years without contributing a single dollar to his retirement account since 2013. That right there is hard to wrap my mind around.
He enjoyed watching his retirement account grow so much through his self directed IRA that he wants to watch it grow again. On May 29th, 2020 he closed on his 2nd single family home in Clovis through his self directed IRA. How is he doing this you may be asking yourself? It is through a concept called leverage where he is leveraging someone else’s money. In this case it is the bank that is giving him a cash out refinance loan on the asset he owns free and clear and a purchase money loan on the home he is acquiring. Again, these loans are not based on his income, assets or credit. He is using non recourse loans backed by his IRA account. These are loans that not very many banks or institutions issue. I like to call these “Unicorn Loans.”
Back in 2013 there seemed to only be one or two institutions that brokered real estate loans based on ones IRA accounts. In 2020 we did some searching and found several more options available. However, upon calling on these so called IRA lenders we discovered that some didn’t lend in California or that most of their guidelines were so strict that they were not able to help my client accomplish his goal of buying a 2nd investment property. Most of these few other lenders were only offering interest rates around 6% or above and that simply killed the chance of this deal happening.
Before we found an investor who could guarantee us that they could do a cash out refinance on his current home and put it towards a down payment on another home, we secured a property in escrow that he wanted to acquire. He wanting something close to where he lived where he liked the curb appeal and knew it would be easy to rent to good tenants. That was on a Sunday in April. So Monday morning I contacted the bank who financed his original investment in 2013. But their guidelines were so strict and their interest rate sub par so we couldn’t use them. In panic mode now I was calling and e-mailing all of the IRA lenders we could find. Hope was growing dim that we could pull this off and actually close on this new purchase transaction. Surprisingly the seller and listing agent accepted our offer without a loan letter. But I assured them that we would be getting a letter to them soon.
These banks will only lend 40-60% of LTV typically and their CA guidelines are more strict because values are high in CA compared to the midwest and other states where most properties will cash flow at those LTV amounts. But banks didn’t just want to make sure that the rents would cover the mortgage payments. They want rents to be 125% of the mortgage payments to cover any vacancies, repairs or emergencies, etc. Another big qualifying factor is money in a reserve account. Most lenders wanted 15% of the loan balance in a reserve account for a rainy day. We had a couple banks who could do the refi but not the refi and the purchase loan. We were down to our last bank. It seemed promising what they were offering and we were hopeful. Their interest rates and reserve requirements were way better than anyone else we could find. We were quoted a rate of 4.5% on the refi and the purchase loan.
It was game on at this point. The low interest rate along with the 6 month principle, interest, taxes and insurance (PITI) reserve requirements made this deal possible again. The difference in reserve requirements meant that my client only needed about $13,000 in his rainy day account instead of around $45,000. That was a huge difference from other lenders. And the interest rate was only roughly 1% higher than what someone could get on their personal residence with an 850 credit score with a traditional real estate loan. I couldn’t believe the stars were aligning to make this deal work. My client was impressed that I found someone who could lend on the home he wanted to acquire. While he was busy with his day job, I was hustling phone calls and e-mails trying to source the financing for his retirement real estate needs, all while the 40 day escrow period on the purchase was ticking down.
At this point it was time to order the home inspection, termite inspection and get any other property inspections or investigations completed. The property checked out rather well, with only a handful of items we negotiated to have the seller fix or replace before the close of escrow. An unusual hurdle in this transaction was that we had to have two appraisal done. One appraisal on the 2013 acquired home for the cash out refinance where we were borrowing $148,000 from that home. About $12,000 of that was used to pay for the closing costs of 2 loans, the refinance and the purchase. Another $13,000 or so was held back in the reserve account. Roughly $120,000 of that $148,000 was used as a down payment for the purchase.
So something a little different about these IRA loans is that since they are based upon properties cash flowing to pay down the debt, the appraisers are required to do a rental survey. A normal residential real estate appraisal uses the comparative market approach where they are only concerned with the recent sales of like kind properties. There is an income approach element to these appraisals where the appraiser will give in their report an opinion of monthly rents for the property. That monthly rent value in the appraisal is what the lenders will use to determine if the rents are at least 125% of the principle, interest, taxes and insurance.
In order to not miss the forest for the trees, let me review what my client now owns in his IRA portfolio. He owns two single family homes in Clovis CA. with a current market value between $550,000 – $575,000. In 7 years he was able to turn $131,000 into $575,000 of real estate. Now, he doesn’t own this real estate free and clear, yet. His loans will be amortized over 25 years but he should have both homes paid off within 10-12 years. Loans on both homes are at 50% LTV or less and he’ll make extra payments each month on the mortgages to pay them down quicker. So in 10 years it will be hard to say what these homes may be worth. But if he rinses and repeats this process, he can build up a nice nest egg for him and his family without contributing any more towards his retirement plan. How cool is that? To see what other investment homes are available in Clovis CA. click here.
Self Directed IRA Real Estate Investment Success Story Clovis CA 93611