Real Estate for your IRA
Stock Market at an All-Time High
The stock market is known for its volatility and unpredictability. Just recently, the S&P 500 tracked higher than ever breaking seven consecutive record-high scores in July. While the most fundamental financial advisor will encourage you to hold steady through the cyclical ups and downs while continuing to make regular contributions into your portfolio, it’s never too late to explore alternative investment vehicles such as real estate. This is especially true if you’re planning to retire within the next decade.
Market Cycles
History has a tendency to repeat itself, so let’s recall some of the market’s history. The first financial market crash of the 21st century, the “dotcom bubble”, resulted from significant attention from media and other sources spiking demand for speculative technology and internet stocks. As a result, news coverage and attention outweighed fundamental analysis. Stocks in these companies rose 582% between 1995 and 2000, but in under two years, the NASDAQ proceeded to drop by 75%.
Not long after, the market experienced one of the worst economic downturns since the Great Depression, known as the 2008 Housing Crisis. Unqualified individuals had been purchasing homes which became labeled “subprime” and were then sold off the original lender’s balance sheets into large portfolios as a means of mitigating risk. As one household after the other began to default on their loans, large banks in possession of these portfolios were either forced to declare bankruptcy or had triggered government bailouts. This became known as the Great Recession. From 2007 to 2009, half of all U.S. households lost 25% of their net worth, while a quarter of households lost at least 75%.
The Opportunity Cost on a Retirement Portfolio
As an investor with retirement on the horizon, there are two concerns to ponder when looking at market cycles. First, what if an unexpected recession struck a household nearing retirement who is holding the majority of their retirement in a 401k consisting of stocks and bonds? The last thing someone wants to do after working hard their entire careers is to go to bed at night wondering if their retirement funds will be able to support them–or worse, if they need to postpone their retirement?
Second, let’s remember the Great Recession lasted nearly 6 years from start to finish for the market to rebound. If a household held all its money in the market through the crisis, and made no additional contributions, it would take around 5-6 years for their retirement account to recover. If a household had $2 million in a 401k, 50% of the fund was in equities, they contributed $2,000 monthly, and the average ROI was 8% (after all things considered), then a 6-year stalemate represents an opportunity cost of nearly $800,000.
Why is the Data Relevant?
The National Bureau of Economic Research notes there have been 10 recessions between 1948 and 2011. This averages out to a recession every 6.3 years. While most recessions won’t be as harsh as the Great Recession or the 2008 Housing Crisis, it would be foolish to ignore the market cycles. Given today’s market continuing to break records, why would you not consider alternative investments?
Real Estate to Hedge Market Turbulence
Real estate presents a unique opportunity because positively-performing assets can be acquired in times of economic prosperity as well as turbulence. When the market is soaring, most who own real estate benefit from appreciation. When the market takes a turn, however, it doesn’t mean real estate investments fail– it means the strategy changes. Outlined below are ways real estate can be a great alternative investment for your portfolio.
Value-Add Real Estate
A variety of strategies in real estate allow profitability in a down market. One strategy commonly employed is value-add investing. You can dive deeper on this topic on our “What Is Value Add Property?” blog, but it involves renovating a neglected property, bringing rents to market value, and reducing expenses of managing an asset.
For example, let’s evaluate a theoretical multi-family property that is riddled with crime, vacancy, late-paying tenants, and an overwhelmed owner. With a good strategy and experienced team, there are measures that can be taken to reduce crime, attract reliable tenants, and implement a sustainable asset management plan. Therefore, a property like this can be purchased at a discount and be restored for significant returns.
Ground-Up Construction
Another real estate strategy is investing in ground-up construction. There are multiple ways for a company to capitalize on land. One way is simply finding land at a discount. An example of this would be finding a land owner willing to sell 5 acres of land for $5 million, and after purchasing the land it appraises for over $6 million! Immediately, prior to the construction of anything, the company gained $1 million (20% return) in equity on their balance sheet. This example is not a rarity in rapidly appreciating markets like Dallas and Houston.
Lets say, using the same scenario above, you’re able to benefit from economies of scale by constructing a large 200 unit apartment complex. Because material and labor are being bought in bulk a company is able to construct the 200 units for $175k per door. At the same time, comparable units in the given submarket are going for $215k per unit. Well, since the company was able to save on material and labor costs by purchasing in bulk, they’ve captured over a 20% return by simply constructing the building. Now the company has options. They can rent out the units for cash flow, refinance the property to pay investors back their initial investment, explore selling the building, all the while providing great tax breaks for investors.
How You Can Invest in Real Estate Deals
If you are an individual or household contributing to a 401(k) consisting solely of stocks and bonds, there are established ways of “rolling over” your retirement funds from a 401k to a self-directed IRA- free of taxation if you don’t touch the funds (not necessarily relevant if you are 59.5 years of age or older). While there are annual contribution limits to a self-directed IRA, there are no initial rollover limits. This means if an individual or couple wanted to diversify from their 401(k) consisting of stocks and bonds, into something like real estate, they could deploy any initial amount of funds. Read more about self-directed IRA on MSC’s Blog.
Lets say, using the same scenario above, you’re able to benefit from economies of scale by constructing a large 200 unit apartment complex. Because material and labor are being bought in bulk a company is able to construct the 200 units for $175k per door. At the same time, comparable units in the given submarket are going for $215k per unit. Well, since the company was able to save on material and labor costs by purchasing in bulk, they’ve captured over a 20% return by simply constructing the building. Now the company has options. They can rent out the units for cash flow, refinance the property to pay investors back their initial investment, explore selling the building, all the while providing great tax breaks for investors.
Why MarketSpace Capital for Your Portfolio?
MarketSpace Capital’s Partners, Advisors, and Consultants are veteran real estate professionals. Starting off in 2012 with one property valued at $3.2 million, MSC’s portfolio has grown to nearly half a billion of assets under management. MSC specializes in value creation by providing a path in (primarily) multi-family opportunities through entitlement, development and construction, as well as a value-add and opportunistic investment strategy.
The MarketSpace standard for pursuing an opportunity is around 20% IRR for its investors. While that remains the standard, MSC’s last 7 exited strategies produced 28.7% investor level IRR. Comparatively speaking the S&P 500 has returned 10.2% annually if bought at inception in 1956 and held through 2020. However, that return is BEFORE management fees, and a typical portfolio structure consists of 30-50% (depending on age) of low-yielding bonds. Even foregoing the possibility of retiring around a recessionary period, it’s clear a 10.2% annual return from stocks and bonds long-term is not a reality.
If not anything else, real estate as an alternative investment in your retirement portfolio is worth exploring. Reach out to us at Info@Marketspacecapital.com, or leave a message on our Website
Lets say, using the same scenario above, you’re able to benefit from economies of scale by constructing a large 200 unit apartment complex. Because material and labor are being bought in bulk a company is able to construct the 200 units for $175k per door. At the same time, comparable units in the given submarket are going for $215k per unit. Well, since the company was able to save on material and labor costs by purchasing in bulk, they’ve captured over a 20% return by simply constructing the building. Now the company has options. They can rent out the units for cash flow, refinance the property to pay investors back their initial investment, explore selling the building, all the while providing great tax breaks for investors.
By: Josh Leonhard
FAQ
Value-add deals are those in which the transaction’s sponsor makes an active effort to elevate the income stream of the property, typically through a significant capital improvement program such as a partial or property-wide renovation.
A self-directed IRA is an individual retirement account, provided by some financial institutions in the United States, which allows alternative investments for retirement savings.
About Us
MarketSpace Capital, LLC is a Houston, Texas-based private equity real estate development firm focused on ground up developments and value-add investments throughout the United States.
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Disclaimer: *For sold properties, actual sales price is reported. For active investments, the Estimated Current Value is based on the Managing Member’s estimate of current value. Recent acquisitions are generally valued at the acquisition price. Values may be internally prepared. This web-page/website is for informational purposes only and is qualified in its entirety by reference to the Confidential Private Placement Memorandum (as modified or supplemented from time to time, the “Memorandum”) of any offering of MarketSpace Capital.
