Northern Colorado Real Estate Investors GroupContact: Paul--Mammoth Property Management, Inc.Telephone: (970) 419-8245When: Last Monday of every month, 6:30pmWhere: Downtown Public Library, 201 Peterson St., Fort Collins
Northern Front Range Investors AssociationContact: Michele LarsonTelephone: (970) 214-3627When: 4th Thursday of each month, doors open at 6:30pm fornetworking, meeting at 7:00pmWhere: Windsor Rec Center, Windsor
Buying and selling real estate is certainly one potentially profitable way to invest the funds in a self-directed IRA, but it is not the only real estate-related investment strategy.
Our story begins with a real estate broker, Jack, who was working with a client to try to sell a $200,000 property. The property had been on the market for about one year. Jack had found a potential buyer, Emma, who placed the property under contract. Emma had lined up a loan for $160,000, but still needed $15,000 to fund the purchase. Her lender was not willing to increase the amount of the loan since Emma had not worked during the past two years. Jack was concerned that the deal was going to fall through.
Byron, also a broker, was an acquaintance of Jack’s. Jack was aware that Byron was interested in sound opportunities to loan money to fellow brokers’ clients. Byron had a self-directed Entrust SEP-IRA with a balance, at that point, of roughly $250,000. Jack brought Byron and Emma together, and Byron agreed to have his self-directed IRA lend her money. He was able to negotiate the terms of the loan directly with Emma, however the actual lender documents could only be signed by his IRA administrator on Byron’s behalf.
Byron offered Emma two loan options. One, a first mortgage on the property for $175,000, with a 30-year amortization, at a fixed rate of 7.825%. This was just a little higher than the bank’s current rate. The deal included a 1-point fee for the loan.
Alternatively, Byron was willing to complement the bank’s loan, if that is what Emma preferred. This meant lending her $16,000 for a second mortgage, with interest-only payments for three years. At the end of three years the loan principal would be due. Byron set the interest rate at 8%, with a $500 fee.
Keep in mind that Byron alone assessed the relative risk in making these loans. He also set the terms of the loans. He was well aware that his IRA administrator could not advise him on these matters.
Uncomfortable with balloon payments, Emma decided on Byron’s first option for $175,000. She negotiated with Byron to increase the loan slightly to cover the cost of the 1-point fee. Ultimately, Byron reduced the fee to ¾ point, and set the amount of the loan at $178,000.
With the parties agreed on the terms, Byron called his title company to have them prepare the loan documents, carefully instructing them that the lender was his SEP-IRA (Entrust, FBO Byron IRA.) He then contacted his local Entrust office to provide them instructions for funding the closing. He had them make sure that all matters regarding the loan were carefully finalized. This included making sure the loan was properly recorded, that the trust deed secured the note with the property, that insurance on the property was in place, and that Entrust FBO Byron IRA was listed as loss payee for up to the amount of the loan. His Entrust office then sent a wire transfer from Byron’s IRA for $176,665 to closing ($178,000 less the $1,335 fee).
Meanwhile, Emma had found a job, and was doing well. She proved completely reliable, consistently making her required payments. Per instructions, she made these payable to "Entrust, FBO Byron IRA," but she mailed them directly to Byron. Byron tracked the payments, properly noting both the interest and principal amounts, prior to forwarding Emma’s check to Entrust.
Byron did have the option of hiring a loan servicing company to handle the payments. The servicing company would have kept all the details for the loan, and handled reporting to the borrower. The loan servicing company would forward the payments to the IRA once recorded.Emma’s credit rating had improved so after six months Bryon decided to sell the note to another lender, whom we will call Plancomp, Inc. Plancomp evaluated the loan, which then had a balance of $177,245 and determined that the market rate for the loan was about 6 ¾. They agreed to buy the note at an interest rate of 7.125%.
Since the note was already paying interest at 7.825%, as Emma and Byron had initially agreed, the value of the note—$189,722—was more than its balance. The note purchaser sent a check to Entrust FBO Byron IRA, who then, at Byron’s instruction, assigned the note to Plancomp, and Plancomp promptly took over servicing the loan
Let’s review the outcome. Byron’s IRA invested $176,665, and received back $189,722 plus six monthly payments totaling $7,706, less expenses of $295 paid to Entrust for their administration services. This is a net gain of $20,469, or more than 11%, in six months.
Byron now has about $270,000 in his SEP-IRA and is only too happy to remind brokers to come to him if they have clients having trouble getting a loan.
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