The Power of Self-Directed IRA Investing

Mike: Welcome to the FlipNerd.com podcast. This is your host, Mike Hambright, and on this show I will introduce you to VIPs in the real estate investing industry, as well as other interesting entrepreneurs whose stories and experiences can help you take your business to the next level. We have three new shows each week, which are available in the iTunes store, or by visiting FlipNerd.com. So without further ado, let’s get started.
Hey, it’s Mike Hambright with FlipNerd.com, welcome back for another exciting VIP interview where I interview some of the most successful real estate investing experts and entrepreneurs in our industry to help you learn and grow.
Today I’m joined by Preston Despenas. He’s a senior partner and cofounder of Growth Equity Group, a residential real estate firm focused on pairing together investors interested in passive opportunities and financing, and cash flowing rental properties.
Today we’re going to talk about the power of self-directed IRAs and how you could use IRA money to invest in real estate or to lend to other investors. There’s a lot of misconceptions, and today we’re going to uncover some of those. Before we get started with Preston, let’s take a moment to recognize our featured sponsors.
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Please note, the views and opinions expressed by the individuals in this program do not necessarily reflect those of FlipNerd.com or any of its partners, advertisers or affiliates. Please consult professionals before making any investment or tax decisions as real estate investing can be risky.
Hey, Preston, welcome to the show.
Preston: Hi, thanks for having me, Mike. Appreciate it.
Mike: Yeah, so you guys are right in my neck of the woods. I told you I grew up in Illinois and you’re over in Chicago. I left there – it’s funny that I know this date, people probably heard me say this before, January 2, 1999, we got 26 inches of snow in one day and that was the end of my Illinois career.
Preston: So it’s safe to say that you probably don’t miss that snow?
Mike: No, not at all, I live in Dallas now, obviously.
Preston: Well, yeah, our corporate office is right here in Chicago, we’re right in between Lincoln Park and Bucktown. We just built out a new 8,000 square foot office right here. Our company’s grown like crazy.
Mike: Yeah, awesome, awesome. Well, before we kind of get started talking about the power of self-directed IRAs, I know that you guys teach and work with a lot of other people on how to use that as financing for buying rental properties. Tell us your background and how you got started and how you kind of got to where you are today?
Preston: Absolutely. I really started just in traditional brokerage and management, myself. I actually started back in [inaudible 00:03:27]. I had an opportunity to come out and work under a broker here in Chicago land that was doing over $50 million in residential real estate annually, and really just got involved in the residential space here in Chicago land before going into the investment side of the business when Brett and I started together all the way back in ’03.
Our company was really putting together wholesale deals before we ever got involved in the self-directed space. In ’08 I want to say, we did our first and with a self-directed retirement account investor. Yeah, through the years I’ve done over $200 million in residential real estate transactions.
Mike: That’s incredible.
Preston: Very thankful and grateful to have had that experience in the past, and I think what we’re doing today is so unique and so progressive that it just comes down to individual investors getting out there and getting educated.
Mike: Yeah, no doubt about it. What’s interesting is there’s a lot of things that have been going on. Even the topic we’re talking about today, a lot of it is not real common knowledge yet. It’s common knowledge inside of the circles that you and I run in, but not for the everyday person, and that’s changing. You could tell over the last few years there’s just this massive movement towards understanding that real estate investing is an actual asset class now.
Preston: Absolutely.
Mike: A bit more than just kind of mom-and-pops know about.
Preston: Yeah, more and more retirement account dollars are becoming truly self-directed, and what I mean by truly self-directed is people are setting up those accounts with custodians out there that allow for alternative assets. What most people don’t know is that these companies like Fidelity or Merrill Lynch or the big financial administrators, they tell you that you can set up a self-directed account number, but what they don’t tell you is that they don’t allow for lot of those options out there that are considered alternative investments, and real estate is one of those things.
Mike: Yeah, it’s interesting because we have a company plan that when we first started, we’re, like, “Well, we can’t use our own money to invest in our own company? We can’t it use to buy the asset class we know the best?” They wouldn’t even allow us to invest in market traded ETFs and things like that. They’re, like, “No, you can’t buy a gold ETF.” We’re like, “What?” Like, “What is this?” It’s just really crazy. A lot of people just accept that, that these are the options that I have.
Preston: Absolutely. If you’re told something by someone that has always invested your dollars for you, either your stockbroker or your financial planner, if you’re told something by those individuals that typically manage your money, then you believe them. What most people are alarmed to find out is that you’ve actually been able to employ this strategy since 1974.
Mike: Wow.
Preston: Let me repeat that – 1974. And here we are today with less than 5% in US retirement account dollars are actually truly self-directed, and this space has doubled in size over the course of the last 10 years. It’s growing, it’s growing, and it just comes down to the individual investor getting out there and getting educated on the strategy.
Mike: Yeah, yeah, so let’s talk about a couple of things. One is, how to find the right company to help you with self-directing, and then I guess we’ve just touched on it a little bit, but maybe talk about some of the other benefits to self-directing, aside from having access to more asset classes. I think there’s a lot of people that are kind of dismayed with not having, really a lot of control over their own investments, and obviously this is one of those, but things where they can get more control of it. Talk a little bit about some of the other benefits that might exist.
Preston: Well, I mean, the real benefits to being able to self-direct and invest in alternative assets, really for me personally, I always highlight the ability to leverage other people’s money. You know, it’s a part of the space that most people don’t understand and that really isn’t readily available to the self-directed investor. For so many years those self-directed real estate investors have been out there paying cash for their real estate, and that is because there’s really only a couple of lenders that will lend non-recourse on the actual asset itself without any recourse on the individual.
So what most people don’t understand is what non-recourse financing is. Because it’s not actually you that’s purchasing the real estate – it’s your self-directed entity, that self-directed account that’s purchasing that real estate – the only note that you’re able to utilize to leverage dollars out of that retirement account is called non-recourse financing. All it really is, is asset-based financing. It’s based on the assets qualifications and its ability to fulfill the mortgage obligation, but what it gives that retirement account investor is the ability to go out and buy better, superior assets with the dollars they invest, and buy more of them so that you are diversifying your portfolio even further.
Mike: Yeah, so said another way, your retirement account can take out a loan and use leverage to buy long-term investment vehicles like real estate, right?
Preston: Exactly, exactly, yeah. I mean, right now I can take an investor who has about $85,000 to $90,000 to invest, and I can get them $220,000, $230,000 worth of real estate. It’s very, very powerful. When you compare it to all-cash purchases that they’ve always done with those accounts because they didn’t know they could utilize as financing, I’m basically taking their returns and I’m doubling them.
Mike: Yeah. Say that again? Because it’s a non-recourse loan, does that mean you typically have to have, relatively speaking, a large amount down if you would if it was a recourse loan?
Preston: Typically on non-recourse financing you’re looking at a heftier down payment because the bank sees it as a little bit more of an increased risk because they don’t have any recourse on the individual, it’s only on the asset itself. If there’s a default on a non-recourse mortgage, the lender can only take the property back. So they do see it as a little bit more of an increased risk, but your typical LTV’s going to be 50% to 60% on those notes.
Mike: Okay, okay. Cool. I’m kind of scratching my head here, it’s, like, 1970, that’s 40 years. I was actually born in 1974, so 40 years ago you could do this, and nobody knew about it then, or very few people.
Preston: I mean, it’s quite amazing and I’m enjoying every day that I’m able to get on the phone with those individual investors and really help them understand taking advantage of these types of strategies because, let’s be honest, if we take a typical snapshot of what the market or what the mutual fund industry or an annuity itself, has done for an individual investor over the last 10 or 20 years, they’re averaging probably right around 6% on their money. Now, you and I both know, as educated real estate investors, that you can do much better . . .
Mike: Oh, sure.
Preston: . . . than 6% for yourself.
Mike: Sure, sure.
Preston: And that’s on an unleveraged dollar, Mike.
Mike: Right. Yeah, so talk a little bit about the uphill battle that you guys face of . . . I’ve had some other self-directed IRA folks on the show before, and it sounds like the biggest battle is creating awareness that this exists in the face of all these deep, deep pocket entities that don’t talk about it, and if you somebody were to ask them, they say, “No, you can’t do that.” They may even say it’s illegal. They say all sorts of stuff to make people believe that it doesn’t exist and the truth is, they probably don’t know it exists.
Preston: Well, I always joke around and I say, “It truly is the strategy that Wall Street doesn’t want you to know about,” because those guys are making a living investing other people’s money for them, and the last thing they [inaudible 00:12:29] that allows for these alternative assets. We kind of joke around about it, but it’s the truth.
It is creating that awareness, and being able to offer enough education to where somebody feels comfortable making that decision. Because let’s be honest, status quo has always been those traditional investments – stocks, bonds, mutual funds, annuities. That is status quo. So for somebody to feel comfortable enough to transfer a portion of their retirement account, that nest egg that they’ve spent years building up, for them to feel comfortable enough, they have to know enough, and they have to understand it.
We take a lot of time over here at the Growth Equity Group individually, one-on-one, over the phone just walking them through everything. We have a ton of materials that would help you understand how to set up those accounts, understand prohibited transactions, and then understand our strategy and the way that it really simplifies it for that self-directed investor.
Mike: Yeah, that’s great. Talk a little bit about some of the prohibited transactions because there are some things that you can’t do. Even though it allows you to do more than you would otherwise, there are some restrictions, right?
Preston: Yeah, I don’t ever pretend to be a certified financial planner or CPA or an attorney that would advise somebody on prohibited transactions, but I do know the rules very well. Nobody, as a lineal descendant can benefit from your retirement accounts dollars, and you cannot look to take advantage of it personally yourself, so there can be no co-mingling of funds between your personal and your retirement account dollars.
Now that being said, you can partner together with a partner on a real estate investment, but the real problems I see arise in the space with prohibited transactions are the rules that prevent you from providing a service to your plan. I don’t know if you’ve heard this before Mike, but a lot of people look at doing fix and flips with their self-directed accounts.
It’s my understanding that the reason the IRS have set up the tax code and the prohibited transactions the way they have, is to prevent you from providing those services to your retirement account. In our opinion, and I know this is a little bit of a gray area, but in our opinion it’s meant to be a completely passive investment, where you’re really not providing any services to that property that you own inside your self-directed retirement account.
Mike: Yeah, so what you’re saying is you can’t go have your self-directed IRA account, buy a property, and then you’re the general contractor on it that charges some fees and presumably makes money, and then you’re the agent that lists the property and makes money, and all those things all along the way where you’re effectively sucking profits out of your retirement account.
Preston: Right, or you’re managing the property for free, or you’re going over there to change a lightbulb. It doesn’t matter what it is, you’re really not supposed to be providing services to that plan. The problem with that is, and where most of our clients, they want to err on the side of caution because if you are flagged with a prohibited transaction, then you are penalized pretty heavily from the IRS, and you lose the benefits of that retirement account. It becomes a taxable event. So you’re penalized, and then your entire retirement account is then taxed.
It’s not a situation that any of our clients even want to be close to. Yeah, they want to be hands-off with it, and that’s what we do over here. What we’re really doing, Mike, is we’re trying to take real estate investment and to make it as simple as those traditional investments – your stocks, bonds, mutual funds and annuities, where you’re signing into your Fidelity account, your Merrill Lynch account, your Charles Schwab account and you check and see how your money’s performing for you.
Well, we’ve taken real estate and we’ve made it that simple for the self-directed investor. The difference is, you can leverage your dollars, because our assets are already prequalified with non-recourse financing, and we’re the ones that have to do all the work.
Mike: Just to clarify, you’re helping investors understand the power of using self-directed IRAs, which you ultimately are providing at Growth Equity Group is a turnkey solution for real estate, right? Some people that are starting to listen to this might think that you guys are actually IRA custodians and things like that. You’re not, you’re just try to educate people on the power of that . . .
Preston: Correct.
Mike: . . . to use for real estate investing, yeah.
Preston: No, that’s great, Mike. Actually that leads me in. We’ve worked with every single custodian and administrator in the country. We’ve closed transactions with almost every single one of them. Probably 20 to 25 different custodians and administrators that allow for those alternative assets. We are not one ourselves, but we help our clients navigate those waters, so to speak.
We’ve noticed in the industry that the major problem in that space, the custodian or administrator on those self-directed accounts is customer service. There’s a lack in the space of customer service, and have enough experience now in the space to know which companies have the highest level of customer service with the lowest fees. So we can help our clients really navigate those waters because of our experience.
Mike: Right, right. Then on your side, what you’re doing ultimately is you have a service that provides a turnkey solution for real estate. I know, because we were talking ahead of time, that turnkey is a very broad statement for a lot of companies that provide some sort of . . .
Preston: . . . and I don’t really like it, Mike.
Mike: What’s that?
Preston: I said it is and I don’t really like it.
Mike: Yeah, yeah.
Preston: What we typically call it is a passive investment, but we’ve labeled it kind of the GEG solution, because it encompasses far more things than your typical turnkey investment.
Mike: Okay, and the biggest piece, of which you’ve already talked about, is the financing piece. A little turnkey people are not showing you necessarily how to get the money or how to use your money more wisely, they’re just providing the property side of it.
Preston: Correct, correct. From a front-end perspective we can kind of operate like a fund because we buy real estate in bulk for all-cash, so we can move in on markets maybe a little bit later than an individual investor and still get a far greater discount on the real estate and that we purchased. Therefore, in turn, our clients become involved at the low market value and further below replacement cost on already occupied, operating, financed cash flowing real estate.
Mike: Yeah. It’s obviously been really a huge movement the last few years at turnkey type providers, people providing property solutions for those that want to invest, but don’t want to do the real hard work, or maybe any of the work. But talk a little bit about why that movement is happening. What’s kind of enabling that?
Preston: I don’t know if it’s a huge movement for turnkey systems. I have noticed on the institutional side of the business, obviously those big funds like your Blackstone, are coming in and they’re buying loads and loads of property in specific residential markets. Obviously the reason for that is to take advantage of pricing ahead of the masses.
That’s been our strategy as well, is moving into emerging and reemerging markets where you see the strong, fundamental economic backbone that you need in order to provide your clients with, really a buffer in terms of any downside risk on a real estate investment. So if you see things like population growth, and you see things like job growth, and major industries in the area, those are things that are always going to protect real estate from any downside risk.
What we did was we identified a market that when I was evaluating tons of other markets around the country I would find anywhere from 20% to 60% decrease in median home values post-2008 in those markets. This market, and very specifically Hampton Roads area in Virginia, bucked every national trend and stayed a steady stable nearly 5% in appreciation rate over the last 10 years. That’s just due to us really identifying the fundamentals in the marketplace.
You’ve got Huntington Ingalls one of the nation’s largest shipbuilders, you have Norfolk right there, which is the birthplace of the Navy fleet. Then you have what’s going on with the Panama Canal expansion right now in conjunction with the Port of Virginia, which is the only port on the East Coast that’s going to be deep enough and wide enough to handle those Post-Panamax ships.
Mike: Yeah, that’s a really interesting thing that’s going on that I bet you a bunch of folks that are listening right now, their eyes just glossed over, they’re, like, “What?” I don’t want to take too much time, but just take a minute and tell us what’s going on there. It’s really interesting.
Preston: The Panama Canal expansion is nearly a $6 billion expansion that’s going on right now, so those post-Panamax, those super huge cargo ships can actually pass through the Panama Canal after it’s been deepened and widened. Well, traditionally those ships had to go all the way down around South America and port in Long Beach California. After the canal expansion’s completed at the end of 2015, early 2016, those ships are going to be able to pass through the Panama Canal, and the only port on the East Coast that’s actually deep enough and wide enough to handle though ships, is the Port of Virginia. So we’re capitalizing on it.
I mean, you’ve got Huntington Ingalls there that’s been awarded billions of dollars to build the new aircraft carriers for the Navy. They continue to hire on new employees. They now employ over 30,000 people there. Then you’ve got the military presence, which is actually the largest concentrated military presence in the country right there in Norfolk. You’ve got Langley right there in Hampton Roads, and then you’ve got almost a $1 billion expansion going on at the Port of Virginia.
Needless to say, as real estate investors, we want to follow where the jobs are being created because naturally you see that population growth, you see the economics present that will support real estate in this area for a long period of time.
Mike: Yeah, you guys are like private investigators, you just found out follow the breadcrumbs and start investing there. That’s awesome.
Preston: Really, Mike, we’ve been following the market for almost two years, just analyzing what was happening in this area of the country, and we finally found the right real estate to move in and start to purchase. We got in at the right time right before, really, a lot of the real estate was bought up institutionally as well as a lot of the commercial property being bought up. Whole Foods just paid 50% over retail for dirt that’s right down the street from our development that we just purchased, so yeah, it’s been crazy.
Mike: One of the things I think is interesting about some of the turnkey models is that it’s gotten much, much easier to own . . . I think historically there’s a lot of people that they wanted to own rental properties in their market, or focus on maybe one other the market. If you’re a California investor, you’re probably not buying properties that cash flow very well, obviously so you say, “Well I’m going to go buy in Houston,” or whatever it is. They find a property manager there and they start to accumulate things there.
What’s interesting now is, because of kind of the rise of better property management, technology, being able to be somewhere without being there, just whether it’s via Skype or something else, is that people are starting to become agnostic to where the market’s at and they move around as the market ebbs and flows. I think that’s only a trend that’s going to continue, but it’s not something that we really had even just a few years ago.
Preston: Yeah, I appreciate you mentioning that because in my opinion, it’s brilliant. It’s how to make the most returns on your dollar constantly. If you’re always getting involved ahead of the masses in markets that are coming around and cycling, then you’re putting your dollars in the best position possible for appreciation on top of the cash flow and equity growth. Yeah, that’s one of the main differences to what we do as a company, as well. We’re very mobile. I mean, we’re going to go to the real estate markets that make the absolute most sense. We’re not telling our investors that one market is going to constantly be the best real estate market for their investment dollars.
Mike: For the rest of their lives, yeah.
Preston: For the rest of their lives, right. No, it does not work that way. I mean, Mike, you know, every market moves a little bit differently. Every market’s absorbed at a little different pace, and we monitor all those things along with building permits, and cost of living index. I mean, we’re an analytics firm. We’re getting data from so many different sources and we really do a tremendous amount of diligence before we ever move in and spend our own money acquiring the real estate to begin with.
Mike: Sure, sure. Well, I know ultimately you help people with understanding the IRA stuff better so that ideally, hopefully they’ll invest with you, right? That’s your business, so we get that. If folks that are listening to this and they want to learn more about using their IRA to invest, where should they go? Where would you send them?
Preston: Well, you mean more about the way we help them?
Mike: Yeah, that was my next question, is how do they learn more about you and about Growth Equity Group, but also just how do they learn more about what the real rules are related to using their self-directed IRAs?
Preston: Absolutely. Obviously you can read up. A lot of it is extremely dry, but IRS Publication 590, read through the ERISA rules and regulations, which is the Employee Retirement Income and Securities Act of 1974. It’s not something most people are probably going to take their time to go out and investigate, so I would encourage you to simply call in and talk to somebody over here that it has already done the research for you.
Mike: Okay.
Preston: It’s really dry reading and a lot of it, if you’ve ever read the IRS tax code before, you probably got through about two pages and then fell asleep.
Mike: Right. Yeah. And to clarify, there was one other thing to clarify if we didn’t make it obvious already, is that if folks wanted to do this they can take their existing IRA accounts and just roll them over into a company that actually does the self-directing part, right?
Preston: Absolutely. Yes, yes. One thing I wanted to note because I know you have a lot of investors who are watching your show, Mike, and on a daily basis they’re out there doing probably fix and flips, maybe some buy and holds, but they’re doing them in their local area, typically. What I want to make clear is that buying real estate with your self-directed account is completely different than buying real estate with non-qualified money outside of your self-directed account.
You cannot really compare the two because on one side of the coin you have real estate that you can purchase typically with conventional financing out there, and then inside a self-directed account you cannot utilize conventional financing. So it makes that investment completely different. What I always tell my clients is, the thing that you want to be comparing a self-directed real estate investment with, is what you have traditionally done with those IRA dollars.
Compare it to what you’re doing in the stock market, compare it to what you’re doing with those mutual funds or annuities or bonds, and then we’re comparing apples to apples because you can’t leverage your dollar on those investments. You know what we always pitch is, “Diversify yourself.” We’re not telling any of our clients to go out and put their whole nest egg into real estate, but what a great diversification tool to help protect you from inflation, right?
Mike: Absolutely.
Preston: Yeah, and I’m sure that you’ve had plenty of people on here explaining inflation, but tangible assets will really set you up to protect those dollars from inflation, and obviously rents directly correlate, as well.
Mike: Yeah, but, Preston, haven’t you read that there’s actually no inflation?
Preston: How did I know you were going to say that?
Mike: That’s what they said on the news.
Preston: What exactly is “quantitative easing”?
Mike: Great, man. Hey, tell us one more time, if folks want to learn more about the stuff you guys are doing at Growth Equity Group, learn more about what we talked about today, where should they go?
Preston: Definitely go to our website, it’s just www.GrowthEquityGroup.com. There is a ton of information on there. They’ll be able to watch webinar presentations on the subject, they’ll be able to download specific property information. We’ve actually got two free e-books for download on the website, as well. But yeah, a ton of information. We have an active blog on there as well with a bunch of media news from the actual local market in which we’re buying in and helping our clients invest in.
Mike: Awesome. Great, well, hey, Preston, thanks so much for your time today, thanks for sharing this information. It’s kind of fitting as we’re going into the new year, here, that people should be thinking a lot more about their retirement accounts and how to maybe make the next couple of years ahead some of their last working years.
Preston: I sure hope so, as well. Mike, we’re really having a lot of success over here, and we have nobody to thank but our clients. They’re terrific people that really want to grab the bull by the horns and they want to learn. Yeah, it’s been a pleasure.
Mike: Great, great, well, hey, thanks for joining us today, my friend.
Preston: Thank you so much, Mike.
Mike: All right, we’ll see you around.
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