Commercial Real Estate Investments: 5 Recommended Steps for Using Your Existing Retirement Funds
Two questions for you:
1. Have you ever felt constrained by the limited investment options in your retirement accounts?
While owning your first stocks or bonds may have been an exciting introduction to investing, you’ve evolved into a more experienced and sophisticated investor, now eager to broaden your investment horizons.
2. Have you ever aspired to invest in commercial real estate but quickly dismissed the idea because of financial constraints?
Real estate has been a consistent winner in countless portfolios, and it’s only natural that you want a stake in it. Your savings account may fall short, but if only you could tap into some of your retirement funds…
If you said ‘yes’ to both of these questions, you’d be happy to know that you can, in fact, use your retirement funds to invest in commercial real estate through a self-directed IRA or self-directed 401(k).
And if this has been a dream of yours, you’ll want to stick around because we’ve compiled this guide to help you transition from dreamer to planner to action taker. We’ll break it all down for you, step-by-step, as we cover the following topics:
Understanding Self-Directed IRAs and 401(k)s
Funding Your Self-Directed IRA and/or 401(k)
Choosing Suitable Commercial Real Estate Investments
Acquiring and Owning Real Estate within Your Self-Directed IRA and/or 401(k)
Securing Expert Guidance for Your First Investment
If you’re ready, let’s take you from dreamer to investor!
1. Understanding Self-Directed IRAs and 401(k)s
Self-directed retirement accounts have their unique characteristics and complexities, and it’s crucial to grasp at least the basics of these accounts (even if you work with an expert to do the heavy lifting for you) before we get into their role in funding your commercial real estate investments.
Self-directed IRAs (SD-IRAs) and self-directed 401(k)s (SD-401(k)s) share the same fundamental purpose as regular IRAs and 401(k)s, which is to serve as a tool for saving for retirement.
However, as their name implies, they offer a distinct advantage — greater control over investing your retirement funds.
Rather than being restricted to traditional investment options like stocks, bonds, and mutual funds, these accounts allow you to explore a broader range of possibilities, including investments in real estate and private companies.
Who Can Open a Self-Directed IRA or 401(k)?
Typically, anyone eligible for a regular IRA or 401(k) can also open an SD-IRA or SD-401(k). However, there are a few things you should know, particularly when it comes to SD-401(k)s.
If You’re Employed:
While many employers offer 401(k)s with a limited selection of investment options, like mutual funds and target-date funds, not each will offer a self-directed option.
In such cases, you might opt for an SD-IRA, which you can open independently, outside of your employer’s retirement plan.
You can contact your HR department to inquire about the availability of this option.
If You’re Self-Employed:
If you’re a business owner with no employees or operating as an independent contractor, you can open an SD-Solo 401(k).
It’s worth mentioning that while eligibility requirements don’t differ significantly between regular and self-directed retirement accounts, the same holds for contribution limits (more on that when we cover how to fund your account) and tax benefits, including tax-deferred or tax-free growth and potentially tax-deductible contributions.
Reasons for Considering a Self-Directed IRA or 401(k)
We’ve established that self-directed retirement accounts can help facilitate the transition from dreamer to real estate investor — but the benefits don’t stop there. To help you grasp the purpose of these accounts before we move on to the hows of commercial real estate investing, here’s a more formal list of reasons for considering a self-directed account:
Desire for greater investment control: More access and control is a primary motivator for a self-directed account. Beyond real estate, investors often explore alternative options like private equity, precious metals, art, and other collectibles, to name a few.
Desire for portfolio diversification: Diversification is a key investment tactic to lower risk. A self-directed account provides a unique opportunity to diversify beyond traditional securities.
Desire for tax efficiency: SD-IRAs and SD-401(k)s come with tax perks akin to traditional retirement accounts, such as tax-deferred and tax-free growth, depending on the specific account type. This approach could allow for growth over time without the immediate tax impact that a regular investment might incur.
Now that you’ve got the basics down and recognize the potential value of self-directed retirement accounts, let’s go over strategies for funding your account(s)!
2. Funding Your Self-Directed IRA and/or 401(k)
Now, you might be thinking that you don’t have spare cash lying around or sitting idle in your bank account; otherwise, you might have already invested in real estate. So, how do you go about funding your accounts?
Well, before you eagerly start depositing money to your self-directed accounts, it’s good to be aware that the contribution limits for SD-IRAs and SD-401(k)s mirror those of their traditional counterparts. The IRS sets annual contribution limits for retirement accounts, which are mostly consistent across the board.
What does that mean for you? For instance, it means you can contribute to both a Traditional IRA and an SD-IRA in the same tax year, but the total combined contribution can’t exceed the annual contribution limit set by the IRS.
To steer clear of IRS penalties, keep track of your contributions to avoid overcontributing. With that in mind, there are several approaches to fund your account:
Transfer or Rollover: If you already have a retirement account, such as a Traditional IRA, Roth IRA, or 401(k), you can move funds from that existing account into your SD-IRA or SD-401(k).
As a reminder, if you are presently employed, and your employer provides a 401(k) plan, the ability to transition to an SD-401(k) will depend on whether your employer offers an option to self-direct.
It’s possible that having an SD-401(k) while still employed may not be an option. However, if you change jobs or retire, you can roll over funds from your employer-sponsored retirement plan into an SD-IRA.
Transferring or rolling over an existing retirement account can be the most efficient way to quickly accumulate the funds needed for investing in commercial real estate, eliminating the need for a significant upfront investment.
Direct Contributions: If you have some leeway in your cash flow and haven’t yet hit the contribution limits for your retirement accounts, you can always go with the conventional approach of making direct contributions.
While contribution limits exist, direct contributions can boost the cash you have available to earmark within your account for commercial real estate investments.
Self-Employed Bonus: If you have an SD-Solo 401(k) for self-employment or small business, you can contribute both as an employee and an employer. This dual contribution capability allows you to save at an accelerated rate!
It’s essential to highlight the importance of consulting with a financial or tax professional before initiating any rollovers or transfers if you’re unfamiliar with how they work. That way, you have a solid understanding of the mechanics behind these transactions and are aware of any potential tax implications.
3. Deciding Which Commercial Real Estate Investments Are Best for You
The funds are in your account, and you’re ready to invest! With your SD-IRA or SD-401(k), you have the flexibility to invest in various types of commercial real estate. To help you start thinking about the many possibilities, we’ve outlined a few options below:
Office Buildings: These can range from small office spaces to large corporate complexes.
Retail Properties: This category includes shopping centers, strip malls, and standalone retail buildings. Tenants can be individual retailers, restaurants, or other businesses.
Industrial Properties: Industrial real estate covers warehouses, distribution centers, manufacturing facilities, and storage units. Businesses often use these properties for their operations.
Multi-Family Properties: You can invest in apartment buildings and multi-family housing complexes, which can provide rental income from tenants.
Storage Facilities: Self-storage facilities are a popular choice for investors. They typically offer a steady stream of rental income from people looking to store their belongings.
Hotels and Hospitality: Opportunities in this category include hotels, motels, resorts, hostels, and bed-and-breakfasts.
Medical and Healthcare Facilities: These include medical office buildings, clinics, and specialized healthcare facilities, which healthcare providers often lease.
Mixed-Use Properties: These properties combine commercial and residential elements. For instance, a building might have retail space on the ground floor and residential apartments above.
Special Purpose Properties: Some investors consider special purpose commercial real estate, such as car washes, gas stations, or movie theaters.
Here are a few valuable tips as you narrow down your options:
Ownership & Responsibilities
If the idea of owning commercial real estate and the obligations it entails leaves you feeling uneasy, don’t let that stop you! Take, for example, investing in a hotel — you don’t need to have in-depth knowledge of hotel management or engage in the day-to-day operations.
There are plentiful opportunities for fractional ownership in commercial real estate, allowing for a more passive investment approach while still collecting a check!
The (Not So Fun) Legal Stuff
It should go without saying that you need to always adhere to IRS rules and regulations when it comes to self-directed accounts.
One of those rules is that all income and expenses tied to your commercial real estate investment should flow through the account that owns the property, not through your personal accounts.
Another rule worth highlighting is that you aren’t allowed to use or reside in commercial real estate owned by your self-directed account. If you’re considering investing in a multi-family property and living in it, that’s a no-go.
This is why we stress the value of partnering with a seasoned professional who knows the ins and outs of these accounts and can provide invaluable guidance on your journey into commercial real estate investing.
4. Acquiring and Owning Real Estate within Your Self-Directed IRA and/or 401(k)
The next step involves finding a suitable commercial property that you’d like to invest in and carrying out a comprehensive due diligence process. This includes tasks such as property inspections, title searches, financial analysis, and any other necessary assessments.
This is the stage where you might collaborate with a real estate agent if you don’t want to conduct your own research.
After negotiating the purchase terms, you’ll work with your chosen self-directed IRA custodian — such as the team at Chicago Trust Administration Services — to complete the transaction. The funds for the purchase will be sourced directly from your self-directed account.
Here are a few essential points to keep in mind:
All ownership documents need to list your self-directed retirement account as the owner of the commercial property, not you personally.
All expenses related to the property (e.g., property taxes, maintenance, repairs) must be paid from your self-directed retirement account. Similarly, any rental income or profits from the property’s sale should be directed back into your account.
Investing in commercial real estate in a Self-Directed 401(k) or Self-Directed IRA typically means you won’t have access to the profits or funds until you reach the eligible retirement age, and early withdrawals may result in penalties.
Given that these accounts and your investments in them are primarily intended to support your long-term retirement goals with the added tax benefits, they might not be the ideal choice if you need immediate access to cash or have short-term financial needs.
5. Securing Expert Guidance for Your First Investment
Most of us have probably encountered wise counsel about avoiding conflict with the IRS. Given the critical importance of compliant funding and managing your self-directed accounts, we typically advise treating this as a DIY project only if you have extensive experience in this field.
Even in our efforts to simplify self-directed accounts, there’s still a certain level of complexity when dealing with them. Given these intricacies, it’s advisable to consult with financial and tax experts, and possibly even legal professionals — especially for your first investment.
While this may seem like a lot of extra work, keep in mind that this can open doors to potential investment opportunities and returns that might otherwise remain out of reach.
How Chicago Trust Administration Services Can Help
At Chicago Trust Administration Services, our focus and dedication centers on self-directed accounts. We’re fueled by our commitment to helping clients explore new opportunities for growth, diversification, and next-level wealth building, and we would love to serve you in this same capacity.
If you’re interested in exploring whether an SD-IRA or SD-401(k) could support your financial goals of commercial real estate investing or if you have any lingering questions, we’re all ears.
To see how we can help, we invite you to schedule a complimentary meeting with us by calling 312-869-9394 or emailing steve@ctasira.com. We can’t wait to chat with you about something we are so genuinely passionate about for our clients.
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*The content and opinions in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
**CTAS professionals are not financial advisors and cannot provide advice or recommendations regarding specific investment decisions.