How I used my Self-Direct IRA to invest in a Santa Barbara Real Estate Deal

As some of you may know, I quit a $70,000/year university job with my own office, benefits, and great coworkers to dive head-first into real estate. I worked there for roughly 15 years and built up a pension and a few retirement accounts with Fidelity which added up to about $30,000.

While I worked at the university I did inquire about how I might be able to use those retirement accounts to invest directly into real estate. The only options they could offer was 203(b) plan which let's me take out a loan on a fraction of my retirement account. In my particular case that was around $2000. LAME!

So how was I going to use those accounts to invest directly into a real estate deal? I was going to have to transfer them over to another custodian and the only way I can do that is if I left my current job. So 30 days after I left my job I was able to roll over those funds to a Self-Directed IRA custodian. Now there is a catch, I decided to roll-over my funds into a ROTH IRA in a "conversion" and paid the taxes on that income this year since my income will be much lower than it was my previous year.

The Deal

I met Brett at a Santa Barbara Real Estate Investor Association(RIEA) meet up. Brett is a broker and investor who has done deals all over California and Arizona. As I spoke with him he seemed very knowledgeable and open about all his dealings. When I went to him for help he was always happy to give some of his time and advice. Earlier this year, I decided to give him a call to update him on what I was doing and he mentioned that he was looking to close on a pair of residential lots at the bottom of the "American Riviera", Santa Barbara. I had lived in Santa Barbara for 20 years and was very familiar with the area. Brett sent me a deal package for "Bella Vista Estates". The plan was to merge two parcels into a 21,000 SF parcel and build 4 condos. The condos are over 2100SF and we are estimating sales at $1000/SF for new construction in that area resulting in each condo selling for over $2,100,000. If you want full details from the deal package, please contact me!

Due Diligence

The first thing you should determine before doing a deal is Do You Trust the Investor? As I mentioned before, I had known Brett from events and fellow investors. Also, he is a licensed broker in Arizona and California with no reported complains. From his deal package, I looked up his company to search for any complains, of which I found none, to see if the company was in the transaction record of some of the properties he claimed to have developed. I also verified the acquisition loan he was using to purchase the parcels. Having lived in Santa Barbara for 20 years I know that housing is and always will be in demand here, and that $1000/SF is actually reasonable for new construction in that area based on comps.

Return and Terms

Now, I won't publicly disclose the return and terms that Brett and I agreed to for investing in his deal. Let's just say it was 25% (it's higher!!!) for 22 months with the option to pull my money out after we secure the construction loan or through the end of the terms. What will my return be at the end of the 22 months? Let's calculate it:

Interest Earned per month: ( $30,000 x 25% ) % 12 months = $625/month

Total Interest Earned: 22 months x $625/month = $13,750

Projected Principle + Interest after exit: $30,000 + $13,750 = $43,750

When I looked back at what I was making for the last 6 quarters of my old retirement accounts it averaged out to 3.5%! What are your returns?

Pulling the Trigger

I decided that I felt safe enough with this deal to put my money in. I had my $30,000 with my IRA Custodian who have a few requirements of their own. They need a Promissory Note, Grant Deed, and Authorization form. Upon approval by the IRA custodian they wired the money into Brett's company account.

Cons

The interest rate on this deal is exceptionally high which is great! However, there is no cash flow with this type of investment. The profit is dispersed on the exit which projected to be in 2 years. You have to be feel pretty damn secure in your investment to let your money sit there for that long with no realized return. Using my Self-Directed IRA is ideal for this situation. If I had used a home equity loan or HELOC to invest in this property I would have had to pay monthly payments on the money I borrowed. Typically, the rate on home equity is Prime rate + 1.

Risks

As with all ventures, there are elements of risk in this deal. Building costs go up. The Market tanks. Planning schedule gets stretched out. All the things that can go wrong are too numerous to count. Ultimately, the worst result is simple: we can't make loan payments, the bank forecloses on the property, and we lose our investor's money. Brett's track record and Santa Barbara's housing shortage makes the worst result highly unlikely in my opinion.

Notes on the IRA Custodian

In short, my IRA Custodian helps keep my retirement funds separate from my personal funds and that I'm investing in assets that don't violate tax law. This isn't free, of course. There are yearly management fees and wire transfer fees. You should definitely shop around and ask specifically what fees each custodian charges. You might also ask to test out their customer portal. I would also make sure that the custodian has a few people that you have direct contact with who are familiar with the asset type you plan on investing in. I found my IRA Custodian through a real estate investing podcast.

Next Steps

Now that we closed, we are going to see if we can update the floor plans to get more square footage and possibly add a deck. In the next 18 months or so we will be working with the city and builders to develop the properties. As the properties are completed we will list and sell them for a profit. I will get my principle back along with my earned interest. That will get paid back to the account I have with my IRA custodian, of course. I can then invest that money in other developments or perhaps in an out-of-state rehab.

Stay tuned for progress updates. If you have questions about this deal or are looking to find similar opportunities then please reach out to me.