When planning for retirement, investment properties offer a unique opportunity to diversify your portfolio with assets that can generate monthly income and long-term appreciation. If managing tenants and property maintenance isn’t for you, don’t worry—there are passive real estate investments that can allow you to enjoy the benefits without the midnight calls about leaky faucets.
Diversification and Passive Real Estate Investments
Diversification is one of the cornerstones of a sound investment strategy, especially for retirement planning. The idea is simple: spreading investments across different asset classes reduces the impact of any one investment’s poor performance on your overall portfolio. While stocks and bonds are traditional choices, adding real estate introduces an entirely new dynamic to your financial strategy, offering both stability and growth potential.
Unlike stocks, which can be volatile and influenced by market trends, real estate tends to follow its own cycle and often appreciates over time. Real estate also provides consistent cash flow through rental income and can act as a hedge against inflation, especially important during retirement when preserving purchasing power is critical.
But the best part? You don’t have to be a hands-on landlord to benefit. Passive real estate investments let you diversify your portfolio without the hassles of property management. These investments are handled by professional asset managers, allowing you to reap the rewards of real estate ownership without sacrificing your time.
Let’s dive deeper into four passive real estate investment options that can enhance your retirement portfolio:
1. Real Estate Investment Trusts (REITs)
What Are REITs?
Real Estate Investment Trusts (REITs) are publicly traded companies that own, manage, or finance income-generating properties. Investing in REITs gives you exposure to a broad range of real estate assets, from commercial office spaces and shopping malls to apartment buildings and hospitals. REITs provide a convenient way to access the real estate market without actually owning physical property.
Benefits of REITs
One of the primary benefits of REITs is liquidity. Since they are traded on major stock exchanges, you can easily buy or sell shares, much like stocks. This is a big advantage if you need flexibility in your retirement investments. REITs also provide consistent income through dividends, as they are required by law to distribute at least 90% of their taxable income to shareholders in the form of dividends. This makes REITs a solid choice for retirees looking for steady cash flow.
Considerations
However, REITs are not without drawbacks. Because they are publicly traded, REITs are subject to the volatility of the stock market. This means that the value of your investment could fluctuate significantly based on broader market trends, even if the underlying properties perform well. Moreover, while REIT dividends offer regular income, they are generally taxed as ordinary income, which could result in a higher tax burden compared to other passive real estate investments.
Finally, while REITs offer exposure to real estate, they do not provide the same tax deferral advantages as direct real estate ownership, such as the ability to execute a 1031 exchange to defer capital gains taxes.
2. Delaware Statutory Trusts (DSTs)
What Are DSTs?
A Delaware Statutory Trust (DST) is a legal entity that allows multiple investors to co-own fractional interests in high-quality, institutional-grade properties such as large apartment complexes, office buildings, and industrial facilities. DSTs are popular among investors looking to participate in real estate without the responsibilities of property management. Investors earn income from the property in the form of regular distributions, while professional asset managers handle all operational duties.
Benefits of DSTs
DSTs are particularly attractive to investors because they qualify for 1031 exchange tax deferrals. If you’re selling a property and wish to defer capital gains taxes, reinvesting the proceeds into a DST through a 1031 exchange can help you achieve that. This makes DSTs ideal for individuals looking to transition from active property management to a passive investment structure.
Furthermore, DSTs offer diversification within real estate itself. Many DSTs hold large, high-quality properties that individual investors would not typically have access to, such as a 400-unit apartment complex or a fully leased industrial warehouse. Because the properties are often leased to long-term tenants, such as Fortune 500 companies, DSTs can provide a relatively stable and predictable source of income.
Considerations
While DSTs offer many advantages, there are also some limitations to be aware of. For one, DSTs are illiquid investments. Once you’ve invested in a DST, you typically have to remain invested until the property is sold, which could take several years. Additionally, DST investments are typically available only to accredited investors, meaning they are not accessible to everyone.
Another key consideration is control. As a DST investor, you have no say in the day-to-day operations or decision-making processes, as these are handled entirely by the sponsor. For some investors, this loss of control might be a drawback.
3. Tenants in Common Properties (TICs)
What Are TICs?
Tenants in Common (TIC) is a structure in which multiple investors co-own a fractional share of a property. Each investor holds an undivided interest in the property and shares in the income, appreciation, and expenses. TIC investments can range from small residential properties to large commercial real estate.
Benefits of TICs
Like DSTs, TIC investments can qualify for 1031 exchange treatment, allowing investors to defer capital gains taxes when they sell one property and reinvest the proceeds into a TIC arrangement. TIC investors receive income from the property based on their ownership percentage, offering steady cash flow.
One of the main differences between TICs and DSTs is that TIC investors typically have voting rights on significant property decisions, such as whether to refinance, sell, or make substantial improvements to the property. This means that while you’re still in a passive investment structure, you retain some control over critical decisions.
Considerations
Although TICs offer more control, they are generally considered less passive than DSTs due to the involvement in property decisions. Additionally, TIC structures tend to be more complex and have higher management costs, which can eat into returns.
Another potential downside is that TICs usually require unanimity among investors for significant decisions, which can lead to gridlock if the co-owners cannot agree. Like DSTs, TIC investments are also illiquid, meaning your capital will be tied up until the property is sold.
4. Qualified Opportunity Zone Funds
What Are Qualified Opportunity Zone Funds?
Qualified Opportunity Zone Funds are a unique investment vehicle created by the Tax Cuts and Jobs Act of 2017. These funds allow investors to reinvest capital gains into properties or businesses located in designated “Opportunity Zones,” which are typically economically distressed areas. In return, investors receive significant tax incentives, including the potential to defer, reduce, or even eliminate capital gains taxes.
Benefits of Opportunity Zone Funds
The primary benefit of investing in an Opportunity Zone Fund is the ability to defer taxes on capital gains. If you hold the investment for at least 10 years, you may also be able to exclude any appreciation on the investment from capital gains taxes. Additionally, these funds allow you to invest in real estate or operating businesses, offering flexibility in your investment choices.
Investing in Opportunity Zones can also provide social benefits, as these investments are intended to spur economic development and job creation in underserved communities. This gives investors the opportunity to generate positive social and economic impacts while potentially earning significant financial returns.
Considerations
Opportunity Zone Funds are long-term, illiquid investments with holding periods of up to 10 years. This makes them unsuitable for investors who may need quick access to their capital. Additionally, because these investments are located in economically distressed areas, they may carry higher risk compared to more stable real estate markets. Investors should carefully assess the specific Opportunity Zone and project before committing capital.
Real Estate Investments Through Retirement Accounts
When it comes to planning for retirement, many investors think of traditional options like stocks, bonds, or mutual funds within tax-advantaged accounts such as a 401(k) or IRA. However, what many people don’t realize is that you can also use these retirement accounts to invest in real estate. By doing so, you can diversify your portfolio, hedge against market volatility, and potentially earn steady income while enjoying significant tax advantages.
While standard 401(k) plans and IRAs often limit investment choices to stocks, bonds, and mutual funds, self-directed IRAs (SDIRAs) and Solo 401(k)s open up a broader array of options, including real estate. This gives investors more flexibility and control over their retirement assets, allowing them to benefit from the stability and potential appreciation that real estate offers.
1. Real Estate with a Self-Directed IRA
What is a Self-Directed IRA?
A Self-Directed IRA (SDIRA) is an individual retirement account that allows you to go beyond the traditional investment choices of stocks, bonds, and mutual funds. With an SDIRA, you have the flexibility to invest in a wide range of alternative assets, including real estate, precious metals, private equity, and more. The key benefit of an SDIRA is that it offers tax advantages while providing you with the freedom to diversify your portfolio with non-traditional investments.
How to Invest in Real Estate through an SDIRA
With an SDIRA, you can directly invest in physical real estate, such as rental properties, commercial buildings, and even land. However, all transactions related to the property—such as purchase, maintenance, and income generation—must be conducted within the SDIRA. This means that all funds used to buy the property must come from the SDIRA, and all income or expenses related to the property must flow through the account.
For example, if you purchase a rental property using your SDIRA, all rental income must go back into the IRA. Similarly, any repairs or maintenance must be paid for using the funds within the IRA, not personal funds.
Benefits of a Self-Directed IRA for Real Estate
- Tax-Deferred or Tax-Free Growth: If you use a traditional SDIRA, your real estate investment can grow tax-deferred, meaning you won’t pay taxes until you withdraw funds during retirement. If you use a Roth SDIRA, your investment can grow tax-free, and you won’t pay taxes on withdrawals as long as you follow the rules.
- Diversification: Investing in real estate through an SDIRA can diversify your retirement portfolio beyond the stock market, potentially lowering your overall risk.
- Long-Term Investment: Real estate typically appreciates over the long term, making it a valuable asset to hold in a retirement account where you won’t need immediate access to the funds.
Considerations for Real Estate in a Self-Directed IRA
- Custodian Requirements: SDIRAs must be administered by a custodian, and there are strict IRS regulations about what you can and cannot do with the property. For example, you cannot live in a property owned by your SDIRA or perform any work on the property yourself.
- Prohibited Transactions: The IRS has strict rules regarding prohibited transactions. You cannot personally benefit from the property while it is held in the SDIRA, meaning you or certain family members cannot live in or use the property, nor can you perform hands-on management or repairs. Violating these rules can result in penalties and the disqualification of your SDIRA.
- Liquidity: Real estate investments are typically less liquid than stocks or bonds, so it’s important to ensure that your SDIRA has sufficient liquidity to cover expenses like taxes, maintenance, and required minimum distributions (RMDs) once you reach age 73 (for traditional IRAs).
2. Real Estate through a Solo 401(k)
What is a Solo 401(k)?
A Solo 401(k), also known as a Self-Employed 401(k) or Individual 401(k), is a retirement plan designed for self-employed individuals and small business owners with no full-time employees. Like a traditional 401(k), a Solo 401(k) allows you to make both employee and employer contributions, but with greater flexibility in terms of investment options, including the ability to invest in real estate.
Solo 401(k)s are particularly attractive for self-employed individuals because they offer high contribution limits and the ability to take advantage of both tax-deferred and Roth (after-tax) contributions within the same account.
How to Invest in Real Estate through a Solo 401(k)
With a Solo 401(k), you can invest in various types of real estate, including:
- REITs: Publicly traded or private Real Estate Investment Trusts (REITs) that allow you to gain exposure to real estate markets without directly owning property.
- Direct Property Investments: You can purchase income-producing properties, such as rental homes or commercial buildings, directly through the Solo 401(k). Similar to SDIRAs, all income and expenses related to the property must flow through the 401(k) account.
- Private Real Estate Deals: The flexibility of a Solo 401(k) allows you to invest in private real estate opportunities, such as real estate crowdfunding platforms or syndicated real estate deals.
Benefits of Real Estate in a Solo 401(k)
- Higher Contribution Limits: Solo 401(k)s allow for significantly higher contribution limits compared to IRAs, meaning you can potentially build up a larger fund for real estate investments more quickly.
- Tax Benefits: Like other retirement accounts, a Solo 401(k) offers tax-deferred or tax-free growth depending on whether you choose to make traditional or Roth contributions.
- Control and Flexibility: With a Solo 401(k), you have direct control over your investments, allowing you to decide when and where to allocate funds to real estate. You also have the option to take out a loan against your Solo 401(k) balance, providing additional flexibility.
Considerations for Real Estate in a Solo 401(k)
- Prohibited Transactions: Just like with SDIRAs, the IRS has strict rules about what you can and cannot do with real estate investments within a Solo 401(k). You cannot use the property for personal purposes, nor can any disqualified individuals (such as your spouse or children) benefit from the property.
- Administrative Complexity: While Solo 401(k)s offer great flexibility, they also come with more administrative responsibilities compared to a standard 401(k). You must maintain accurate records and may need to file annual reports with the IRS once your account exceeds $250,000.
- Liquidity Considerations: Real estate investments are generally illiquid, so it’s important to ensure that your Solo 401(k) has enough cash flow to cover property expenses and required minimum distributions (RMDs) after age 73 (for traditional Solo 401(k) accounts).
Considerations for Using Retirement Accounts for Real Estate
While investing in real estate through a retirement account such as an SDIRA or Solo 401(k) can provide significant advantages, there are several important considerations to keep in mind:
1. Prohibited Transactions
The IRS imposes strict rules on what can and cannot be done with real estate held in a retirement account. For example:
- Personal Use: You and certain family members (referred to as disqualified persons) cannot live in, rent, or otherwise benefit from the property. Violating these rules can lead to penalties and disqualification of your retirement account.
- Hands-Off Management: You are prohibited from performing any work on the property, including repairs, improvements, or management duties. All property-related tasks must be handled by third-party managers or service providers paid from the account.
2. Liquidity and Cash Flow
Real estate is typically less liquid than other types of investments, such as stocks or bonds. Therefore, it’s important to ensure that your retirement account has sufficient liquidity to cover expenses related to the property, such as taxes, maintenance, and property management fees.
Additionally, for traditional retirement accounts, you will need to plan for required minimum distributions (RMDs) starting at age 73. If your real estate investments are illiquid, this could make it difficult to withdraw the necessary funds to meet RMD requirements.
3. Custodian and Administrative Costs
Both SDIRAs and Solo 401(k)s require custodians or trustees to manage the accounts, and these accounts often come with higher custodial and administrative fees than traditional IRAs or 401(k)s. You’ll also need to ensure that all transactions are conducted at arm’s length and are properly documented to avoid penalties.
4. Tax Advantages
Investing in real estate through a retirement account offers significant tax benefits, such as tax-deferred or tax-free growth. However, it’s important to weigh these benefits against the potential complexities and costs associated with managing real estate within a retirement account.
Consider Passive Real Estate Investments for Retirement
Passive real estate investments can provide diversification and income, complementing a portfolio focused on stocks and bonds. From REITs to DSTs, TICs, Opportunity Zone Funds, and now real estate through 401(k) and IRA accounts, each option offers distinct advantages and tax benefits. Diversification is often viewed as a prudent investment strategy, but it doesn’t guarantee protection against losses.
If you’re a current or former landlord, passive real estate investing allows you to stay involved in the real estate market while letting someone else handle the property management. Don’t miss out on the potential income, appreciation, and tax advantages these investments can offer as you plan for a secure retirement.
For more information on how 1031 Exchange Place can help you achieve your retirement goals through passive real estate investments, contact us today!