No personal use: Investor eyes high-end vacation rental

The recent national story about a $12 million sale of waterfront mansion that would be used only for investment and rented out to vacationers and travelers sparked some interesting comments from friends.

They wondered about the high-end rental market, attempted to calculate the number of individuals who could afford ultra-priced homes and the possible mortgages that might accompany those residences.

We assumed the new buyer does have a 20 percent down payment ($2.4 million), and the contacts to get jumbo financing on $9.6 million. A 30-year, fixed-rate jumbo (4.15 percent) would mean monthly mortgage payments of $46,655.

On friend said: “The buyer probably has his homework and has a good idea of who would pay fifty grand a month for a rental.”

That statement deems to be considered from a few angles.

First, the buyer most likely feels the home will never be worth less in the future. While $12 million is a huge number, it was also the minimum bid set by a noted New York auction house. Granted, all real estate is local, but you can be assured that the East Coast company did its research before setting the initial minimum bid figure at $15 million. When the original deadline passed with no takers, the price was reduce an additional 20 percent to $12 million.

Second, the buyer probably believes the cash is better placed in waterfront real estate than in another asset. The buyer/investor is considering the home as a long-term hold that he hopefully bought near its lowest price point and will sell at a much higher point.

Third, there’s a chance that the property is held inside a pension plan, limited liability company, 401 (k), traditional individual retirement account or Roth IRA. If so, those funds could have afforded the owner the only avenue to purchase the home while providing other opportunities for financing.

While the wealthy typically have more access to alternative financing vehicles, all individuals with IRAs have the option of investing in real estate. If you purchase the property with Roth IRA funds or convert your conventional IRAs to Roth IRAs for the purchase, the appreciation of the property would be tax free.

Self-directed real estate IRAs are not only relatively easy but they are also not subject to some of the guidelines that apply to employee-sponsored qualified plans enforced by the Department of Labor.

To prepare for your real estate IRA, designate the amount of your retirement funds that you wish to use in the property deal and open a new IRA account with an independent administrator. Two national firms handling real estate IRAs are Entrust Administration – www.entrustadmin.com and Pensco Trust – www.pensco.com.

According to some IRA custodians, some self-directed IRA clients are actually buying their future retirement home at today’s prices in highly desirable locales.

The guidelines covering real estate IRAs are stringent. If you break one of these rules, you could jeopardize your tax-free status on your account.

• The land or house must be treated like any other investment.
• All rental profits must be returned to the trustee.
• You cannot manage the property. But your trustee can hire a third party – a real estate broker, or local manager – to collect rents and maintain or improve the property.
• The house or property (or proceeds from its sale) must remain in the trust until distribution at retirement. If trustee is instructed to sell the property, funds can be transferred to another account for reinvestment.

You cannot use IRA money to buy your own residence or any other property in which you live. It has to be investment property. But when you retire, you can direct your IRA to turn it over to you as a distribution at the current market value.

If you are convinced a piece of real estate will undoubtedly appreciate, check in to a real estate IRA. You, too, could buy low and sell high.

New book: Follow real estate agent and basketball coach Ernie Creekmore as he attempts to solve another murder – this time a “helicopter” parent constantly prodding his star athlete son. Tom Kelly’s “Hovering Above a Homicide” is now in print and E-book form. Get a signed copy at TomKelly.com or purchase at bookstores everywhere and online.