Self-Directed IRA Tips: Conducting Due Diligence on Partners and Developers
Self-Directed IRAs are a proven wealth builder and income generator. No other asset class delivers such a potent combination of current income, capital gains potential, leverage – thanks to the possibility of increasing rents over time and finding additional revenue streams – inflation protection. But of course, no real estate investment is a sure thing. Investment carries risk, and sometimes Self-Directed IRA investments fizzle. Due diligence is a critical skill for any real estate investor. This is especially critical if you are committing Self-Directed IRA funds to an investment along with others. Not only do you need to conduct a sober assessment of the value of the property and its potential for profitability; you must also assess your fellow partners and other stakeholders.
Ask these questions before committing Self-Directed IRA money to an investment.
Does the promoter have skin in the game?
Consider a ham and eggs breakfast: The chicken was involved. The pig was committed.
The difference is key: When you are investing in a real estate deal along with others, you want other partners and your managing partner to be like the pig, not the chicken. You want them as committed to making the deal work as you are.
Obviously, a professional real estate agent cannot be personally invested in every deal he represents. But real estate developers should be, or you should exercise extreme caution: If the opportunity is good enough for your money, why is it not good enough for them?
Real estate developers and promoters should eat their own cooking. Look for projects where the promoter and general manager (for limited partnerships and LLCs) has a significant portion of his or her own wealth invested alongside yours. You want a true managing partner, and not just a manager, at the helm.
Furthermore, if the investment goes south, a promoter with no equity of their own in it is not likely to stick around and make it work. They may just move on to the next project, leaving you and your fellow investors who actually do have your own money invested holding the bag.
What is the commission?
There is nothing wrong with sales commissions. But you should have your eyes open about how much you are paying when you are investing hard-earned Self-Directed IRA assets through a broker. If they take too much money up front in fees and commissions, you have much less money working for you in the investment, compounding for you over time.
Furthermore, it will take that much longer for you to recoup your investment, because you are starting out well underwater. It could take years to break even.
How experienced is the management team?
Have the managers been through the wringer before? What is their track record? Have they developed and managed properties of this type before? If this is their first venture, who were they working with before? Were they learning from some of the best in the industry, or did they leave a bad firm?
Also, where is the management team located? Are they near the property or do they have to buy a plane ticket to visit the property they manage?
How much are they borrowing?
Leverage is a powerful tool in real estate investing. But it is a risky one, too: The more money they are borrowing, the more even a small fluctuation in property values can hurt you, and even leave you upside down in your position for years.
It is important that the property meet your risk tolerance criteria, after accounting for leverage.
Furthermore, if the partnership or LLC is using a lot of borrowed money, you may not want to borrow money yourself, in addition to their own built-in leverage. That is just adding leverage on top of leverage. It feels nice in a strong market, but a downturn could be very painful indeed.
What is the exit plan?
Real estate is highly illiquid. It is the nature of the beast. But there should be some planning for a profitable exit, even if it is a few years in the future. The developer could have plans to sell the entire development at a profit after some wise investments enhancing the value of the property. They should be able to give you a rough timeline.
Even if the developer plans to hold indefinitely, there should be some way for you to sell your interest at some point. If not, then you should be paying a lower price to compensate you for the lack of liquidity.
Larger projects have little trouble helping a small investor out of their position, in time. For smaller, less established firms, it is much more difficult.
Interested in learning more about Self-Directed IRAs? Contact American IRA, LLC at 866-7500-IRA (472) for a free consultation. Or visit us online at www.AmericanIRA.com.