Many self-directed investors start out opening a self-directed retirement account because they want to invest in real estate. Once they have added a few rental properties to their portfolios or invested in a real estate syndication using their self-directed account, the most common question we get at Mainstar Trust is, “How can we do more of this?”
The simple answer is “rinse and repeat,” continuing to add new properties to your self-directed retirement portfolio by identifying good leads on deals and then conducting the necessary transactions. However, many investors begin looking for ways to diversify while remaining in the real estate space. Often, they do not necessarily want to own physical property exclusively. They would like monthly payments (and interest) but without the hassle of dealing with property management or the liabilities associated with rental properties. That is where note investing comes into the equation.
Most self-directed investors have a good, general idea of how note investing works. However, like most well-informed, independent individuals, they may not necessarily “know what they don’t know,” so to speak. To help you get started with note investing in your self-directed IRA, we have compiled a list of 3 important things to know about note investing before you get started.
Many investors who are already active in the real estate space assume that “note investing” means being involved in mortgage lending. While it certainly can mean this, it does not exclusively mean this. The term “note investing” spans a wide array of private lending activities, including lending on real estate projects, lending to retail buyers, and lending on things outside of the industry altogether. It is imperative that you understand the many ways the term can be understood if you want to start investing in notes successfully.
In real estate, note investing generally refers to one of three things:
As you can see, even within the real estate space, the term “note investing” can mean many different things.
If you are originating a new note, then you and the borrower can agree on the terms of the loan. However, you must be very sure you are not violating any consumer protections or usury laws by charging too much interest or setting down a repayment plan that does not abide by consumer-protection standards.
Furthermore, if you are using a self-directed retirement account to make the loan, you must make sure that you are not interacting in any way with a disqualified person. Disqualified individuals include linear relatives, business partners, and, in many cases, professional associates. It is important to have the terms of the note reviewed by a trusted legal professional who understands both note investing and self-directed IRAs in order to be sure your terms will not inadvertently distribute your IRA before you are ready to do so. Even if you are not setting the terms of the note yourself but, instead, acquiring the note in another way, you should still have a trusted advisor review the transaction before moving forward.
Typically, the note agreement will include, at a minimum:
Although your self-directed IRA custodian will require paperwork from you in order for your retirement account to invest in the note, your custodian is not responsible for (or expert in) legal issues surrounding note investing. While the company will work to clarify and confirm the information in the investment paperwork, they will not provide you with legal advice or investment advice.
Of course, Mainstar Trust does pay intense attention to detail and we will monitor every aspect of the transaction in which we are legally permitted to be involved.
Please note: Not all alternative investments require Accredited Investor status. Please review the private placement memorandum, subscription agreement, or prospectus for purchase.
Always take the time to consult with trusted, professional advisors to ensure you understand tax, legal, and investment issues related to the use of IRA funds in LLCs.