In a prior article, we discussed various ways to get started as an active operator or as a passive investor. A typical follow-up question I often hear is – But how do I find the capital to get started (actively or passively)? In this quick tip article, we will discuss various means to do so.
- Personal Liquidity. While in most cases this usually means excess cash sitting in the bank account earning nearly 0% interest, there are other personal liquidity sources you can create:
• Track your expenses and create a monthly budget. Then set aside excess cash flow monthly that you can eventually invest in a property.
• Instead of spending your commission or annual bonus on things or liabilities, purchase income-producing assets, like real estate. An annual bonus could easily be a down payment on a property (single-family) or help you get started as a Limited Partner (LP) in syndication.
• Sale of assets – that old car or other personal property or equipment.
- Cash-Out Refinance Of Your Primary Residence. One of the beauties of real estate is the tax advantages it creates. Since refinancing your residence represents a loan, a cash-out refinance is not considered taxable income and may be an excellent source of liquidity to get started. Since you are effectively increasing the amount of the loan/mortgage, the key is to ensure your monthly cash flow is sufficient to cover the debt without creating too much pressure on your day-to-day living needs or leaving you with no cushion for unexpected events.
- 1031 Exchange Proceeds. Section 1031 is a provision of the Internal Revenue Code that allows a business or the owners of investment property to defer federal taxes on certain exchanges of real estate. The provision is used by investors who are selling one property and reinvesting the proceeds in one or more other properties. Before you go down this path, please consult with a qualified 1031 exchange intermediary and your CPA, as the exchange must be like for like. There could be a potential mismatch if you are looking to roll proceeds from an investment property you owned individually for example into syndication. In those cases, you may need to implement a Tenant In Common Structure, which the syndicator may or may not be open to. However, a 1031 exchange is still a good way to roll a smaller property into a larger one or potentially purchase two properties with the gain from the sale of the one you previously owned and over time stack up against your investment portfolio.
- Self-Directed Retirement Accounts (QRPs, IRAs, etc.). A self-directed IRA (SDIRA) is a type of individual retirement account that allows you to save for retirement with assets that are typically not permitted in conventional IRAs, including precious metals, real estate assets, and cryptocurrencies. Qualified Retirement Plans (QRPs) are a type of self-directed retirement plan that comes with added tax benefits and creditor protections. The key factor to note here is that if you choose to use proceeds from your SDIRA or QRP, it is the qualified account that will make the investment in the real estate property (vs. you as an individual or your single-member LLC). In that case, there are added restrictions you may need to be aware of (particularly if you are an active operator) such as – you cannot actively participate in managing the property. Any gains and the cash flow proceeds remain in the qualified plan and can grow tax-free. This is an excellent tool to use to
diversify your retirement savings beyond the stock market, which most traditional 401Ks and IRAs are limited to.
- A Loan Against Your Whole Life Insurance Policies. If you are managing risk and looking for ways to increase returns, whole life insurance is not only an excellent risk management tool but also a great savings tool. Over time, as the cash value of the policy grows, you are able to act as your own bank and take a loan against the policy (sometimes at a loan value as high as 93%). This is an excellent source of liquidity for short-term cash needs. But such liquidity may also be used for other projects – starting a business, getting the down payment on a property, etc. The key to remember is that even though this is a loan you make to yourself, you will be required to make interest payments at a minimum and the loan eventually needs to be paid off (or else the outstanding loan balance will be deducted from the cash value/death benefit at the time of death). Thus, there may be a slight timing mismatch. However, as most syndications either exit or return the majority of your capital within a 3-5 year period, that may be another source of liquidity for you.
We hope this quick tip article helped illuminate additional sources of liquidity that were just there waiting for you to discover. And we hope it provided additional ideas to help you get started in your real estate journey!
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Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.