The recent national story about a $12 million sale of a waterfront mansion listed for $40 million six years ago sparked some interesting comments and questions from our adult children at Sunday night dinner.
They wondered about the market and considered real estate as an investment, and calculated the number of individuals who could afford ultra-priced homes and the possible mortgages that might accompany those residences.
"I don’t know anybody who could take a $28 million hit."
We don’t, either. Perhaps LeBron James.
"Was the seller dreaming at first, or has the higher-end market fallen that much?"
In the "anything goes" days of 2004, people believed just about any asking price was attainable.
"What would the payments be on a mortgage that size?"
We’re assuming the new buyer does have a 20 percent downpayment ($2.4 million), and the contacts to get jumbo financing on $9.6 million. A 30-year, fixed-rate jumbo (5.75 percent) would mean monthly mortgage payments of $56,022.
"The buyer probably is looking at it mainly as an investment."
The final statement especially rings true and 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 reduced an additional 20 percent to $12 million.
Second, the buyer probably believes the cash is better placed in Mercer Island waterfront than in another asset. While real estate is down right now, some of it will absolutely rebound, especially parcels with specific amenities like waterfront and mountain views. 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. Three national firms handling real estate IRAs are Entrust Administration, Kirkland, Wash.-based Guidant Financial, and Pensco Trust.
According to David Nilsson, president of Guidant Financial, some self-directed IRA clients are actually buying their future retirement home at today’s prices in highly desirable locales.
"They’re renting out the place for now and will claim occupancy after they take their final distribution after the age of 59 1/2," Nilsson said "Many of our self-directed IRA investors are buying everything from raw land to condos and beach huts to country estates with IRA funds, and are realizing their profits tax-deferred within their accounts."
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 into a real estate IRA. You, too, could buy low and sell high.
Next week: Financing a property inside a pension plan, limited liability company, 401(k), traditional individual retirement account or Roth IRA.