Invest in Real Estate with a 401(k): Everything You Need to Know

The Big Picture on How to Invest in Real Estate With a 401(k):

• • Publicly traded REITs, borrowing from a 401(k), and using self-directed IRAs or 401(k)s are some of the ways to incorporate real estate into retirement savings.
  • Self-directed IRAs (SDIRAs) and self-directed 401(k)s offer greater flexibility and control over investment choices, allowing for direct property ownership, real estate crowdfunding, and real estate syndications. 
  • While there are significant benefits to investing in real estate through a 401(k), such as tax advantages and the potential for high returns, there are also risks and challenges.  Consulting with financial advisors and experienced investors is crucial before making these investment decisions.
    

Want to double down on the tax benefits of real estate investing with your 401(k)?

I get it. Fortunately, you have several options for investing in real estate with a 401(k) or 403(b) account.

Not all of them are created equal, however. And the more flexibility you want, the further you’ll have to venture off the beaten path.

Benefits of Using Your 401(K) For Real Estate Investing

Why even consider using your retirement account for investing, you ask? Well, here are the top reasons:

Options for 401(k) Real Estate Investing

Sit down with your accountant or financial advisor to discuss these options for investing in real estate with a 401(k) and decide which one best fits your goals.

We’ll start with the easiest options and work toward the more flexible but involved options.

1. Public REITs

Many 401(k) administrators already offer publicly-traded REITs as built-in investment options. If you want to include publicly traded REITs (real estate investment trusts) in your broader portfolio anyway, your 401(k) account is a convenient place for them.

With so many REITs available, it’s become so easy to pick and choose one that you’d like to own. However, remember that public REITs don’t offer much diversification from stocks. There’s an uncomfortably close correlation between REITs and stocks, which defeats the purpose of diversifying your portfolio to include real estate.

The correlation between U.S. REITs and the broader U.S. stock market is 0.59, comparable to that between the total U.S. stock market and other sectors such as telecommunications stocks, energy stocks, and consumer staples.

You’ll have to look further afield if you want true diversification with uncorrelated assets.

2. Borrow Money from Your 401(k)

Often, the cheapest person to borrow from is yourself—or at least your future self, by borrowing from your 401(k) balance.

You’ll still pay interest at a lower rate than bank loans. That interest goes toward your 401(k) balance, not a lender’s.

You can use borrowed funds to cover the down payment on a rental property, closing costs, renovation costs, or anything else. Loans from your 401(k) are flexible, cheap, and don’t require lengthy credit applications. If you default, it doesn’t report on your credit history.

But you pull cash out of your 401(k) account that would otherwise be invested and earn a return. It’s up to you to ensure you earn a higher return on your borrowed funds than you’d have earned if you’d just left the money in your 401(k) invested-in stock index funds.

If you leave your job, you must repay the loan balance quickly. In the case of default, the IRS considers the balance an early withdrawal and charges you taxes and a 10% early distribution penalty.

3. In-Service Rollover to an SDIRA

With a self-directed IRA (SDIRA), you can invest in nearly anything you want, including real estate.

But can you transfer funds from your 401(k) to your IRA while you still work? In most cases, you can; the Profit Sharing Council of America (PSCA) estimates that up to 77% of employers allow in-service rollovers to IRAs.

Of course, “can” is different from “should.” Self-directed IRAs require a custodian to oversee your IRA funds and keep you in compliance. And custodians charge for their services, typically hundreds of dollars each year. Not to mention that you need to find one you can trust and have reasonable fees. 

Self-directed IRAs let you invest in anything from real estate crowdfunding platforms to direct property ownership to real estate syndications. Many of our real estate investment club members invest via their SDIRA.

Suppose you invest in a self-directed Roth IRA, and your investments are compound tax-free. At compound returns of 15–30%, as we aim for in our real estate investment club, doubling your money tax-free every few years can mean doubling your money tax-free.

As a final thought, in-service rollovers can allow you to contribute huge amounts to your IRA. So long as you meet the income requirements, you can max out your IRA and 401(k) contributions yearly.

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4. Open a Self-Directed 401(k)

If you’re self-employed, you can open your own solo 401(k) or small business 401(k). You can also opt for a self-directed 401(k), which allows you to control investments like an SDIRA.

Even if you work a 9–5 job, you could open a self-directed 401(k) for your side hustle. Even real estate investing can count as being in business and eligible for opening a 401(k)!

Again, expect to pay a 401(k) custodian or administrator fee. They take on most of the regulatory headaches and paperwork but still add more complexity than buying index funds or public REITs in your employer’s 401(k) plan.

You can invest in nearly anything you want in exchange for those downsides. That could include fractional shares of rental properties, fractional real estate syndications — ranging from self-storage facilities to apartment complexes, mobile home parks to retail and beyond, property-secured debts, or direct property investments.

Active Real Estate Investing with a 401(k)

You can buy investment properties directly with a self-directed 401(k) or SDIRA. But it comes with some complications and downsides.

To begin with, only your down payment counts as a tax-sheltered investment. If you borrow a rental property loan, that portion of the property doesn’t count as an IRA asset, and you pay normal taxes on it. Only a percentage of your property counts as an IRA investment, with all its tax advantages. That adds plenty of wrinkles to your tax return (and forehead, in all likelihood).

Additionally, you can only take out a non-recourse loan when you buy properties with your SDIRA or self-directed 401(k). Non-recourse loans don’t allow the lender to come after you if you default. As you can imagine, few banks offer them. Check out North American Savings Bank as one lender who does, but expect a harder road to take out a non-recourse loan than a typical rental property loan.

In short, buying rental properties in a self-directed IRA gets tricky. I don’t do it, nor do most real estate investors I’ve known.

Passive Real Estate Investing with a 401(k)

Most people who buy real estate with a 401(k) or self-directed IRA invest passively. In other words, they don’t buy properties directly but instead invest in larger real estate projects by professional investors.

One common example is real estate crowdfunding investments. That broad umbrella covers everything from fractional ownership in properties to real estate investing funds to pooled or individual loans secured by real estate. 

For example, you can buy fractional shares in rental properties on Ark7 or Arrived, pooled real estate funds on Fundrise, or secure short-term loans on Groundfloor. I’ve invested personal money in all of those and more. These options are the some of the easiest ways to invest in real estate using your 401(k). 

Or you can go further and invest in private equity real estate syndications. One common “drawback” of these is the lack of liquidity and the long-term commitment of 2–7 years, but you probably won’t withdraw funds from your retirement accounts within that timeframe anyway.

Another downside is the high minimum investment, typically $50–100K. But if you invest as part of an investment club where members pool their funds together, you can invest with far less. Many of our Co-Investing Club members invest with a self-directed IRA, and the minimum investment is $5K instead of $50–100K.

That makes it much easier to diversify your real estate investments, spreading your money among 10–20 investments instead of a single property or fund.

Passive real estate investing in a 401(k) or IRA also makes your accounting and tax return easier. Real estate crowdfunding platforms send you a 1099, and real estate syndication sponsors send you a K1.

In both cases, you just plug the bottom line number into your tax return rather than trying to calculate which portion of your rental cash flow counted as retirement account income and which didn’t.

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Alternative: Do Your Stock Investing in Your 401(k)

Personally, I don’t invest in real estate with a 401(k) or self-directed IRA.

A diversified portfolio includes both stocks and real estate. If I’m going to own both anyway, what’s the point in jumping through all the extra hoops to buy real estate in a 401(k) when I could just hold my equities in my 401(k) and own my real estate separately?

After all, real estate comes with plenty of built-in tax advantages. Consider all the tax deductions for rental properties or the on-paper-only write-off for real estate depreciation. Most real estate syndications let you take accelerated depreciation, showing a loss on your tax return even as you collect distributions in real life.

Imagine you hold 50% stocks and 50% real estate as your asset allocation. You can hold the stock portion of your portfolio in your 401(k) and IRA to skip the headaches of working with a self-directed IRA custodian or a 401(k) administrator.

Final Thoughts on Investing In Real Estate With Your 401(k)

Before signing up with the first overpriced self-directed 401(k) custodian you find, sit down and talk to a neutral tax professional. While you’re at it, talk to a few veteran real estate investors about their thoughts on real estate in 401(k)s.

I don’t bother with them, nor do most real estate investors I know. But the option exists if you want to pursue it—just do so with caution and knowing all the pros and cons.♦

How do you plan to invest in real estate with your 401(k)?

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