Non-recourse loans on rental properties are becoming an increasingly common way for retail investors to diversify their individual retirement account holdings.
Non-recourse investment opportunities allow retail investors to potentially realize significant gains from real estate appreciation, as well more modest monthly tax-free gains from rental income.
Jason Zook, IRA loan officer with North American Savings Bank, closes about 20 to 25 non-recourse loans each month, and NASB as a whole closes about 40 non-recourse loans monthly. The bank issues an average of about $3 million in non-recourse loans per month.
Zook also owns multiple homes in the greater Kansas City area that he’s bought using his self-directed retirement account. It’s an investment opportunity that spans the entire age range, from Gen-Yers and Millennials to seniors who are required to take mandatory distributions.
“It’s another way to diversify, regardless of age,” Zook says.
What are Non-recourse Loans?
A non-recourse loan means there is no recourse against the borrower or the individual retirement account in the event of a default – the only recourse for the lender is the property itself. Since an investor can walk away from the loan with little personal liability, banks typically require a minimum down payment between 30 to 40 percent (or higher) so that investors have serious skin in the property.
- Curb appeal
- Home size
- Home age
- Expected cash flow
- Property sale history
- Cash reserves available in the IRA to service debt
Only certain properties qualify for non-recourse loans, including:
- Single-family homes
- Town homes
- Certain multi-family units
Zook says that while NASB figures in all of the main property characteristics, the overriding considerations are the property’s expected cash flow and the liquidity of the investor’s self-directed IRA.
“As long as the property is in good condition, we look at the loan to be paid back based on expected cash flow from the property and the health of the IRA,” Zook says. “We want to make sure the IRA has positive cash flow so that it can stand on its own in case of a decline in property values. There has to be positive reserves to continue servicing the debt.”
Writing the Book on Non-recourse Loans – Literally
North American Savings Bank of Kansas City started the first national non-recourse loan program back in 2004. Matt Allen, Vice President with NASB, wrote a book on the subject titled, “Leverage Your IRA – Maximize Your Profits With Real Estate.” (To receive a free digital copy of the book and get additional information about non-recourse loans, call NASB at 866-735-6272.)
Since the loan is based on expected cash flow, NASB prefers to see at least 20 percent positive cash flow so that the rental property always at least breaks even. Beyond breaking even, investors also should have funds for required maintenance, repairs, vacancies, or property management fees.
Potential investors can strengthen the balances in their IRA accounts to meet liquidity requirements by rolling money over from corporate-sponsored IRAs or by making annual contributions to their IRA. The maximum allowable annual contribution to an IRA is $5,500, or $6,500 for people ages 50 and up.
Zook says investors often prefer to purchase rental properties in their home markets so they can have greater oversight in their investment.
“If you live away from the property, you have a trust a property manager,” Zook says. “You also have to figure out how to keep up the property. That’s why a lot of people do non-recourse loans for properties right in their own backyards because they are more familiar with those areas.”
Investments, for the most part, are safeguarded against default through careful vetting of the property.
“We won’t allow investors to get into a situation where our loan won’t be paid back,” Zook says. “We only borrow on select properties that are qualified through appraisal – the only challenge is having potential borrowers find properties that are right for them and also right for us.
“However,” Zook adds, “once we get started, it’s a very document-friendly loan – you don’t have to fill out a whole bunch of paperwork. We don’t collect information on the borrower’s income, assets or employment; we only pull their credit. Even if there issue there, we can still get a loan done if we are comfortable with the property’s equity position.”
Interest rates on loans typically start in the mid-5 percent and typically are amortized over a maximum of 20 years for fixed rates and 25 years maximum for adjustable rates.
Non-recourse Loans: Are They Right For You?
Many retail investors who purchase rental properties using non-recourse loans have backgrounds in real estate. Others are retail investors who simply come across good deals and jump at the chance to buy properties under market value. Others seek diversification of their retirement holdings through a tax-free investment vehicle.
“A lot of IRA gains are tax-free, any kind of appreciation on the property when you sell it is tax-free,” Zook says. “Some people buy vacation rentals or short-term rentals and have someone else pay their loan while the property is appreciating. Or if the investor is at retirement age, they can take the property out as a distribution instead of taking their IRA dollars and then live in the home. There are multiple ways non-recourse loans benefit IRA investors.”
Rocket Dollar helps retirement investors unlock the full power of their retirement dollars through Self-Directed Solo 401(k)s or Self-Directed IRAs that can be used for a wide range of alternative investment classes, including the types of real estate available.