Self Directed IRA Investments in Real Estate: Direct Owned Real Estate vs. REITs

Self Directed IRA Investments in Real Estate: Direct Owned Real Estate vs. REITs

myIRAhack.com believes that real estate has an important role in any retirement portfolio. What percent of your retirement portfolio should you hold in real estate? One commonly accepted rule of thumb suggested by Yale Chief Investment Officer David Swensen’s asset allocation target is to hold approximately 20% of a portfolio  in real estate.   Swensen suggests holding REIT stocks, not the directly owned real estate so many self directed IRA real estate investors own.

There are advantages and disadvantages to owning real estate investment trusts (REITs) compared to directly owned real estate. But what counts is performance, right? So how have REITs performed against single family homes?

This is a difficult question to answer and properly analyze. For starters, the information on single family rental homes, the type often held in self directed IRAs, is notoriously difficult to find in sufficient volume to properly analyze. myIRAhack.com has offered some analysis of the single family home rental companies that went public following the housing crisis. But this is a small sample size.

Looking at home price appreciation alone, and ignoring rental income, we have a good idea of how home prices have performed against one of the most liquid REIT ETFs, the Vanguard REIT ETF. There are many caveats here, but we’ll point out a few:

1) past performance does not guarantee future performance, and we are NOT providing investment advice,

2) the Vanguard REIT ETF currently holds almost 150 different stocks which constantly changes and whose component companies have varying degrees of leverage,

3) as mentioned, the Case Schiller home price data does NOT include rental income, just home price appreciation for the US and a few selected cities, while the Vanguard REIT ETF takes into account dividends

4) myIRAhack.com attempted to “correct” for the lack of leverage in the Case Schiller data by assuming a 30% equity / total capital used amount. Thus, a 5% annual price appreciation would become 8.33% (5% divided by 30%). This math gets fuzzy however when prices fall such that the equity is wiped out,  a bank would likely foreclose on a property.

Open & Shut Case?

This graph shows Case Schiller home price data compared to the Vanguard REIT ETF from July 2010 through March 2015. The seeming massive outperformance of the Vanguard REIT ETF makes single family homes look like a sucker’s bet:

VNQ v CS simple

Source: S&P/Case Schiller Home Price Indices, Yahoo Finance, myIRAhack.com research

Not So Fast!

This graph shows Case Schiller home price data assuming 70% debt to total capital (30% equity) compared to the Vanguard REIT ETF from July 2010 through March 2015.  REIT outperformance all of the sudden disappears compared to the San Francisco market. If you  factor in approximately 5-8% of rental income a year, and now single family real estate looks quite competitive to holding REITs.

VNQ vs CS 30 pct

Source: S&P/Case Schiller Home Price Indices, Yahoo Finance, myIRAhack.com research

Conclusion

myIRAhack.com thinks there’s a role for both REITs and direct or LLC (LP) owned real estate in an IRA. We suggest you perform your own due diligence and consult with competent legal, financial and tax advisors.

Good luck.

 

Social Icons

%d bloggers like this: