The following was written for Equity Trust by Jeff Watson, attorney and founder of Watson Invested, which primarily deals with established real estate investors - particularly those who are using self-directed retirement accounts. Jeff has been a landlord and real estate investor since 1994. His real estate investing experience includes rehabbing, creative buying, long-term holding of numerous rental properties and apartment buildings, short sales in more than one state, private lending, and self-directed retirement account investing.*
When it comes to sports, we often hear it said that there is no “I” in “team.” When sharing with individuals who want to know more about self-directed retirement account investing, I stress the importance of networking and learning how to develop “financial friends” and “economic allies” with whom they can collaborate and conduct business involving their self-directed accounts. I go on to explain that they have to learn how to “play nicely.” That coincides with the statement that there is no “I” in “team.” The deal has to make sense for everyone involved, and everyone has to be able to reasonably benefit or profit from the deal.
When speaking to audiences about self-directed investing, I share with them the difficulties I see in transactions wherein one party has designed the transaction in such a way that they captured most of the profits from the beginning of the investment, and it makes it very hard for the other investor to have a reasonable benefit or profit. While I understand that those who do private lending want to make sure they get a healthy return, you have to look at the entire deal to determine when and how you should take your profits. That’s part of making sure you have teammates who understand what it is you are doing and the needs of that particular deal or investment. Is everyone comfortable in meeting those needs?
You’ve probably seen a situation in which an individual wholesales a house to a rehabber, and that rehabber has to struggle to make a profit; or maybe you’ve seen instances where a private lender structures the deal in such a way that their borrower struggles to make a profit in the transaction. Those are the situations I encourage you to avoid.
Towards that end, let me give you two suggestions to make sure these situations don’t happen to a self-directed account deal in which you are involved:
Make sure everyone involved in the transaction clearly understands the transaction so they can explain it in two or three simple sentences that perhaps even an eight-year-old child can understand. I have seen too many investors who made investments with a self-directed retirement account and later regretted it because the person with whom they invested or to whom they lent money was far more sophisticated than they were, and they felt like they had been taken advantage of.
There are three key questions that need to be asked and answered.
WIIFM – “What’s in it for me?” How is my self-directed account (if that’s what I am using) benefiting in this transaction? When will that benefit occur?
WIIFY – “What’s in it for you?” How will your account benefit from being involved in this transaction? In order to answer this and the preceding question, you have to have a thorough understanding of the deal and investment.
“What if…” – This is one of the most important questions to ask for any investment opportunity. Ask yourself “what if” and insert reasonable things that could change or go wrong. This is not where you insert the ridiculous or the one-in-a-million possibilities, but rather where you insert the realistic questions. What if the economy slows down? What if a contractor doesn’t perform as agreed? What if the vacancy rate skyrockets? What if the property catches on fire?
These kinds of questions should be addressed before the deal is finalized. This will serve to keep everyone on the same page and build team spirit, and it helps you finalize your due diligence to determine if it’s a transaction you really want to do. Equally as important, it allows everyone with whom you are planning to do business to determine that they, too, will benefit from the relationship and the deal.
*Jeff Watson is not affiliated with Equity Trust Company or its affiliates. The information provided in this article is for educational purposes only and should not be construed as tax, legal, or investment advice. Whenever making an investment decision, please consult with legal, tax, and financial professionals.