Investors traditionally hold stocks, bonds, and mutual funds in their retirement accounts. But, for people looking to diversify their retirement portfolios, other options – like passive real estate investments – exist. As such, we’ll use this article to explain how to use retirement funds to invest passively in real estate. 


Specifically, we’ll cover the following topics related to passive real estate investing with retirement account funds:


  • SDIRAs vs Passive Investing in Standard Retirements Accounts
  • 401k vs IRA Passive Real Estate Investment Options
  • Option 1: REITs
  • Option 2: Real Estate ETFs
  • Option 3: Real Estate Mutual Funds
  • Option 4: Real Estate Industry Stocks 
  • Final Thoughts 


SDIRAs vs Passive Investing in Standard Retirements Accounts


Let’s begin with what we’re not discussing in this article – SDIRAs, or self-directed individual retirement accounts. These retirement accounts allow individuals to hold a variety of alternative asset classes, including real estate. And, as the name suggests, the individual account holder directly manages the account’s investments while a separate custodian handles the account’s administration


SDIRAs offer outstanding options to invest in real estate in a retirement account. But, they also require far more A) cost, B) administrative burden, and C) active involvement than standard retirement accounts. Accordingly, we do not consider this sort of investing to be purely passive so will not address it in this article. Instead, we will discuss using SDIRAs to invest in real estate in a separate article focused solely on these types of accounts. 


In this article, we will outline the passive options investors have to invest in real estate via standard retirement accounts, that is, traditional and Roth IRAs and 401(k) plans.  


401(k) vs IRA Passive Real Estate Investment Options


As tax-advantaged retirement accounts, 401(k)s and IRAs both offer investors significant benefits. And, these accounts share many similarities. In particular, both plan types include either traditional or Roth options. With a traditional 401(k) or IRA, investors receive a tax benefit now. That is, contributions reduce current taxable income, and account holders pay taxes on withdrawals in retirement. On the other hand, the Roth versions of both plans offer tax benefits later. Contributions do not reduce current taxable income, but individuals can withdraw funds in retirement without paying taxes. 


The primary difference between the two involves sponsorship. Whereas 401(k)s are employer-sponsored plans, individuals establish IRAs. Additionally, 401(k) plans offer higher annual contribution limits than IRAs, and many 401(k)s receive an employer matching contribution. 


With respect to selecting passive real estate investment options, individuals can technically purchase any of the below investment options in either account. However, as employer-sponsored accounts, 401(k) plans typically offer far fewer investment options than IRAs. And, employees have no control over 401(k) plan administration, preventing them from expanding these investment options. As a result, if a 401(k) plan does not offer a particular real estate investment option, investors cannot purchase it within the plan. Instead, investors can either A) roll their 401(k) plan funds into an IRA; or B) establish a separate IRA and begin making contributions to it. 


NOTE: Investors can face tax consequences to rolling any traditional retirement plan into a Roth plan. Before making this move, be sure to consult with your CPA or tax advisor. 


In the next four sections, we’ll explain four options to use retirement funds to invest passively in real estate. Each has its own considerations, but they all provide investors an opportunity to passively expand their retirement portfolios into real estate. 


Option 1: REITs


REITs, or real estate investment trusts, offer investors a path to investing in commercial real estate without personally buying and managing the underlying properties. Congress created this option in the 1960s to expand real estate investing to a wider pool of potential investors.


Most REITs own and – typically – operate income-producing commercial property. Additionally, some REITs choose to invest in the mortgages behind these properties. Regardless which approach they take, to meet IRS compliance guidelines, REITs must return at least 90% of their taxable income as shareholder dividends each year. These dividend requirements prove appealing to many investors, as REITs generally offer far greater dividends than traditional stocks and mutual funds. 


Investors can purchase publicly-traded REITs just like they would any other stock, making investing in REITs a convenient option for passive real estate investing. And, a major advantage exists to using retirement account funds to purchase REITs. Unlike most stock dividends, REIT dividends do not receive favorable tax treatment. Instead, the IRS taxes these dividends at an investor’s ordinary income rate. Consequently, holding these investments in a tax-advantaged retirement account can save investors a tremendous amount of money in taxes.   


Option 2: Real Estate ETFs


Individual REITs generally focus on a single property type. For instance, some REITs focus on industrials, while others hold portfolios of multifamily properties. This narrow approach tends to increase concentration risk. 


For investors preferring more diversification than an individual REIT offers, they can purchase real estate exchange-traded funds, or ETFs. ETFs are publicly-traded and provide dividends, and investors can use their retirement funds to purchase them. Similar to mutual funds, ETFs track underlying assets – generally individual REITs. As a result, real estate ETFs provide far more asset class diversification than an individual REIT.


Rather than focus on a single property type – like most REITs – real estate ETFs track a variety of underlying individual REITs. And, they typically do this by passively tracking an index of REITs. This means that, by purchasing shares in a single ETF, investors gain exposure to the property types of every single REIT in the underlying index. For investors looking for truly passive investment options, this can be a great strategy. Instead of needing to spend time and energy researching and building a diversified portfolio, investors can achieve diversification across the real estate industry with a single ETF. 


Option 3: Real Estate Mutual Funds


Real estate mutual funds act similarly to ETFs. Investors purchase shares in a single fund, and this fund owns a variety of underlying assets. As such, purchasing shares in a real estate mutual fund offers investors an immediate level of diversification and dividend income in their retirement accounts. 


Unlike ETFs, which tend to passively follow an underlying index, many real estate mutual funds are actively managed. This means a manager makes the specific investment decisions for the entire mutual fund. For individuals preferring a more tailored investment strategy, choosing a particular real estate mutual fund may make more sense than an index-tracking ETF. 


However, this option generally comes with additional costs, too. Due to this active management, many real estate mutual funds charge higher fees than ETFs. Additionally, they typically require larger initial purchases. For retirement account decisions, this means investors need to weigh A) the performance of individual mutual funds against B) the associated costs. In other words, does the historical performance of a particular real estate mutual fund seem to justify the additional fees? Individual investors will need to make this decision based on their own investment objectives.


Option 4: Real Estate Industry Stocks 


Individuals can also use their retirement funds to indirectly invest passively in real estate. With REITs, ETFs, and real estate mutual funds, people invest in income-producing properties (or the associated mortgages). However, the broader real estate industry includes more than just the properties themselves. 


For investors looking for a means to gain indirect exposure to the real estate industry, they can use retirement funds to purchase stocks of companies in related industries. Construction, development, building materials (e.g. steel, lumber, etc.), mortgage lending, sales and marketing, and property management are all examples of industries directly related to real estate – that don’t actually own and operate the underlying properties. And, investors can purchase shares of companies in these industries with retirement funds. 


Purchasing individual company shares inherently increases investment risk, as investors limit their diversification. But, the alternative remains true, as well. Investing in shares of individual companies can lead to significant returns. Accordingly, investors need to balance the desire for increased return potential with the risk of investing in single companies. 


Final Thoughts 


Passively investing in real estate can offer outstanding returns – and diversification – in a retirement account. And, REITs, ETFs, mutual funds, and related-industry stocks all provide passive investment options. 


However, we realize that, even after outlining the above considerations, deciding on the best investments can seem challenging. If you’d like to discuss different real estate investing options for your unique situation, we’d love to chat! Drop us a note, and we’ll set up a meeting to talk about using retirement funds to pursue passive real estate investment opportunities.