It comes as no surprise that investing in real estate usually requires a larger upfront investment than stocks, bonds, and other common assets.
Whether you want to purchase a property to manage or invest privately in a syndication, you usually need $100,000 or more to invest. For some, their 401(k) plans may surpass that threshold, making them an attractive option for investing in real estate.
But the rules are not always clear. Read on as we explain how you can use your 401(k) funds to invest in multifamily real estate and discuss your best options.
Can You Invest Your 401(k) in Multifamily Real Estate?
The short answer to this question is no unless you have a self-directed 401(k).
The IRS sets specific guidelines on what you can invest in through a 401(k) plan. Standard 401(k) plans offered by employers will limit your investment options to stocks, bonds, and mutual funds.
A self-directed 401(k), on the other hand, allows you to invest in a much broader set of assets, including commercial and residential real estate. You can also use this type of 401(k) to take advantage of other alternative investments, such as mortgage notes, private equity, cryptocurrency, and precious metals.
You can roll a 401(k) into a self-directed IRA, but we’re getting ahead of ourselves. Next, we’ll explore your best options for investing in real estate with a 401(k).
Your Options for Investing a 401(k) in Real Estate
While you may not be able to invest in multifamily real estate through your employer-provided 401(k) plan, there are three popular options to choose from:
- Take out a loan from your 401(k)
- Open a self-directed 401(k) or self-directed IRA
- Roll your 401(k) into a self-directed IRA
Let’s explore each one in more detail.
Take out a loan from your 401(k)
While you can withdraw from your 401(k) early, this will incur penalties if you are younger than 59 ½, so we’ll exclude this from consideration. You are allowed to take out a loan from your 401(k) and face no tax penalties. However, there are a few caveats to be aware of:
- You can borrow up to half your vested account balance, not exceeding $50,000. The exception to this rule is if your balance is less than $10,000. In that case, you can borrow the total amount.
- You’ll need to pay back with interest, typically at the prime lending rate plus 1%.
- The loans operate on a 5-year term.
We’ll explore your options for investing in multifamily real estate later, but one thing to note is that some come with time restrictions.
For instance, if you invest privately in a syndication or fund, you may need to invest on a 3-5-year term. Additionally, should you leave your job, then you may need to pay back your loan in a much shorter time frame or risk defaulting and facing tax penalties and a 10% payment on the outstanding balance.
For these reasons, loans are probably not always the best way to invest a 401(k) in multifamily real estate.
Open a self-directed 401(k) or self-directed IRA
If you cannot open a self-directed plan with your employer, then you can open a self-directed plan as a separate retirement account.
There are two options here:
- A solo 401(k): A solo 401(k) is a 401(k) plan for business owners with no employees. With a self-directed solo 401(k), you can contribute from the employer and employee side, allowing you to contribute more than your employer-provided 401(k) plan with more freedom for what to invest in.
- A self-directed IRA: You can always open a self-directed IRA, which gives you a separate retirement account and the freedom to choose how you invest.
In either option, you will have the freedom to invest in your retirement account however you wish. It’s worth noting that self-directed retirement accounts have certain reporting requirements that you need to fulfill for the IRS. Ensure you read up on the requirements or discuss this route with a financial professional.
Roll your 401(k) into a self-directed IRA
Rather than start from scratch, you can also roll your existing 401(k) into a self-directed plan. This gives you the flexibility to choose how you invest with (potentially) a much larger amount to start with than if you opened a new plan today.
Converting a 401(k) to a self-directed IRA typically takes 2-4 weeks and requires the following:
- Open a self-directed IRA and request a rollover distribution from your 401(k) administrator.
- Initiate the transfer and ensure you choose “direct rollover” to avoid tax withholding.
- Pay setup fees to establish your self-directed IRA, along with annual maintenance fees.
Self-directed IRAs follow the same contribution limits as traditional IRAs: as of 2024, you can contribute up to $7,000 annually ($8,000 if you're 50 or older). However, these contribution limits don't apply to funds rolled over from your 401(k) – you can roll over any amount from your existing retirement account. Keep in mind that while the rollover itself is a tax-free event when done correctly, you'll need to complete the process within 60 days if you receive the check personally to avoid tax penalties.
We recommend the same advice as before: consult a financial professional when converting your 401(k) plan and self-directing it.
5 Benefits of Investing Your 401(k) Funds in Multifamily Real Estate
While it’s possible to invest your 401(k) in multifamily real estate, there is clearly some work on your part. Is it worth the effort?
We’d say yes, despite the caveats that working through investing in multifamily real estate comes with many benefits. While it’s hard to pick our favorites, these would be our top five:
- Passive income: Regular monthly rental payments from multiple units create a steady cash flow stream, potentially providing financial independence over time.
- Appreciation: Multifamily properties typically increase in value through both market appreciation and forced appreciation via strategic improvements and increased rental income.
- Numerous tax benefits: Investors can leverage depreciation, mortgage interest deductions, and operating expense write-offs to significantly reduce their tax liability.
- Certain classes/markets may offer stability: Class B and C properties in strong secondary markets often maintain high occupancy rates and consistent returns, even during economic downturns.
- Ownership in a tangible asset: Unlike stocks or bonds, real estate provides physical property ownership that can be improved, refinanced, and used as collateral while serving as a hedge against inflation.
You’ll probably note that we specify multifamily as opposed to any real estate.
That’s because while both multifamily and single-family real estate offer many of the same benefits we just listed, multifamily real estate is a far superior investment. That’s because multifamily real estate allows you to diversify rental income across a much larger tenant base and much stronger cash flow. Read more about how multifamily compares to single-family real estate in our guide.
If you’re sold on diversifying your portfolio with multifamily real estate, read on as we share the best places to invest your money.
The Best Ways to Invest in Multifamily Real Estate
There are a number of ways to invest in multifamily real estate, but the most common are:
- Purchase property: Direct ownership through a traditional mortgage allows complete control over the investment, from property improvements to tenant selection, while building equity through monthly payments.
- REIT: Real Estate Investment Trusts provide exposure to large portfolios of properties with high liquidity and low minimum investments, perfect for investors seeking dividend income without management responsibilities.
- Mutual Fund: Real estate mutual funds offer diversified exposure to multiple REITs and real estate companies, professionally managed with lower risk through broad market diversification.
- Real Estate Syndication/Private Deal: Pooling capital with other investors through syndication enables access to larger, institutional-quality properties while benefiting from professional management and passive ownership.
Which of these should you choose? It largely depends on your investment goals and risk tolerance.
Purchasing a property is likely the most risky as it requires the most capital upfront and puts all the responsibility on your shoulders. However, you also get to assume all (or most) of the benefits.
Meanwhile, a REIT or mutual fund diversifies your funds and allows you to invest passively, assuming far less risk but also getting less exposure to the upsides of real estate investing and the tax benefits.
For those looking for a hybrid of the two: owning a tangible asset and receiving numerous tax benefits while investing passively, a real estate syndication is an excellent choice. A real estate syndication allows you to invest passively alongside an experienced investment team that sources, manages, and sells the property—all the while receiving distributions from the property, taking part in the many tax benefits, and sharing the profits on sale.
Some real estate syndications give you an even better deal: by investing as a Co-GP, you can receive the same benefits as the GP managing the deal while still investing passively. Not many firms make this special offer, but Colony Hills Capital is proud to extend an offer to invest as a Co-GP in every deal we run.
Interested in Investing in Real Estate? Download the Free Multifamily Investors Guide
If you’re looking to invest in multifamily real estate but are unsure where to start, we recommend downloading our free multifamily investing guide. We wrote it to show you the ins and outs of investing in multifamily real estate. Fill out the form below to get your free guide. In it, you’ll learn:
- The tax benefits of investing in multifamily real estate
- How to choose a firm
- The best markets to invest in
And more!
