Betting your retirement on real estate

Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005).

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NEW YORK (Money) -- Question: I'm 52 years old and think I might get laid off soon. If I do, I'm thinking of rolling over the $250,000 in my 401(k) into a self-directed IRA that I would invest in real estate and try to make money in foreclosures, rental properties, etc. Do you think this is a good idea? --Larry C., Eldersburg, Maryland

Answer: The last time I got questions about investing IRA money in real estate was at the peak of the housing bubble back in 2005. Back then, when house prices in some frenzied markets were climbing at double-digit annual rates, people were looking to invest almost any money they could get their hands on in real estate, including the funds in their IRAs.

And if the idea of investing in real estate within their IRA somehow hadn't occurred to them on their own, there were plenty of advisors, consultants, columnists and self-directed IRA custodians raving about the opportunities to boost your IRA's growth rate by buying housing and other real estate.

My take on this issue at the time was that while real estate was a hot investment I didn't think it was such a hot idea to invest one's IRA stash in it.

For one thing, I warned that after big runups in the past, house prices had fallen precipitously and in some markets had taken almost 10 years to regain their peaks. I also noted that owning real estate within an IRA can be a hassle. Most people don't have enough dough in their IRA to buy enough properties to diversify properly. (Financing a purchase for an IRA is possible, but complicated.) And since there are limits ($5,000 this year, plus $1,000 if you're 50 or older) to how much you can contribute to an IRA in any year, you could run into problems if the cost of property maintenance and repairs exceeds the amount of cash you have in your IRA or that you're allowed to put in.

So now that at least some of the air has been let out of the real estate bubble have I changed my mind about investing in real estate through an IRA?

Not really.

Granted, since prices have fallen (make that "collapsed" in some areas), I think that housing is a more attractive investment today than it was back at the height of the boom. If nothing else, you're getting the same sticks and bricks at a lower price. (To get a handle on current prices in your area, you can check out sites like Zillow, Trulia and Cyberhomes.)

That said, even with incentives designed to spur demand, such as the $8,000 first-time homebuyer credit, it's still unclear (to me at least) how long it will be until we see a sustainable turnaround. And given how the last boom turned out, you have to wonder how robust the upturn will be.

But even setting that issue aside, you still have to deal with the other difficulties I mentioned about owning real estate in an IRA. One more thing you might want to consider is that real estate isn't the most liquid investment around. That could be a problem if you need to raise cash from your IRA in a hurry (which could be a possibility for you if your premonitions of being laid off are accurate).

To sum up, I don't think an IRA is a particularly good vehicle for investing in actual real estate. If you feel you really want to take advantage of beaten-down home prices, I'd recommend you consider using funds from other accounts if possible.

Even then, I'd avoid investing in actual properties if it meant tying up a large portion of your overall portfolio in real estate. After all, you probably already own a home, which gives you plenty of real estate exposure. And even if that's not the case, the properties you buy are probably going to be located in one town or region of the country. In terms of diversification (or lack of), that's the equivalent of limiting your stock investing to companies in one industry -- not a good idea.

All in all, I think you can get enough of the diversification benefit and return potential that real estate has to offer by investing in REITs or mutual funds that specialize in REITS or other forms of real estate. (For a few suggestions, check out our picks from our Money 70 list of recommended funds.)

I know this answer won't make me popular with real estate buffs and the people who push self-directed IRAs. But my feeling is that if you can get a good portion of the benefits of real estate while reining in the risk, that's the more prudent way to go.