Real Estate in DB Plan

[Guest YATPA]

Small DB plan covering doctor and 4 staff. Doctor's PVAB in the plan comprises about 80% of total PVABs. Doctor wants to purchase undeveloped land with plan assets. Recognizing the fact that there are a whole host of other issues related to having real estate in the plan, what % of plan assets could he use for this purpose and still meet the diversification obligations?

[WDIK]

I don't know if there is a specific percentage, but 20% is often used as a rule of thumb, probably because this is a specific question on Form 5500. I am fairly certain that in a couple of instances I have dealt with, reporting over 20% invested in real estate triggered an audit. However, these were for defined contribution plans. Since the DB does not have individual accounts, I would not think that it would draw the same scrutiny.

[david rigby]

Could be suspicious. Be careful about

- PT,

- ERISA section 407.

[mwyatt]

Considering your doctor will take it on the chin if this investment craters and others will get what's coming to them under the terms of the plan, one would think that it wouldn't be such a big deal, as compared to a PS plan where if tanks, all involved are hurt. However, what is the rational here? As Pax points out, there are prohibited transaction issues potentially floating around (what exactly is your doctor's rational for this "great" investment?). Also, have to consider your end game (and there will be one, considering this is a small DB plan with a limited life expectancy). What happens with this investment when the plan terminates? Doctor can't buy it (PT) and certainly can't roll it over to an IRA. Where do you go from here...

[Kirk Maldonado]

Watch out for UBTI problems.

[Guest YATPA]

Doctor's rationale is that he was burned badly in the market over the past few years (held Global Crossing, etc.) and has an aversion to equities now. He currently owns a condo in Hilton Head and has watched it increase substantially in value over the same time period and feels that would be a better investment for the plan from a return standpoint. I've communicated the PT and other issues to him and have not been able to dissuade him from this route. Thanks for all the input, everyone.

[Guest Harry O]

You also need to concern yourself with liability protection. If the property has environmental problems, the plan could be wiped out beyond its initial investment. You should get legal advice on how to structure the acquisition to avoid this issue.

[mbozek]

The DOL believes that no more than 25% of plan assets should be in one investment.

[Guest Pete Swisher]

Every time I've seen this there has been an apparent PT attached. If the doc is talking about purchasing a condo which he himself uses, intends to use, or owns part of, then it's hard to see how that wouldn't violate ERISA 406 PT rules. The real estate these guys want to buy always seems to be something they already own interests in or are tied to somehow, and that is not OK.

Check out ERISA Facts by Nick Ferrigno and FRank Bitzer--I seem to recall a case they cite on this issue where 60% of plan assets were in real estate and the plan was held to be diversified, though that is a single extreme example. Owning a single condo in Hilton Head doesn't sound remotely diversified to me...

mbozek--where did you hear/see the 25% figure? If you have a cite I'd love to get it.

[mbozek]

The 25% figure was given by the director of enforcement for the NY Regional office of the PBWA a few years ago at a conference I attended. It appears in several laws suits that the DOL has filed against plan fiduciaries for failure to diversify assets.

[TCWalker]

*******Check out ERISA Facts by Nick Ferrigno and FRank Bitzer--I seem to recall a case they cite on this issue where 60% of plan assets were in real estate and the plan was held to be diversified, though that is a single extreme example.********

The case is Metzler v Graham, 112 F 3d 207 (5th Cir 1997), and it was a defined contribution plan investing 63% of plan assets in one tract of land adjoining others in which the owner has in interest.

There are the 7 factors or prudent diversification to look at that come from the conf rep and are reprinted in a few cases, including the one above. I wonder if your Doctor is willing to risk an audit and a demonstration that the diversification requirement of 404(a) is satisified...all things considered the long term economic cost of the investment could be alot greater than the purchase price.