Using LLCs for Real Estate Investments
A question that I am being asked quite a lot these days is: “We believe that it’s a great time to invest in US real estate, but how do we do it? Is there anyway to protect ourselves from potential law suits? What if we want to invest as a part of a group?”
A potential solution for these questions would be using LLC, which is an acronym for Limited Liability Company. This entity is vastly used as an investment vehicle, as it creates a separation of entities between the members (“shareholders” of the LLCs) and the LLC itself, somewhat like a corporate. My friend and fellow investor Cori from www.connectrei.com wrote a great post exactly about that:
“Before going further into the topic of using a limited liability corporation (LLC) as part of your investment strategy, I want to emphasize how important it is to consult a professional when making a decision about whether an LLC is the right tool for you, and how to use it properly. I’m just an investor and am writing from my investment experience and working with other investors.
In this article, I’m going to discuss the use of LLCs in residential investing, not commercial. The use of an LLC in commercial investing is common and typical.
Most experts and veteran investors probably will say you always should use an LLC when making a real estate investment. I have to say I agree with them. In theory, they are correct. But we know very well that in real life there is a big difference between theory and reality. In real life, banks do not want to lend money to LLCs, especially ones that were established “yesterday” for the sake of owning real estate. Until recently, I never knew the real reason banks do not want to lend to LLCs, but now I know why. Banks package loans and resell them on the secondary market. LLC packaged loans are considered less attractive, which makes it harder for the bank to resell them. In addition, the banks want a real person behind a loan, not some entity. The latter always was a bit hard for me to understand. Even banks that do lend to LLCs want a personal guarantee, so if the bank has your personal guarantee, why would it still need a real person?
What is a limited liability company? Well, it’s a way to protect your assets. When owning a property, you want to be protected. Let’s say something happen to the tenant in the property, and wants to sue. If you own the property, he/she may go after you and all your assets. Aha! Well, having an LLC creates a barrier between you and your assets, like a firewall, and should make you safer. So, if the tenant goes after you and your property is held by an LLC, then he/she only can go after the equity you have in the LLC (your property) and not after all your assets—at least that’s what experts are telling us.
Okay, here’ a paradox. You need an LLC to better protect yourself but cannot purchase the property through your LLC. So, how can one invest? I have battled this question while owning several properties. One way would be to buy the property under my own name and quitclaim it into the LLC. But when doing so, I am in breach of the mortgage contract and the bank can call my loan, something I feel uncomfortable with.
Now, let’s take a wider perspective and try to understand the bigger picture of what we are trying to accomplish. Let’s assume an LLC gives us 99 percent protection (you tell me if it is true or not), and let’s say the lack of an LLC is zero protection. Aren’t there things we can do that will put us in a better protection scenario? In my mind there are, such as property insurance, umbrella insurance, and owner’s proactive actions.
The three-tiers plan
The first thing you should do is make sure you have a good insurance policy on your property— let’s call it the first tier. If you’re not sure if it is good, talk to an insurance agent, maybe not even the one you normally use but a fresh one. Second, add an umbrella policy to your property or properties—call it the second tier. From my experience, umbrella coverage first covers your two main liabilities: your car(s) and home; then, you add your rental properties into the umbrella coverage. It’s likely that the umbrella insurer would want to review your individual property policy to make sure it is sufficient before approving your umbrella. I like to call owner proactivity the third tier. You probably can take two approaches with regard to your properties (and life in general). You can wait for things to happen, break, and roll over to your doorstep. Or you can take action before such things break—be proactive.
If you inspect your property inside out once a year, or more frequently, or have your property manager do it for you, you will be able to identify problems about to take place. Maybe your tenant neglected to mention, or even caused, them and doesn’t want you to know. If you spot things before they happen and fix them, you probably will never put your LLC or insurance to the test altogether. We know that when you inspect, you most likely will find things to fix, which means additional expenses for you. Do you really think that by avoiding them, the problems will go away? Think again. Isn’t being pennywise and dime foolish? In my opinion, it is more important to be proactive and avoid negligence. I hope it never happens to any of us, but there is always a chance you and your tenant will find yourselves in court. When I picture such situation, I immediately think that as the owner I’m already at a disadvantage, even in a Republican state. But if I can say in court that I did everything I could, including an annual inspection and fixing problems before they even occur, I do believe that it will help me appear to be a caring person and not a rigid landlord.
So, there it is. You may want to consult an expert first when setting up LLC for your investments. And LLC or not, you should make sure you have a good insurance policy, and maybe even an umbrella. Lastly, take care of your property.
If it sounds like I’m an insurance person, I’m not. I’m just an investor trying to solve my real estate challenges. I believe that sharing them with others will benefit me as well. I know there are other alternatives to LLCs, such as land trusts, but I’m not familiar enough with them to recommend one way or the other. There is one other advantage to using an LLC, or other similar solutions, and that’s the ability to hide your assets and make it hard for others to see what you actually own. Hiding your net worth gives you less financial exposure and makes you an unattractive target for hungry attorneys.
If you have some other insights about this article, or are familiar with other methods of solving these issues, I’ll be happy to hear from you. If you know of a lender that lends to LLCs, I’ll be even happier to hear from you.“
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Nice writing. You are on my RSS reader now so I can read more from you down the road.
Allen Taylor