First Real Estate Investments: Benefits of Forming an LLC or Direct Ownership
Conundrum: I'm wondering what the benefits are from both a risk-management and cash flow (tax) perspective of organizing an LLC to make my first few property investments, versus owning the houses in my name. I am about a year away from the process of actually putting down money and feel like an LLC would protect me from lawsuits/financial risk and potentially provide tax benefits, but there must be drawbacks of not having direct ownership. Anyone have any experience with this or know of another user on here that I could chat with?
Main Considerations:
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I will probably have about 1 - 1.5 million dollars of straight cash to work with.
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I'm looking at town-homes in primary/secondary US Markets in the Mid-Atlantic.
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The idea is to steadily acquire more and more cash-producing assets, I'm not trying to "flip" houses.
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Aside from the money I'm pooling to make these investments, I do not have much personal wealth built up. I have respectable savings but not enough to buffer me from bankruptcy if everything goes straight to hell in a hand-basket.
Just out of curiosity what's your reasoning for doing that much SFR? You could buy a few small MF properties for that amount of money down if you take some reasonable leverage out. Less transactions/costs in doing it that way and you can scale to where you can bring in a manager more quickly.
Good question. A lot of it comes down to what you consider MF versus just a town home. If I see a quality MF property with 2 or 3 units available or three stories that can be broken up into separate units, then I will certainly make that investment. I guess that's technically considered Multi-Family but it's basically just a partitioned town-home and not really a genuine MF complex.
Besides that, assuming I operate at 40% leverage and come up with $1.5M of cash on my own, then that gives me $2.1M of cash to invest. My problems with MF at this stage are...
A) I would way rather own 3 or 4 QUALITY town-homes in nice communities, with reliable single-tenants that I can sign on for the long term, versus buying a cheap MF property on the city outskirts and have to deal with a half-dozen shady tenants, with short leases, and worries of getting robbed every time I come to tour my own property.
B) For the type of quality I want and the specific neighborhoods I'm looking at, 2.1M could probably only get me one solid MF property, and I don't really want to put all of my eggs in one single basket. If I was going to do that I'd just buy a killer vacation house that I could rent out and still reserve for myself a few times a year.
C) There's less CapEx with quality town-homes in nicer neighborhoods, where I can expect my tenants to maintain the property to reasonable standards. There are always expenses that the landlord has to take care of - but if some guy in SE DC blows his fucking unit up because he's trying to cook meth over a gas stove, or a bunch of college dudes from Howard University concave the floors of their apartment because they host a frat-party in my property, then I really have problems to deal with.
Getting a little off the actual question about LLC/Direct Ownership but: aren't single tenants generally more of a worry than an 80% leased up MF though?
What specific market(s) are you looking in? I can glean at least DC but how far does Mid-Atlantic stretch for you?
Boston, MA (especially South Boston) is built off these types of places but currently I feel that market is overpriced. Just this morning online I saw a 3 story "MF" for sale (3 segregated units = the entire building) and included in the sale is the vacant lot directly adjacent ($4M asking).
SE DC might be a good time to look. The amount of cranes in the new wharf/Nationals Park area is unreal. Just toured Related Companies new property there - that thing is lights out. Who knows what will happen in the next few years if Amazon puts roots with HQ#2.
Unless it has changed recently, LLC’s do not qualify for conforming loans. Difference between conforming and non-conforming is huge. A very good insurance policy is just as good for protection from slip and fall etc. Depending on the state you are in, LLCs are not ironclad either.
I suggest looking/searching for personal accounts with LLCs and rental investment accidents. After looking into it, I decided not keep SFR in LLCs, a lawyer will advise you to do so, but they are selling their services. It is advisable to check on your properties often, if you see something that could potentially be hazardous, get it taken care of.
There’s a good chunk of information on this topic on biggerpockets.
@peg - could you walk me through the reasons why LLCs do not qualify for conforming loans and the major differences btwn Non-Conforming and Conforming?
@Peg don't go for it man. It's a trap. This fucking guy can't understand how to open up a jar of peanut butter without asking for clarification.
I have done this exact thing i Philadelphia. The timing is all wrong now. Wait for a recession. I'm a seller now not a buyer. The time to buy was 10-14. Every bubble indicator I can think of is flashing bright red.
I have done single families one at a time. Bought mostly unihabitable properties (missing plumbing or heating) rehabbed them, then financed them at ARV with smaller banks.
I would suggest picking one general area and studying it very closely. You will see the trends as they are happening in real time. Is the neighborhood full of new construction? Do any construction projects look stalled? Etc etc. It was a great play while it lasted but QE3 went too far and now people are as crazy as they were in 07.
every bubble indicator!!!??? ALL of them!!!
A bit of an exageration but I have a few proprietary indicators that I'd like to share:
and so on and so on...
Have invested in many commercial props over the yrs. Separate LLCs is your safest bet (limit the liability to that specific prop). You will likely have to personally guarantee the loans so the LLC may get a loan, but essentially, you are responsible for it. (Community Banks may be the best place to secure financing as the big banks are still a little gun shy)
Here's another VERY IMPORTANT reason to separate each prop via LLC. EXIT PLAN. You're doing this with family members and everyone gets along great....how nice. Trust me, there will be a day when: 1. Not everyone agrees on the purpose of the property - some will want to sell / others retain for cash flow.
Say you and I are partners of U&I Holdings LLC. We own a MF and it's doing well. You want to buy another one and I don't. I don't want the extra risk and therefore don't want it in the LLC. Or worse, it goes in and you want to keep it going forever while 5 yrs out, I want to sell. Are you going to buy my shares? No. I find another buyer. Now you're in business with a 3rd party you don't know. Or worse, I can't find a buyer so we can't sell (because you don't want to). I lose my job and can't afford to keep financing and ultimately go through bankruptcy. Now you're stuck with the whole gig.
If you separate each by LLC, the magnitude of those issues goes away.
You may think those are crazy scenarios. You may think I'm a cynic. If those scenarios bother you, don't even get started because they will happen, at least in some form, over the long haul. You need to be very realistic.
Real world - own 5 different LLCs witha combination of 3 buddies. Some all 4 are equal partners. Some I'm a lesser partner (didn't want to commit as much capital). Some only 3 of us participate. We have different hold time goals for each. One we may do a lot of improvement on (capital intense - so I didn't want to be an equal on that), one we will wait for a good commercial buyer (like Walmart), one just keep going because it's cash neutral so why not, etc. Been together 15 yrs. Our plans were very similar at the start. Now they seem vastly different. One want to retire, sell everything and move to the mountains. One wants to build up and I'm in the middle. (we recently had to buy the 4th out). It gets messy all by itself!
That said, it's a good thing to do if you have the stomach for it and understand there are days you will get stuck with buying a new roof, AC, vacancies for a long time, etc.
Beautiful. I didn't even think of this. Do you find that the amount of overhead of owning multiple LLCs is significantly more work/money? Problem is that this fund will be 75% my own capital but I'll be doing 100% of the leg work.
The LLC formation and accounting is not that big of a deal. I'm a believer in CPAs and attorneys so I go that route. If you want to do it on the cheap, then you can get the boiler plate stuff from lawyer.com or whatever it is. Re accounting, each LLC will need to file it's own tax return and spit out a K-1 to you individually for your 1040. I have a CPA do it and handle all the depreciation, carryover, etc.
Another benefit of multiple LLCs is you can't take the tax write off on depreciation, capital loss, etc until the entity is liquidated so if each property has it's own entity, you don't have to wait for the write offs. We'll sell one property this yr, close down the LLC, and I'll get a 75k tax loss to offset other gains. Couldn't do that if they were all tied together. I'd have to wait until everything was liquidated which may never happen.
CPAs will figure this all out for you. IMO, worth the expense to do it right.