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:

  • I will probably have about 1 - 1.5 million dollars of straight cash to work with.

  • I'm looking at town-homes in primary/secondary US Markets in the Mid-Atlantic.

  • The idea is to steadily acquire more and more cash-producing assets, I'm not trying to "flip" houses.

  • 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.

Comments (48)

 
May 27, 2018 - 2:42pm

I would say talk to your attorney and accountant, we can chime in and what not on here, but they will know what's best.

-Are you planning on a separate LLC for each property? If so, it will probably be harder to get loans.

-It will also cost a lot more to set up/ run each year.

-Are you buying with a set of investors? If so, is it per property or just overall? LLCs can be useful in this case as a good way to get in writing what your responsibilities are.

 
May 27, 2018 - 2:46pm

The idea would be to set up a [Last_name] Holdings LLC, with funds purely from my immediate family, and slowly acquire more and more property within it. You're probably right about talking to a lawyer, I was just curious if anyone had done it before and knew of any particular hang-ups with either method. Lawyers and Accountants seem like the main drawback with the LLC. From my understanding the documentation, obtaining of licenses and paperwork filing of an LLC can be somewhat burdensome.

 
May 30, 2018 - 4:58pm

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.

"Who am I? I'm the guy that does his job. You must be the other guy."
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May 31, 2018 - 1:39pm

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.

 
May 31, 2018 - 1:34pm

Fair enough!

"Who am I? I'm the guy that does his job. You must be the other guy."
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Jun 1, 2018 - 1:17pm

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?

REPE God:

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.

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.

 
Jun 2, 2018 - 10:36am

You 100% want to own real estate in an LLC and there are no drawbacks as opposed to direct ownership. LLC's are passthrough entities and as such if you 100% of the LLC, you own 100% of the building.
The LLC creates Limited Liability which may shield your personal assets if there is a lawsuit against you or the company. If you want to create additional layers of protection, one LLC will own the asset and other will be the property manager, if you do get sued it should be the manager company which will have even less assets to attack in a lawsuit.

Corporations suffer from double taxation and unless you are an international investor it makes more sense just to go with an LLC.

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Jun 2, 2018 - 1:17pm

Yeah, I've done more research and feel that way as well. Only thing that's a hassle about the LLC is that I'm still working full-time so the record-keeping aspect will be a bit more of a headache as I will need to keep full financial statements an such. Can't imagine an accountant would charge me too much to put together some statements for $2M worth of properties though.

 
Jun 2, 2018 - 6:48pm

You can 100% keep the records yourself while working full-time. I did this for two properties in Boston before leaving to invest on my own full-time. So long as you keep an accurate record of your P&L then a decent accountant can do your tax return for ~$1,500.

Also absolutely keep an LLC for each asset. It's a pain to set up and you have to keep the companies current with the secretary of state (which is a few hundred bucks a year) but it insulates you from so much risk. The downside to not doing it if you've got a slip and fall or the like is really high and there's no real cost other than a few hundred bucks per LLC per year

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Jun 4, 2018 - 2:40pm

Not sure what Peg Leg is referring to - I have three separate assets with conforming loans in single member LLC's that flow to my personal tax return. You can't yet get a conforming loan in a Series LLC, but you absolutely can in a regular LLC. The issue though isn't so much about maintenance but rather your liability.

Basically it comes down to this, if you own each asset personally and something happens at one asset someone can come after every single thing you own including the other assets. For instance, say a tenant throws a party and one of their guests falls down the stairs. They could claim unsafe property conditions and come after all of your personal assets as compensation if you own the asset personally. If you own it in an LLC, your liability is limited to what that LLC owns (i.e. the asset itself).

Lana? Lannaa???? LANA!!!!!!!!!?!?!?!

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Jun 2, 2018 - 11:39pm

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.

 
Jun 5, 2018 - 2:55pm

I'll bite, conforming is a Fannie or Freddie loan, the interest rates are over a point lower than non conforming and the loan term considerably longer.

 
Jun 2, 2018 - 11:51pm

Also be sure you get a "Landlord" insurance policy. A standard policy will not cover rentals, also look at policy terms for vacant insurance. If you currently have an umprella policy for personal use, that will also not cover business entities/transactions etc. You'll need a separate business umbrella if you get one in addition to an individual property landlord policy.

 
Most Helpful
Jun 5, 2018 - 10:42pm

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.

 
Jun 7, 2018 - 12:31pm

A bit of an exageration but I have a few proprietary indicators that I'd like to share:

  1. % of commercials on the radio for "How to flip homes for fun and profit" seminars >50 = check
  2. Price cuts on high end real residential (smart money / strategic buyers) with bidding wars on the low end ( financially illiterate / just scraped enough money to get in the game) = check
  3. Significant increase in # of 'news' articles sponsored by residential brokers claiming 'there is no bubble' (he doth protest too much)= check
  4. Significant increase in men wearing brightly colored pants / obnoxious suit patterns / ridiculous socks= check
  5. First time buyers who have no idea what happened in 2008 because they were in high school = check
  6. Status signalling automobile purchase that you can't really afford and doesn't really make sense as a mode of transportation (2007 = Hummer; today = Tesla) = check
  7. People acting like conventional measures of RoR don't apply anymore because 'this time it's different" = check
  8. People projecting that any property in any horrible location can just be bought and AirBnBd at a profit because they assume people will always have endless money to travel = check

and so on and so on...

 
Jun 6, 2018 - 8:20am

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.

  1. There will be props and projects that not everyone agrees to on the way in.

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.

 
Jun 6, 2018 - 11:02am

I second what rickle is saying. We own all of our real estate in separate entities and a big part of why is so that ownership percentages and members can be different based on the property.

 
Jun 6, 2018 - 11:21am

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.

 
Jun 6, 2018 - 12:41pm

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.

 
Jun 6, 2018 - 3:39pm

Lol

In 'charge' of one to one and a half mil and you come on an anonymous forum primarily made of college students for advice?

Holy fuck man...troll of the year award to you.

If the glove don't fit, you must acquit!
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