Some Very Basic RE Questions

Hi all,

Apologies for what may be some very basic questions, but I'm thinking of starting my own "real estate business" and would like some additional info.

BACKGROUND: Graduated in May 2019, Finance and Econ major, Real Estate minor. Currently an Investment Banking Analyst. My plan (so far, obviously I'm only 22 and things could change) is to start my own Real Estate business. I plan on saving my money and all my bonuses throughout my time in IB (and hopefully PE later on in the future), build capital, and start acquiring apartment units slowly to build passive income.

CURRENT SITUATION: I have a great credit score, live a very prudent life, have zero debt (great DTI ratio), and money available for a down payment (~$250k). As I filed my taxes for 2019, I realized how f*cked I am. I'm using everything available to me (maxing out 401(k), Traditional/Roth IRA, HSA, 529 Plan, etc.) and realized I need to start getting more creative with my finances so that I can reduce my tax burden even further. Here came the idea that I should start my "business" now, rather than later.

IDEA: I purchase an apartment unit and take advantage of near-record low mortgage rates, rent it out to build ~$2k of passive income a month (gross), and then take the SALT deduction (up to $10k) and deduct my mortgage interest. However, through my formal education in Real Estate, I know the best way to purchase Real Estate is through an LLC. Essentially, I'm thinking of legally creating a business (e.g. ABC LLC), then purchasing an apartment unit through another LLC (e.g. 100 Main Street LLC), and the first "parent" (not sure if parent is the right word) would be the owner of the 100 Main Street LLC. As I acquire more units throughout my life, I would create an LLC for each purchased property, have it owned by the "parent", and limit my liability. I would then be able to create a net loss on the books of 100 Main Street LLC through operating expenses, CapEx, and D&A, and pass that through to my personal taxes, correct?

HELP: What I'm trying to understand is the best way to structure this. Do I need to create the parent LLC and then a separate LLC for each apartment purchased. How many layers of LLC's are required? How do I go about doing that (I know it's a silly question, but genuinely do not know)? Looking at the tax laws, it would appear the net loss I've created can only pass through to offset other "passive income" and not ordinary income (unless I'm designated as a "Real Estate Professional" and real estate is my primary business and source of income). Are there books I can read about to teach me how to create these structures? I'm genuinely passionate about Real Estate and hoping in my 30's to make it my main profession, but as of right now just trying to make my first investment. I would appreciate any insight or help (hoping @CRE comments here, really look up to all your knowledge and character on this forum) from professionals with much more knowledge than me.

SIDE: More future-looking here, but very curious on this strategy. If I acquire 10 units, create a property management firm (e.g. ABC Management LLC), then have the parent firm (ABC LLC) hire the property management firm (ABC Management LLC) to manage the properties and collect the ~3% management fee. Why do Real Estate professionals do this? What are the tax advantages? I really would like to learn as much as possible about Real Estate tax strategies, and how to structure your own Real Estate firm.

Thanks!

 

dude, you don’t need a lawyer to buy one apartment unit. you’re not a BSD yet. just form an Llc through legal zoom, buy a rental unit with a broker’s help, and get an accountant to help with your taxes next March. you’ll learn the tricks of the trade as you go

 

I believe there is tax advantage to RE ownership if you own it personally rather than through an LLC. For example, you get to take the SALT deduction (though this administration f*cked us with the $10k limit) and also get to deduct mortgage interest.

However, from my understanding, if you LLC you are right in that there is no tax advantage to your ordinary income (which I believe is what you mean by W-2 income), because the net loss can only be used to offset gains on other passive income (unless you're designated as a RE professional).

 

Apolgoies for the confusion, should have made it clearer in my original post. By no means was I intending to purchase an entire apartment *building *, but rather a single unit in the building. I personally am not a fan of the co-op structure, so was really looking to purchase a condo unit in a small brownstone building. This condo would likely range anywhere from $350k to $500k (only looking for a studio/1 bedroom), so $250k will be more than enough for me to cover a 20% down payment. Was just trying to learn more on whether and how to purchase the building through an LLC and what are the tax advantages of doing so.

 

I would say you’d find better use of your money trying to get a 2-4 unit building outside of NYC. My fiancée and I have been saving up for that in the LA County area. We’re not going to Beverly Hills/ Santa Monica, but rather more inland and then still living in an apartment closer to work.

“The three most harmful addictions are heroin, carbohydrates, and a monthly salary.” - Nassim Taleb
 

You're on to it. Shit gets really complicated. One of my advisors has a large RE portfolio and his CPA just finished doing 30+ returns for 30+ different LLCs for a bunch of different deals. All run by him and financed by his investors.

I suggest befriending 1. a mentor in the RE space 2. a kickass attorney 3. a fire CPA tax nerd NOTE: I didn't say hire. Befriend. Then as you move up the RE ladder you don't have to start a relationship from scratch you can focus on executing.

Like someone else said - don't get too far ahead of yourself youngin'. Start small work yo way up.

"Out the garage is how you end up in charge It's how you end up in penthouses, end up in cars, it's how you Start off a curb servin', end up a boss"
 

I guess you're right, maybe one LLC would suffice for the first investment. Thanks for that term - umbrella corp - I guess I should have remembered that from my time in college! Will try to learn more about the legal structure slowly. Currently work in NYC, but looking to make my first purchase in the Hoboken/Jersey City area. Thanks!

 

The problem you're going to run into is that you can't get FHA or conventional home loan financing if you acquire a property with an LLC. You personally have to be on the title of the property for these consumer loans. To finance an LLC as borrowing entity you'll need commercial lender such as a local or regional bank, freddie/fannie or debt fund which will require net worth (70 - 100% of loan amt.) and liquidity requirements (20-30% of loan) for non-recourse carve-outs and potentially repayment guarantee if you cant find a non-recourse loan.... which you won't come close to with only $250k. You could potentially find a HNW that will sign as loan guarantor or save up a lot more money if you want to go the LLC route.

 

Appreciate the comment and additional information. Tbh, I totally forgot to consider that I won't be able to get a conventional or FHA loan if I purchase through an LLC. As I had clarified above on another comment, I'm looking to purchase a single unit (condo) in a small brownstone apartment building (not a whole building). If I find a condo that's in the range of $350k-$400k, would $250k of liquid cash be enough? If yes, how would I go about financing the investment through the LLC? Thanks!

 

I think you're going to find it extremely difficult to find a commercial lender that will spend their time on a ~$300K loan origination. If I had to guess your best bet would be a small local bank for recourse financing. Most banks, CMBS shops, debt funds have minimum lending thresholds well above $1MM. Even Freddie's small balance loan programs has min. ~$1MM loan size. You're also going to run into the problem that $250k probably isn't enough NW for a local bank.

I'd advise checking out Quicken loan's investment loan program which provides financing up to 85% LTV with max loan amt based on region and loan sizing constraint of 50% debt service to income ratio in which you can use contractual lease income as well as personal income as part of the denominator. With $250k cash you could potentially go out and buy a 4-unit property (or multiple single units) with a total capitalization of ~$1.6MM. Downside is that you dont have protection from an LLC....you could talk to a RE lawyer about ways to mitigate your personal liability.

 
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