First rental property questions

[David Yacubovich]

Hello BP community!

We finally decided that we want to try to buy our first rental property. And with that decision came a lot of questions and anxiety. I tried to research as best as i can the forum and all the available tools, but still have questions. I would greatly appreciate responses and some directions. I know that most of my questions will be the basic ones, but, i would like to understand what should we do. 

1. Is it better to start first rental as myself or it is better to form LLC?

2. If it is better to form LLC, should i do it before i buy the property or after?

3. If the property is out of state, should the LLC be formed in the state of the property or in my state?

4. If i buy property as LLC, i heard that it will limit my mortgages to commercial mortgages only. Wha is the recommendation here?

5. If i buy the property as myself and then transfer the title to the LLC, it could trigger the pay in full clause. Thoughts?

I probably will have more questions in the future :)

This is all i have for now. I know that is a lot, and i really appreciate your responses!

David

[Nicholas L.]

@David Yacubovich

there are probably good answers on the LLC questions in the forums. i googled and found this thread for example.

https://www.biggerpockets.com/forums/52/topics/1198212-purch...

i have questions for you - do you already own, or are you renting? can you house hack, or does your lifestyle / family situation not permit it? are you talking to lenders and agents? are you going to REIA meetings? do you have substantial savings?

[Mohammed Rahman]

Hey @David Yacubovich - firstly, congrats on making the decision! 

Although a lot of your questions are good to ask, they may be overkill for your first ever property. A lot of folks may disagree, but I don't think that by owning 1 property and deciding whether to put it in an LLC or not would make or break the deal. Additionally, depending on how you plan on purchasing - most conventional lenders won't underwrite a purchase in the name of an LLC that has no income/history.

1. Either, whatever you prefer. Depends on how you plan on purchasing

2. Either. Risk of forming it after and trying to transfer it (assuming your property has a mortgage) is that it may trigger "due on sale" clause. I have a blog about this on my website. 

3. Probably a good idea to do it in the state you're in. Not sure if it really matters so much at this scale. 

4. I recommend buying it under your personal name. Buying under LLC means you're limiting yourself with financing.

5. Yes it may trigger it depending on the lender. They have it setup so if there is any "transfer" of the property deed that they are able to claim the loan balance due. 

Hope this helps! 

[David Yacubovich]

Quote from @Nicholas L.:

@David Yacubovich

there are probably good answers on the LLC questions in the forums. i googled and found this thread for example.

https://www.biggerpockets.com/forums/52/topics/1198212-purch...

i have questions for you - do you already own, or are you renting? can you house hack, or does your lifestyle / family situation not permit it? are you talking to lenders and agents? are you going to REIA meetings? do you have substantial savings?

 Thank you for your response @Nicholas L.

I do own my primary residence. I will not be able to house hack :). I just started to talk to agents and other investors in the same area. I do have some savings that i would invest into the property. They might not be substantial, but it depends on who you ask.

Thank you!

[David Yacubovich]

Quote from @Mohammed Rahman:

Hey @David Yacubovich - firstly, congrats on making the decision! 

Although a lot of your questions are good to ask, they may be overkill for your first ever property. A lot of folks may disagree, but I don't think that by owning 1 property and deciding whether to put it in an LLC or not would make or break the deal. Additionally, depending on how you plan on purchasing - most conventional lenders won't underwrite a purchase in the name of an LLC that has no income/history.

1. Either, whatever you prefer. Depends on how you plan on purchasing

2. Either. Risk of forming it after and trying to transfer it (assuming your property has a mortgage) is that it may trigger "due on sale" clause. I have a blog about this on my website. 

3. Probably a good idea to do it in the state you're in. Not sure if it really matters so much at this scale. 

4. I recommend buying it under your personal name. Buying under LLC means you're limiting yourself with financing.

5. Yes it may trigger it depending on the lender. They have it setup so if there is any "transfer" of the property deed that they are able to claim the loan balance due. 

Hope this helps! 

 Thank you @Mohammed Rahman for your detailed response. It does provide me clarity about the direction i should be taking.

Thank you!

[Becca F.]

With #5, I called two of my lenders and I asked them if it would be okay to transfer the properties to an LLC and if that would affect my mortgages but that it should be ok. One said to email the Assumption Department. If you decide to switch it over into the LLC I would ask let the lender if they say it's ok, get it in writing that they won't call the note due (if the loan is in your personal name).

The thread Nicholas sent you is really informative. I fall into the camp of getting lots of umbrella insurance, being a responsible landlord and knowing your landlord-tenant laws. I currently don't have LLCs.  

Half of my California investor friends (who own 1 to 5 rental properties with equity from $1 to $5 million) don't have LLCs. The ones who have LLCs have scaled a lot, own way more than 5 properties, etc. Not sure what state you're in but in CA I'd have to pay an extra $800 franchise tax for each LLC even if I set up the LLC in another state (I was going to do the LLC in Wyoming for anonymity using a registered agent). If the LLC isn't set up correctly it opens up a lot of other issues - can be pierced.

I don't think there's one right answer, LLC or not, depends on the individual.

[Tanner Lewis]

1. I always think it is better if possible, if using conventional financing you will need to do it in your personal name, you can do an LLC with DSCR

2. before you buy the property, you can do it wile under contract

3. Doesn't matter, if out of state, you will need your LLC registered to do business in that state

4. You wouldn't need a pure commercial mortgage, you can do LLCs with DSCR loans, which are pretty similar to conventional loans, just more investor friendly: can do LLCs, qualify off property income not personal income, 20% down and 30 year term

5. Yes this is correct. The chain of title will also show that you bought the property which would negate any anonymity protections with the LLC (Wyoming LLCs). The due on sale clause will be standard for every lender that I know of.

[Nicholas L.]

@David Yacubovich

OK. The reason I ask is, and I'll be blunt... it's tough out there right now. If you have, say, $30K in savings, what you should NOT do is spend all of it on some random property that shows in a spreadsheet that you'll make $102 a month, and then you buy it and get crushed by repairs and maintenance. I wasn't sure why you were so focused on LLC related questions... as again, to be blunt, those generally aren't that important compared to knowing a market, buying a good deal, having a good team set up, and things like that.

[Nathan Gesner]

You shouldn't focus on all this LLC nonsense. Our grandparents didn't invest under an LLC, and they survived. I have never encountered anyone who was saved because their investment property was under an LLC.

Focus on buying property and managing it well. This means understanding and obeying the law, which will do far more to keep you out of trouble than having an LLC will.

An LLC is useful for two things: anonymity and legal protection. In most cases, neither is warranted.

Warning: I am not an attorney, and this can be a complicated topic. Please note the information provided below is a layman's definition designed to provide a basic understanding for the general audience. You should consult an attorney or CPA for your specific situation.

ANONYMITY: When you create the LLC, your name is recorded on the documents and published on the Secretary of State's website for all to see. So you're not completely anonymous. If you want to be completely anonymous, you can use a Registered Agent. The Registered Agent will record the documents on your behalf so only their name and information appear on the documents. I've done this with my properties because I'm well known in my small town and don't want people to know what I own.

LEGAL PROTECTION: By placing your assets in an LLC, you are legally separating them from your personal assets. If someone injures themselves and sues, they will be suing the LLC and not you personally. If your insurance coverage isn't enough, they could seize the LLC assets, but not your personal assets.

Additional thoughts:

1. An LLC is not free. You can spend as little as $100 to form an LLC, or you could use an attorney and spend $1,000 or more. There are also additional costs of operating and maintaining an LLC, like separate bank accounts, annual report filings, tax filings, etc.

2. There are rules to follow! If you fail to follow the rules, you may open your personal assets to a lawsuit. An example of this would be mixing your personal money and LLC money in the same bank account.

3. You do not need a separate LLC for each property or a series LLC! Don't make your life more complicated than it has to be. Most professionals will recommend a separate LLC for every $1 million in assets but I don't think that's necessary. In my case, I have residential rentals in one LLC, commercial properties in another, self storage in a third, and my real estate company operates in a fourth. Some have more than $1 million in equity while others have less.

4. The need for an LLC is grossly exaggerated on BiggerPockets and other websites. Have you ever heard of a Landlord being sued by a Tenant and losing property? I've been on this board since 2010 and haven't found an example yet. You've probably heard of big Landlords losing property, but only because they were flagrantly violating Fair Housing, running a slum, or otherwise violating the law in an egregious manner. You are more likely to be struck by lightning twice. The vast majority of lawsuits against Landlords are for wrongful eviction, security deposit disputes, and Fair Housing Violations. Your primary insurance policy with $300,000 in liability coverage should be sufficient in 99.999% of all lawsuits.

5. The best protection for you and your investments? Know and obey the law. I manage around 400 rentals with 14 years of experience and have never been sued once. Even if I were sued, I document everything and obey the law, so I won't be found guilty. Even if I were found guilty, the cost would be in the thousands, not in the millions. Insurance would cover it, I would pay the deductible, and no assets would be lost.

If you are in an area like San Diego where people are more likely to sue, a judge is more likely to find you guilty, and the payout is expected to be higher, you may consider an umbrella insurance policy. This policy will provide additional coverage above what your existing policy covers. It's easy to obtain, costs very little, and doesn't require extra, on-going effort to maintain.

[Brittany Minocchi]

Hey David!

1. Whichever you prefer - there are pros and cons to each and I talk to investors who do it both ways 

2. Before - you'll need to provide the entity docs when you are going through the mortgage process (if you choose to go the LLC route)

3. The LLC would need to be legally allowed to operate in whichever state the property is in

4. Correct - you cannot get conventional financing under an LLC/entity

5. Correct - this will be a clause with the majority of lenders. Whether or not they enforce it, who knows

[David Yacubovich]

Thank you so much to all of you for taking time and reply!