Day one. Where do I get started?

Question

My passion lies in rental properties. I have been looking at doing rentals for years, and today I have decided that it is time to cut all of the dreaming and hoping and wishing, and get started. But, I am not sure how to get started. There seems to be a plethora of things to do, and no clear winner for priority.

My wife and I have been renting for a while, and we are hoping to start off by 'House Hacking' (Buying a split-level, and renting one level while living in the other) as we can't afford to buy a property solely for investment (minimum down payment is 25%). I really want to do this right, and make sure that I am not setting myself up for a headache in the future. One of the things that I am concerned about is liability. I want to mitigate liability, and I believe an LLC corporation is the way to go. Do any of you have a template for the Operating Agreement specifically set up for holding and managing real estate?

Also, any 'gotchas' or things that you wished you had known when you got started would be greatly appreciated!

Bill S. · Answer

@Ryan Den Otter your best defense against liability is properly screening and managing your property while maintaining proper insurance. It's my understanding that you can't get a conventional (FHA/low down payment) owner occupied loan in your name and then title the property in an LLC. I haven't really heard of a way around this. The basic rule is if you want an owner occupied loan you have to have your name on title and live there.

Most loans have "due on sale" clauses that allows the lender to call for full payment if the ownership of the property is transferred (like into an LLC). It doesn't happen much I'm told but it's an added risk if you go that route.

I understand starting right. I think you would be best off focusing on getting financing lined up and then finding a property.

Ibrahim Hughes · Answer

@Jeff Rabinowitz

- I'm in the habit of saying "likely' when I'm not sure.

Ryan Den Otter · Answer

@Jeff Rabinowitz Thanks for the response! Isn't it a taxable event to transfer ownership of a property? My concern is: If I don't set up the LLC at the time of the purchase, and have the LLC purchase the property, I will incur taxes when I try to do so for that property later.

Jeff Rabinowitz · Answer

Ryan, welcome to BP. You have already started. Explore the site, read articles and learn. Don't worry about the LLC. It isn't necessary until you start doing deals and may not be necessary even then. If you set the LLC up too soon it may not be structured properly for the deals you are actually doing and you may use it improperly. Once you start doing deals you will recognize if it is time to use an LLC.

Ryan Den Otter · Answer

@Joe Kim Right. The asset that I am trying to protect by adding the property to an LLC is my own personal assets. If the tenant slips on ice on the front sidewalk on a property owned by me, and decides to sue me, he can go after my personal assets. Putting the rental property into an LLC will help mitigate the plaintiff's ability to go after my personal assets.

Now, based on what a couple of you have mentioned, it isn't possible to get an FHA loan if the property is not in my name. So, it may not be doable in this case, and good insurance is the solution. But, I think, in practice, it is good to protect your own personal assets by putting rental properties into LLCs or other such corporations. I have heard that it is better to 'own' nothing and control everything.

Jerry Padilla · Answer

@Ryan Den Otter  financing will have to be I your name if you are going to go conventional or FHA.

Joe Kim · Answer

I agree with Jeff that LLC is not for everyone.

Please remember LLC would not prevent lawsuits but only limits the amount of damage from a lawsuit to any property(s) covered in the LLC and not affect your other investments and home.

In some cases, an LLC may deter greedy lawyers/plaintiffs in going though with a lawsuit if not much equity is in the home and only a limited award can be had suing the LLC.

However, for beginning real estate investors with less than 5-10 properties with very little equity, good insurance (both property insurance) and personal insurance (umbrella) is a better way to go.

Why?  LLC will eat into your cash flow and profits.  Not only does it cost to hire a lawyer to set one up (you can do one through Legalzoom for super cheap but not advised).

Costs of LLC:

Anywhere from $600-$1200 for a good lawyer to set up the LLC.

Annual fees (Variable by state)

Increased tax preparation (small)

I prefer a good umbrella insurance and high liability for each property ($1 million).  That combination will likely be a much cheaper way to go and still give you protection and umbrella gives  you added protection for other personal lawsuits.

Keep in mind that most insurance companies will only allow 4 properties under your umbrella.  The way around that is to get a "commercial" liability insurance for your properties ($1 million liability).

I have 6 properties and do not have any plans to set up LLC at this point.

Jeff Rabinowitz · Answer

@Bill S., I am not a lawyer but it is extremely unlikely that a transfer to an LLC that has the same ownership as the property would trigger a due on sale clause. I only know of one very active investor who was sent a letter one time. (She routinely does this and has purchased hundreds of properties.) When she explained the ownership was the same the bank withdrew their demand. The property was purchased as an investor property not owner occupied property. I have done this occasionally, though I do not use LLCs very often, and have never had an issue. Again, it is possible that the due on sale clause could be triggered but it is very unlikely.

Ibrahim Hughes · Answer

I wouldn't reinvent the wheel on this. Network at your local REI meetups and REIA meetings. Those guys and gals likely know a few good investor-friendly attorneys and CPA's.  Many of whom "likely" (lol) attend the meetings themselves.

Ryan Den Otter · Answer

Sounds like great advice, @Ibrahim Hughes Thanks! I will have to look around a bunch to find a good CPA and attorney here in Denver. I am very used to getting the 'It's too risky!' and 'You would be crazy to invest in real estate' run-around from attorneys.

Day one. Where do I get started?

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