To create an LLC or not??

Question

After each reading Bigger Pockets "The Book on Real Estate Investing", a colleague and I have decided that we are ready to begin diving into the world of real estate. However, in our discussions we are back and forth on the idea of creating an LLC over a legally binding operating agreement. We have looked at both the positives and negatives to creating the multi-member LLC but are still undecided. One MAJOR downfall is that our business plans calls for a financing plan and, as we understand it, it is extremely difficult to obtain a conventional mortgage in the name of the newly formed LLC. We have left a few voicemails on different local banks this week but have not heard back on what we can do.

My question to the Bigger Pockets community is, How do you finance your deals if under an LLC? Just starting out would we be better off to create the operation agreement and have one of our two creditable names back the financing from the lender? What other options do we have that are being overlooked?

Thank you for all the input in advance! Without places like this many of us would never start.

My question to the Bigger Pockets community is, How do you finance your deals if under an LLC? Just starting out would we be better off to create the operation agreement and have one of our two creditable names back the financing from the lender? What other options do we have that are being overlooked?

Thank you for all the input in advance! Without places like this many of us would never start.

Bruce May · Answer

Ty, the Due On Sale clause in bank notes do get enforced regularly. Early on I did exactly what you are thinking about doing and I got a call from the bank advising me to switch it back or the note would be due immediately, so of course I switched it out of the LLC. Over the past few years I've become less of a fan of the LLC's for many reasons. I now do many of my investments in trusts, which, I believe, is the only legal transfer you can make with your home that won't trigger the Due On Sale clause.

Arpan Patel · Answer

Either way, the lender will want personal guarantees. You may have more lending options if you close in your personal names and you can transfer to an LLC later but in general maybe try one deal with just the operating agreement and then with the proceeds start getting all your docs in order. First I'd try a proof of concept to see if you guys can get through a deal together and then go from there. How we financing is always in the name of the company buying the property. We have multiple LLC's so it just depends on which name we want to go with. The stipulation is I have a larger tolerance for risk but if you don't then maybe it is better to get the LLC formed first and then go out and find a lender who will lend to the LLC (there are many) and then go from there. Higher start up costs but if you are a bit more risk averse then that may make you feel better about the process knowing you have your ducks in a row. I hope that helps!!

Bruce May · Answer

For me it came down to efficiency. As you probably know, in California every LLC will cost you $800 for your annual filings. Each LLC has to also have it's own EIN, bank accounts, tax filings, etc. I found it to be tedious. I received training in trusts and like how they operate and for what I do they serve me well. If I was doing more business than I have in the past I would still consider an LLC for the protections they provide. I still have an LLC, but in the past I had multiple LLC's and didn't like it. Also, you can get started without having one and form one later if we decide it's something you really need.

Ty Hunt · Answer

So after a few voicemails left at local banks, I began receiving calls back. From our brief discussions over the phone and my clear description of buying the property personally, then rolling it over to the LLC it seems that they do not care here. I specifically asked about the due on sale clause and each one of them said the only way they would pursue that is if I would stop paying the mortgage. While this is all great news if  I want to form the LLC, this whole procedure and more research has led to other options. One of which was supplied by @Bruce M. and that is the formation of a trust. From my research this would be the most expensive route but would allow me to protect my assets and move the LLC to the trustee and not fear the due on clause from the bank. Our third option is to obtain a large insurance policy and forgo the two other options due to the low cost and ease of setting up, at least for the first few deals.

We currently have sit down meetings for next week with an insurance agent and a mortgage lender. The following week we will be meeting with a CPA to get their opinion of the situation and we have yet to secure a law office that we wish to have a consultation with.

Thank you for all the feedback!

Ty Hunt · Answer

Thank you @Arpan Patel I've also read that most have the clause in each loan agreement that can terminate the Lon once the home is changed from my personal name to that of the LLC. While most don't act on this clause they have the potential to. Would you just go with the exchange and ask for forgiveness later and plead your ignorance to the legally binding contract? I definitely don't want to step into a purchase, change names, and have to come up with the cash quickly to pay off the loan in full all within a few week period.

Thanks again for your input!

Casey Murray · Answer

I would recommend eventually using a LLC. You can start out with nothing and if/when business picks up, create the LLC for protection. Best of luck.

Arpan Patel · Answer

I'd ask for forgiveness, yes. Just make sure you do what you say you will in that you pay in a timely fashion so they have no reason to look back at the file and investigate.

JR M. · Answer

@Ty Hunt thank you for following up. I have come to same conclusion as you, except am still considering the LLC route. I am looking at multifamily properties with average to below average rents, so I feel like the risk of being unprotected in the deal outweighs the cashflow on the properties

@Bruce M. - I have been following your posts and have found your advice quite valuable (since you are from my area of North Coastal San Diego). What is your reason for foregoing the LLC lately?

Michael Lee · Answer

Hello and welcome to this website!  One thing you may have heard is that most banks will loan you the money but they will have you sign the loan personally.  There are several types of firms that do the lending in various ways and terms.  Your letter sounds like a sales pitch and you need to know that a letter like that has a special place for that on the BP site.  One big reason to use a LLC or a corporation is to keep your personal belongings stay safe and stay where they are regardless of any legal action if anybody sues the business.  You might need to ask a lawyer or CPA which is the best way to go.

Best wishes!

To create an LLC or not??

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