First property purchase as an LLC vs. Personal?

Question

My Mother and I have partnered to create an LLC to begin our real estate portfolio that we intend to slowly scale.  Our basic criteria includes side by side duplexes that create at least 1% combined rental income on the buying price of the property.   We know the benefits to protecting our personal property with an LLC, but we are now being told that purchasing a 2 unit property through our LLC requires a commercial loan with a 25% down payment.  Our business is in Wisconsin.

Does this sound correct to others? Have other experienced investors started this way? I thought that commercial loans were for anything larger than 4 unit properties? If this isn't the case, would it be smarter to take a personal loan for our first property and then eventually change the title and mortgage over to the LLC at a later point when we have established credibility in our business.

Marcus Auerbach · Answer

@Keith Miller a few things I'd like to clarify for you: the main difference between commerical and residential loans from your perspective are the terms: a residential loan has typically 30 years of fixed interest and is amortized (paid off) over 30 years, which makes for lower monthly payments. A commercial loan has usually just for 5 years and also amortized faster (25 years), which creates a higher monthly payment and you have to find a new loan after 5 years.

IMO you are crazy to start out with a commercial loan - for residential investments (1-4 units) and and personal ownership 30 year fixed rate loans are golden. Lower payment and no interest rate and refinance risk. You can only get a 30 year fixed loan in your name, not as a limited liability company.

About an LLC: if you read enough books about REI you start to believe that you have to have an LLC to get started with a duplex. (Clearly a different story if you buy an apartment complex with a 7 figure down payment!)

A lot of people don't realize that an LLC does not offer protection by itself, it just creates a financial firewall if set up correctly. The legal entity is your 5th and final line of defense. You can achieve a similar effect by your first 4 lines of defense: running a sound business and well maintained hazard free properties, a great and well laid out lease like Wisconsin Legal Blank, your required landlord insurance policy and #4: an umbrella insurance policy, which will cover you up to a million or more. So what would need to happen for you to #1 get sued for more than a million and #2 for the judge to find you guilty?

Question to ask yourself: Do you have a remaining legal risk, and how big is it? And how does that compare to interest rate and finance risks? Life is always risky. There is no absolute protection. But in over ten years I have not met anyone or spoken with anyone who had that happen to him. But then I have also never known anyone got struck by lightning or hit by a falling coconut, and those are things that happen - and I am still not scared of beaches lol

Because I am not your attorney and I am not telling you what you should do, please watch Brand Turner's video about LLC's:

Hope this helps!

Jason Bott · Answer

@Keith Miller most investors will finance their first few deals under their personal name.  Better terms and easier to set up the financing when starting out.

Keep in mind, the term "Commercial" does not apply consistently across the banking, real estate and insurance industries.  For Banking and Insurance, if the entity is not a person, then it will usually be considered commercial.

At some point, 6-10 properties, your loan officer will say you can not add any more properties under your personal credit.  This is when most investors need to make the move from financing personally to commercial lending.

Ryan Seib · Answer

An LLC automatically gets you out of residential into commercial loan options. Not living in it also makes it commercial, unless you agree to live there for 1-2 years (which I believe varies by lender). Realize the banks are trying to fit the loan into one of 2 major categories: (1) a "residential" loan that the bank can sell to Fannie Mae/etc., and (2) an "in-house" loan which means the bank is using its "own" money to lend you and thus can use its own standards.

A bank can generally lend as many loans as it can get its hands on via option (1) since the federal government will buy all of those loans and bank make risk free money on such deals. BUT they have to meet the specific, non-variable, immutable, rules of the federal loan standards in order for the government to buy the loans. (I am exaggerating a little on the immutability of federal loan standards--but for your purposes it is best to assume they are). This category (1) is the reason you cannot use an LLC--that is just one of the federal loan standards. Nothing you or they can do about it if they want a (1) loan.

The bank is happy to do option (2) as well but that is their own money.

I hope that helps!

Jacci Konkle · Answer

Keith, if you are not occupying one side of the duplex personally, in my experience, the lenders consider it a commercial loan and require 25-30% down.  They will not allow your LLC to be the borrower though.  You might find one that will allow it with both you and your Mom personally guaranteeing the loan, but it won't work in just the name of the LLC.  Also, every lender I have worked with requires anyone who owns 25% or more of the entity to personally guarantee the loan, so not just one of you will be able to do that if you own the LLC 50/50.  I buy my rental property in my personal name.  There's no real benefit to me to have it in my LLC.  Talk to a quality insurance provider to make sure your liability is covered.  If you need someone in WI, I have an excellent guy who has specialty insurance products for what we do, and he is an investor himself.

Also, if you don't have the down payment money, consider getting creative and looking for an owner financed deal.  Retiring landlords are often willing to get creative, and have the equity position to do it!

Marcus Auerbach · Answer

okay lets try the link again: Brandon Turner on LLCs

Scott Schultz · Answer

@Marcus Auerbach makes some very valid points, what I may add is Size of the loan, most of mine are small, $50k or below, so my first rental loan was commercial, I have 1 Fannie Mae, I borrowed $80k the rest are commercial with 15 year amortization, terms of 3 and 5 years, with high equity, so rate risk and refi risk is low. I see the cost of a secondary market loan (usually between $1300-$2700) to be a lot for a small balance loan, even the $80k I was on the fence, but I got a good rate on 15 year fixed, and paid $1300 for the loan (all costs) I still hold that one in my personal name, as I do several others, the LLC is a tool, but is often over emphasized, especially for new investors. Hope this helps.

Keith Miller · Answer

Thank you all for your insight.  This was really helpful!

Merle Brubacker · Answer

@Keith Miller I'm from Wisconsin and most of the local lenders in my area consider an investment property anything you don't plan to live in.  Hence everything else gets a commercial loan.

The terms widely vary between lenders and even on a commercial loan I haven't found any that require 25% down. And most look at cash flow, property value comes in second.

Gabriel Graumann · Answer

@Keith Miller I'm not familiar with Wisconsin law, but my understand of traditional lending sources is that they are simply looking for who has the ability of repaying the loan. If the LLC is new and has no standalone financial history, a lender will require a personal guarantee from one or both of you when signing the loan. A residential or commercial loan can be used for nearly any property type depending on the circumstances, so it may simply be that this particular lender has a different criteria for defining their commercial loan products than other lenders. Sounds like you need to interview 5-6 more lenders to determine what your best options are.

First property purchase as an LLC vs. Personal?

Most Popular Reply