LLC or not? What do y’all think?

Question

For some reason most hard money lenders require having an LLC or business entity. What do you guys think about that? Up till now I haven’t felt the need to form an LLC because I haven’t even bought one investment property yet, but a lot of investors are telling me it’s the thing to do.

Steve Buckman · Answer

Hi Marco,Your question about using an LLC (or going as a sole proprietor) seems to come up frequently in the BP posts. I'm not exactly sure why? Maybe because there are opposing views on the subject and it keeps the conversation alive. I recognize your post had to do with lending to an LLC and HMLs. Here's the thing, are you asking the right questions. If not, then you're probably not going to get the answer that's right for you.As a real estate investor (and a licensed attorney in Tulsa, Oklahoma), it's pretty rare for me to think that having rentals in a sole proprietorship is a good idea. Based on my background, I tend to see risks and liability as a higher priority than nearly anything else. So for me personally the answer to your question about an LLC is simple and uncomplicated. It's not that I don't like to keep life simple. I do. But, the benefits of an LLC far outweigh the cost and the increased complexity of doing business in an LLC rather than my personal name. So the question for you to give a little thought is "why are you starting in real estate"? Is this a hobby? Is this just for fun and adventure? Are you wanting another line item for a resume? If your reason is any purpose other than accumulating wealth, then an LLC may not be as important to you as an LLC is to me. In 35 years of practicing in the litigation field including construction defects, insurance coverage, and civil litigation, I've seen some pretty surprising scenarios. Situations that experienced people in their own line of work never dreamed would occur. Just ask anyone who was injured in a car accident if they expected to end up in the hospital before the day was over. The answer is always, "No, I would've stayed home!" The unexpected is what hurts. You can plan for what you know is coming at you. Once you establish your objective with real estate, the answers to all of the questions start to come into focus. This isn't legal advice. I don't represent you and I am not forming an attorney/client relationship with you. I am probably not even licensed in your state. My suggestion is that you find a competent and experienced attorney in your local area to consult about the use of an LLC. A lot of the advice in BP comes from varying professions with different perspectives. If the advice doesn't match up with your own personal objectives, then it's probably not what you need to hear. Examine your own goals and you'll begin to ask different questions. My opinion may not be yours. All the best in your REI!P.S. - we place some general information (that is not legal advice) on our law firm website.

Steve Buckman · Answer

@Horton M. - Thank you for your question and I agree that the use of an LLC doesn't typically allow for the best lending options. If a client was asking me the question (and they do), then I would schedule an appointment to discuss in detail their objectives, risk tolerances, and making sure they understand the potential consequences. Like you, I also see pitfalls to having the insurance in one name and the property in a different name. Even assuming the insurable interest issue is resolved in favor of there being coverage, the scenario sets the stage for litigation that will add to the expense. My initial comments above suggest that every investor identify for themselves their priorities. For some, the attractiveness of the lending rate will be enough to forego the protection an LLC affords. While I have my own view that liability protection is a higher priority than the interest rate on the loan, I respect that others disagree. Experienced investors have typically been down this decision tree before. They understand the trade-offs of both approaches. Some of the newbies in RE don't appear to grasp that "investing" in RE is really operating a business with all types of liabilities. So the lure of a few percentage points appears like a deal too good to pass up. But, they sometimes overlook that making money doesn't accomplish much if you can't keep it. Thanks again!

Horton M. · Answer

@Steve Buckman Agreed that one should use an LLC to the extent possible. Using an LLC, it seems there are two issues: (i) loan originator will not loan to an LLC, limiting financing options (particularly ones with good rates) and (ii) if one is willing to originate in their own name then transfer to an LLC (accepting the due on sale clause risk), the insurance is now in their person name with the property in their LLC, raising insurance issues. I am curious what you would say to a client who wants limit their risk, but also grow their business. Thanks and I enjoy reading your posts!

Mike Burkett · Answer

@Marco Morkous @Andy Webb Our HML loans to investors are for short term fix and flip investments and we do require the property to be titled in an LLC or other entity. (Has to do with home mortgage laws and the ability to homestead a property). If an investor is buying or refinancing into a rental property, we don't necessarily need the property to be in an LLC. It can be either. We prefer an LLC. If an investor buys a property in an LLC as a rehab and turns it into a rental he can refinance into a 30 year loan. Fannie Mae will allow you to deed that property in your personal name prior to closing. (If the LLC ownership is the same as the individual(s), there is no "seasoning" penalty. If you want to leave the property in an LLC, we can also 30 year mortgages outside of Fannie/Freddie. Those rates are a little higher than Fannie/Freddie.

Horton M. · Answer

@Steve Buckman thanks for the detailed response. I agree with you on all counts. It's really just about understanding the business and legal risks under each scenario. Keep up the great posts!

Brock Mogensen · Answer

You can create a basic LLC for a few hundred bucks. If they are requiring it and that lender is your best source, might as well create one.

Michael Corso · Answer

LLC will protect your personal assets.

Odie Ayaga · Answer

We had this discussion recently in another thread, but generally an LLC conveys the understanding that it's a business, therefore, non-owner occupied transaction. Owner-occupied transactions fall under Dodd-Frank rules and licensing which is not the purvey of most hard money lenders. As such, most will only lend to LLC's. There are more and more lenders popping up nowadays that will lend to individuals, but the vast majority will lend only to business entities.

Alison Lee · Answer

I just bought a SF with cash and we put it under an LLC. The only reason we do it that way is in case of a lawsuit. It protects my other assets if we get sued.

Andy Webb · Answer

Most HML's I have worked with here in TX do not require an LLC for buying rentals. Not sure where you are located - you might flesh out your profile a little better. In fact, for a rental investor, our local HMLs understand that we will want to refi out of hard-money into a 30-year fixed rate Fannie Mae or Freddie Mac product, which cannot be done under an LLC...so of course they let us buy in our names. For protection you can just buy a good sized umbrella (liability) insurance policy for a few hundred bucks.Now if you are flipping the property, then I would want to have it under an LLC.