Considering Forming an LLC. Am I Making a Mistake?

Question

I'm in the process of purchasing my first rental property. I was considering starting an LLC, as I wish to have more properties in the future. At the same time, I have heard that banks charge a higher interest rate for this, and that is outside of my personal financial situation to afford. What do you guys recommend?

Shera Gregory · Answer

There are many, many posts in the legal, tax & financial forum on this topic that I recommend you explore. You will learn a lot by reading the back-and-forth discussions. My opinion is that there's not a one size fits all answer for this. In my state, Virginia, the ongoing cost to maintain an LLC is very low so the primary expense is getting a good operating agreement. You will find many opinions on whether or not to use the more generic operating agreements that can be found online. For some folks the content of the OA is crucial because they are using it to define really critical aspects of their operations such as how a two member LLC is to be managed. For other folks the main goal is for the LLC to exist to hold assets. As Greg Scott alluded to, the LLC is meant to protect (or shield) the assets that you own OUTSIDE the LLC. Many people have real estate in their personal names and get a good umbrella policy for additional insurance. Other folks don't want their own names in the public record as owning real estate so they go with an LLC (NOT listed under the person's home address) or even a land trust to avoid that. As far as the bank financing goes you are correct that the decision to buy in your own name vs an LLC puts you onto a different path with the types of loans you can get. A big consideration is how you want to balance the desire for protecting various assets vs access to loans you can get in your own name which are generally at lower rates.

Mike McCarthy · Answer

@Shiva Sharma I don’t think an LLC is worthwhile for an investor’s first couple properties (assuming single family or up to 4-unit). It’s an additional level of complexity and probably won’t help with liability protection.

I’d instead focus on finding a good property, mortgage it under your name (and get great rates), and get good landlord and umbrella insurance.

Once you hit 5-7 properties, you’ll probably be forced to start looking at commercial loans, and that’s a good time to consider LLCs.

Greg Scott · Answer

Disclosure:  I am not a lawyer.

If you do not have enough cash to form the LLC, what are you trying to protect by having an LLC?  It's like building a castle for nobody to live in.

Even the most shamefully greedy lawyer will see it is not worth their time coming after you.  They will just try to max out the liability coverage your insurance provides.

Tim Buckingham · Answer

I'd like to chime in here and I think forming the LLC is worthwhile if thinking long term for my situation. I believe COVID-19 with have the same impact as the 2008 recession in a few years (lets say 24 months).

In my opinion this is a good time to create a LLC so in two years its aged which is a good criteria for business lending (two years of creation). Combined with other factors this can lead to business lines of credit and business loans so you don't have to leverage your personal credit (I should note that banks don't like lending to real estate based entities due to their high risk nature).

Not sure what state you're located in but the costs with forming and keeping an LLC can be costly. For example I have formed in Maryland where I'm a resident and on average it costs about $350 to have someone like IncFile register plus I'll need to pay the state $300 annually to keep it active plus money for a registered agent.

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Tim Buckingham · Answer

@Greg Scott,

Sorry if I miscommunicated but I don't know anyone that has successfully gotten a business loan or business line of credit for "real investor companies". I have however gotten business loans (American Express) by building a relationship with them (first a business charge card, a business loan, and then business credit card) over a four year period. That is until I stopped paying the state annual fees to keep my LLC active.

I'm not familiar with the courses that were teaching the technique you used but I have seen this work so I'll be going a similar route. Sorry for the crude drawing but I just threw it up in Visio in like five minutes :)

Michael King · Answer

@Shiva Sharma

It's good to plan ahead and think about this stuff, and good comments noted umbrella policy. I would devote my time to working the money making side before worrying about protecting something I don't have yet. You are proactive, that's good.

Buying an investment property in your name brings higher interest; maybe about 1% higher. I don't know about getting a loan in an LLC. You could buy a place in your name and then transfer the title to your business entity a year later. Well this is how my bank is instructing me on this stuff.

Greg Scott · Answer

@Tim Buckingham  Do you know anyone that has had success getting an unsecured business line of credit for an LLC formed to hold rent property?

There were a lot of people selling courses like that 10 years ago.  I tried working that for a while and the most credit I got was something like $1000, which was insignificant towards growing the business.  Things could be different now, but my sense is you will grow faster by simply buying great properties and re-investing rather than focusing on trying to build business lines of credit.

Roberto Michienzi · Answer

Is there a benefit to having an LLC on a 3unit, as my first property,It is an FHA (currently under contract so I am the guarantor) with the intention of trading up to a bigger property in 3 years? Lets assume next bigger property is a 5 unit or greater.

Shiva Sharma · Answer

Thanks! I was looking for honest opinions and I appreciate your advice. Sounds like it's not a worthwhile option for me.

Considering Forming an LLC. Am I Making a Mistake?

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