All Forum Posts by: Joseph S.

@Curt Davis,

That's an interesting perspective regarding lease length.

I understand your point (multi-year leases would appear to provide more consistency and peace of mind for the owner and potentially less turnover and placement expenses over time). But how does this actually play out in practice?

You have a huge pool of properties to draw statistics from so I certainly appreciate your experience. Have you compared how long a tenant stays with a one-year lease switched to month-to-month vs a two year lease? I imagine that the length increases by some amount, but I doubt it would be a full year since many tenants feel fine riding out a month-to-month lease until they decide to leave.

Do the downsides (forfeit of owner ability to increase rents after the year and potential to get stuck with a trouble tenant constantly calling for minor repairs) compensate for whatever this additional length of stay is?

What do you actually recover from tenants who break the two year lease? In most cases aren't full value deposits (equal to one month's rent) going to be forfeited by the tenant anyway in order to resolve whatever repairs they are responsible for? I imagine you can send them to collections for a portion of whatever term they didn't stay (only the time lost before you find another tenant), but isn't this always a huge headache that you wind up settling for pennies on the dollar if you get anything at all?

But the real question is would you really want to hold a tenant to their lease if they truly wanted to leave? I can only see that ending badly…

@Curt Davis, two questions:

1) Can you please advise what management companies offer 8% fees and 1/2 a month's rent placement fee? Are they any good in your experience?

2) What do you mean when you say a one year lease is a failed model?

@Joe Cusick

I assume that since you already have a PA LLC you've done the due diligence on that state to ensure they hold a presumption that a business entity is a distinct legal entity and has a fairly consistent practice for determining when to pierce the corporate veil – and that this happens rarely.

Depending on the size of your portfolio it may be worth having separate entities up to determined asset levels. For example, splitting a $50M portfolio into 5 LLCs can generally ensure that if you suffer a lawsuit that wipes out one basket the others aren’t affected – essentially limiting your liability.

However, most folks with portfolios less than $10M generally don't need to consider splitting it up this way since adequate insurance coverage in a single LLC should mitigate most of the risk.

TN has both excise and franchise taxes. Unfortunately, unlike most states, TN doesn’t shield LLCs, LLPs, and S Corporations. So if you do hold TN property in an entity (even and out of state entity) other than a Sole Proprietorship or General Partnership, which don’t have the desired veil for the intended purpose in the first place, then be sure to look into getting a FONCE (family owned non-corporate entity) exemption.

If you do use the PA LLC to purchase property in TN, then you'll need to apply for a certificate of authority.

You asked whether it is recommended to purchase the property personally and then put the LLC on the deed after you acquire the property. Depending on the state this can have varying tax consequences. So the question would be why not purchase the property with the LLC in the beginning instead of transferring it after? If the answer is because of financing, then you should closely review your lenders documentation – most of them have a due-on-sale clause which could trigger when transferring to the LLC. If you're not financing and the ending location for the property is the LLC, then it's probably best to start there.

All this said, if you have a portfolio with less than $10M in assets, I'd stick with a single LLC to avoid all the extra cost and paperwork as @Douglas Skipworth mentioned.

@Doug Rose, I wasn't quite sure by the way your reply was structured, but it sounded like you said you could avoid CA tax liabilities as long as the corporation operated and did business strictly outside of CA even if you lived in CA. If so, I'd caution you to read Example 1 on page 4 of the FTB's General LLC Information Form 3556 (https://www.ftb.ca.gov/forms/misc/3556.pdf):

“Paul is a California resident and a member of a Nevada LLC. The Nevada LLC owns property in Nevada. The LLC hires a Nevada management company to collect rents and provide maintenance. Paul has the right to hire and fire the management company. He occasionally has telephone discussions from California with the management company in Nevada regarding the property. He is ultimately responsible for the property and oversees the management company. Paul conducts business in California on behalf of the LLC.”

As crazy as it sounds, simply being a member of an out of state LLC and personally residing in CA is sufficient to satisfy the "doing business" clause.

@Jerry W.

Ah, progress! Thanks for the heads up!

@Roger Poulin Thanks for the confirmation - happy to help!

@Isabeaux N. I don't really have a compendium of sources I can point you to other than to say that in our digital age just about everything is only a quick google search away.

Here are my thoughts (again, take these with a grain of salt - I'm not an attorney or CPA):

Knowing that being incorporated out of state doesn’t reduce your tax liability and creates extra paperwork and fees, I don’t know that it’s worth it. However, from what I understand the best states to incorporate in are Nevada, Wyoming, Delaware, and South Dakota.

Nevada is fast. Almost every filing can be done online with results in minutes. Nevada has very strong asset protection law, creditor protection and liability protection for its owners, but it now has an updated Commerce Tax return for LLCs and while there aren’t any costs for those not doing business in NV, you still have to take the time to file it.

Wyoming is cheap, has no state income tax, good strong laws, and privacy, but they are also slow, don’t have expedited filing options, and require original ink on their paperwork.

Delaware has perhaps the strongest corporate veil protection laws and the only state with a Chancery Court. But like Wyoming, it also doesn’t have an online filing option.

South Dakota has good laws and no income tax (personal or corporate), and relatively low incorporation and maintenance fees.

Since TN law does hold a presumption that a business entity is a distinct legal entity and has a fairly consistent practice for determining when to pierce the veil - Federal Deposit Ins. Corp. v. Allen, 584 F.Supp. 386, 397 (E.D. Tenn. 1984) – if I lived in the state I’d probably incorporate there to avoid the extra costs and paperwork. However, I can understand why somebody would choose to incorporate in the Big 4 for peace of mind.

Here's what I understand (but take it with a grain of salt since I'm not an attorney or CPA):

Tennessee doesn’t have a state income tax so if you own your properties personally you are only subject to federal income taxes.

However, anybody really interested in real estate needs to consider protecting their finances from liability with a corporate veil. Tennessee has both an excise tax and a franchise tax. The excise tax which effectively is an income tax, is a flat 6.5% tax on net earnings from doing business in the state. The franchise tax is based on the greater of a business’s net worth or book value of real and tangible property owned or used in Tennessee with a rate of 25 cents per $100, of the business’s net worth with a minimum tax of $100. These taxes can take a HUGE chunk out of your final cash flow. An annual report must also be filed - LLCs costs no less than $300; C Corporations cost $20 (they don’t recognize S Corporations), LLPs cost no less than $250.

Many states shield LLCs, LLPs, and S Corporations from these taxes. However TN only provides such an exemption to Sole Proprietorships and General Partnerships – both of which do not have a strong corporate veil (which is the main reason why you incorporate in the first place). You can see a breakdown of how each of these entities is treated with examples here: http://www.nolo.com/legal-encyclopedia/tennessee-state-income-tax.html.

Fortunately, it appears there are a couple exemptions that can allow you to get the benefits of a corporate veil without paying the taxes. The one I am personally considering is the FONCE (family owned non-corporate entity) exemption which waives both the excise and franchise taxes if at least 95% of the entity’s ownership must be directly held by family members AND substantially all (66.67%) of the activity of the entity is either the production of passive investment income or the combination of the production of passive investment income (which includes residential rental income) and farming. See the explanation here: https://www.tn.gov/revenue/article/fae-fonce-exemption.

However, in 2009 the TN legislature amended the FONCE exemption to no longer include rent from industrial and commercial property – so if you’re into commercial real estate investment (which includes property with more than 4 units) you’re paying the full bill. See details here: http://www.wallerlaw.com/News-Events/Bulletins/24893/Tennessee-Modifies-the-FONCE-Exception-to-the-Franchise-and-Excise-Taxes-and-the-Filing-Requirements-for-Many-Other-Exemptions. It may also be worth noting that the FONCE does have some critical reporting and application instructions so be sure to review this carefully with your CPA.

All that to say, you're pretty much screwed if you're into commercial (you're either paying huge taxes as an entity or huge insurance premiums to limit liability), but have a safe out if you're invested in residential with an LLC with a FONCE exemption.

If you're investing in TN from out of state your own state may have their own fees and taxes you'll need to consider.

@Brent Coombs, I’ve seen a number of methods used for estimating maintenance costs. Most people that I’ve had the opportunity to do business with use the percent of property value because it ties directly to the cost to repair the physical asset, whereas rental income can vary significantly in relation to the cost of repairing the property. It also doesn’t hurt that Fannie Mae suggests using that method as well. Here’s a few sources referencing that method (http://www.jwbrealestatecapital.com/how-much-rental-income-to-holdback-for-maintenance-and-repairs/, http://www.zillow.com/blog/investing-101-estimating-rental-property-expenses-94824/, http://homeguides.sfgate.com/much-should-landlord-allocate-monthly-maintenance-repairs-80019.html, http://money.usnews.com/money/personal-finance/articles/2012/05/29/look-at-maintenance-costs-before-leaping-into-homeownership). However, as long as maintenance is properly forecasted and allocated, the method used to arrive at the number is neither here nor there.

Just out of curiosity, what percent of rent do you typically allocate for maintenance and what are the typical property value ranges?

Regarding insurance, I set the deductible at the highest the carrier allows – in my case $5k. Years ago I was a property and casualty underwriter for a major insurance company and learned that a number of people get the concept of insurance backwards. They over insure, pay out the nose each month for that coverage, and then use the policy for every minor issue that's covered. This results in 1) a higher monthly cost for initial coverage and 2) rate increases or policy terminations once they start making claims – and these follow you from insurer to insurer. This gets even worse when you start building a larger portfolio. You only want to use that coverage in the event of a liability issue or a near total loss. If you’ve purchased your property with enough margin and this occurs you just take the face value of the policy, close shop on that asset, buy another, and possibly pocket a few bucks in the process.

@Brent Coombs

@Kyle L., @Brent Coombs, yup, if you get the right type of insurance (a high deductible, named perils fire policy) you can get insurance for that amount (quote in hand) in this area.

For clarification, I meant maintenance/repairs would be 2% of the property value ($980), not 2% of rent ($264). Estimating 5% of the property value for repairs and maintenance essentially has you fully rebuilding the property once every 20 years. That seems high for me – I typically target 2% (50 years). That said, based on the area, it might be necessary to go higher than my traditional target.

Regarding current rehab cost, the $7.5k will cover everything necessary to make it rent-ready and will resolve most (but not all) of the deferred maintenance.

Your note regarding boots on the ground is crucial. I do have fairly solid (at least so far) property management currently in place on another property I own in a different area of Memphis. However, I can’t get average maintenance cost, vacancy rates, risk information from them based on their portfolio (they hold this information close to the chest) which is what makes BP such a good sounding board for me.

@Tyler Watts

@Tyler Watts, thanks for critiquing the financials. I feel pretty good about those too; but like you said, the location is where I’m concerned.

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@Alex Craig, @Curt Davis, thanks for the advice. You hit the nail on the head - the area really is what concerns me regarding this deal. As you mentioned, there are currently 10 duplexes on sale in this area (though all of them are 2-2s priced in the $65k - $75k range not including repairs, where my deal would be a 3-2 for $49k inclusive of repairs). The property I’m looking at is just a couple streets east of where apple blossom ends (it’s on Firethorne – does that help in any way?). I found your other post and the average rehab cost to get a property back on the market was very helpful as well ($1400 every 18 months is pretty close to my estimate of 2% of property cost at $980 per year so I’m glad I’m in the ballpark).

Let me ask you both, at some point purchasing for buy and hold in this area would be worth it (at an extreme example, any of us would pull the trigger if it only cost $1), so what would it take to make this deal look positive in your books? What would you say would be a good price (rehab included) for the property)?

Hi All,

I have a potential deal in Memphis, TN for a long-term buy and hold duplex (3 bed, 2 bath each side) that I'm a bit torn on (running into some paralysis analysis) and would love your thoughts! I tried to include all the pertinent information below:

Rental Income: $13,200

Rent: Currently has a tenant on one side at $550 per month without a lease – I’ve made it a condition of the sale that the tenant has either signed a new lease with my property management company or delivers that side vacant; other side is not rented out due to required rent ready repairs; rental comps in the area show between $550-600 (I’m being conservative and assuming $550).

Expenses:

Vacancy: 10% ($1,320)

Property Management: 10% of gross rents ($1,188)

Property Taxes: $2,065 ($905 for City of Memphis, $1,160 for Shelby County)

Property Insurance: $450 per year

Repairs and Maintenance Assumption: 2% of Property Value per year ($980 per year)

Utilities: separately metered; all paid by tenant except for lawn mowing at $25 once a month for $300

Advertising: 6% (roughly ½ of first month’s rent) $792 per year

Debt Service: Based on $49k purchase + repair price, 20% ($9.8k) down, 5% 30 year fixed is $2,525 per year

Location:

This is probably where most of my concern is coming from: Western edge of Hickory Hill, Memphis, 38115; major cross streets: just SW of Clarke Rd and Winchester Rd

Acquisition:

Purchase Price: $42k, seller to pay closing costs

Repairs: $7.5k

Total Acquisition Cost: $49.5k

ARV: Large range of comps in the area, best guess is $60k

Financial Metrics:

Net Operating Income: $6,105

Cap Rate: 12.33%

Cash Flow: $3,580 per year, $298.33 per month, $149.17 per unit per month

Cash-on-Cash Return: 36.5%

Do you think it's a good deal? What's a good price for this duplex?

@Alexander Price Thanks for the referrals. I’d love to hear detailed feedback from any of those you suggested.

@David Hutson Thanks for the response. I did look into turnkey, but based on the limited returns I decided to go the route you mentioned regarding buying and paying to have the homes repaired - so far it's working out quite well in the areas I’m investing. I am willing to take on additional risk (in the forms of higher turnover, repairs, evictions, etc.) if the returns are high enough to make it worth it (I'm thinking of it as small cap or international stocks). However, I’m not willing to take on the risk without a well founded estimate of what I should expect. I appreciate you sharing your personal experience and it does help to show that some people are making a go of it in Frayser, however I think I need a broader pool to better gauge the asset base.

In all honesty, I've seen a number of people who do manage large portfolios post positively in other threads regarding investing in this area, so I'm trying not to read too heavily into the fact that they aren't willing to share their results (but who knows, maybe they just haven't had an opportunity to respond yet). For the time being, I’m going to take the advice of most of those who shared their experience on this thread (thank you @Curt Davis, @Alex Craig, @Chris Clothier) and keep my investment target on A and B properties. I’m certainly open to reviewing areas like Frayser if those with active experience managing properties successfully in that area would be willing to share their raw results.