In a podcast I recorded recently, I gave my take on the question I get asked almost daily: “Before I start buying investment homes, should I create an LLC?” I begin by stating that this is a legal question and should be posed to a lawyer.
The 30-Year Fixed Rate Loan
As a non-lawyer, I point out some issues: We talk about the benefits of getting the fixed-rate 30-year loans. These loans are referred to as “FNMA loans” ( since they follow the FNMA – Federal National Mortgage Association guidelines). The FNMA loans will not be given to a new LLC. They will be given to an individual with income, a credit score, etc. Thus if you create a new LLC and buy the property in the name of the LLC, you will likely be giving up on one of the most powerful pillars of single-family rental investments: the 30-year fixed-rate loan.
Also, again, speaking as a non-lawyer (always fact check with a lawyer), an LLC has protective qualities only if it adheres to being a completely separate entity from you. It needs its own bank account, checks, (checkbook) books (bookkeeping or software like Quickbooks), etc. If there is a shortage in the LLC, you cannot just transfer money to it. That would be commingling funds and may destroy any protective qualities the LLC might have had.
In addition, lawyers have been telling me that court cases indicate more and more that for meaningful protection, you need to have a multi-member LLC and not just a single member one.
A single-member LLC is liked because it is a “pass-through” entity. That means the financials of the LLC flow through to the owner’s taxes and no separate tax return is needed for the LLC. However, a multi-member LLC needs its own separate tax return, K-1’s issued to the various members (and who is that other member, by the way?). That means more costly accounting fees and time spent.
In addition, some states require (besides a tax return), a yearly fee. California, for example, charges $800 per year per LLC.
I also mention that when you buy a home for $180,000 and put 20% down, you have a loan of $144,000. If a lawyer considered suing you and looked at this home, it would be unattractive – since the lawyer may not be a real estate professional, and he or she would assume that selling a $180,000 that has a $144,000 loan on it, will yield virtually no money after commissions, expenses, and perhaps selling quickly (it is not always an ideal time to sell). Thus the very existence of the mortgage is already a good protective measure.
Knowledgeable lawyers I know recommend using insurance as the first line of defense. Get good liability insurance on the home, and get umbrella insurance to cover up to your entire net worth.
Recently, I interviewed one of the best lawyers I have met on this subject, Brett Lytle, partner at McDowall Cotter out of the San Francisco Bay Area. Brett is also one of our expert guest speakers at our quarterly Expo once or twice a year. The podcast interview can be found in the Member’s area on our website: www.icgre.com/members
In a Fortune Magazine article by Chris Morris, published in February, it is reported that in January 2019, there was more inventory available and houses sat on the market about a week longer than in January 2018.
As of January, there was an available inventory of 1.59 million homes overall, versus 1.53 million in December 2018. Of course, the article is lacking by treating the entire country as one monolithic real estate market. Needless to say, there are hundreds of markets, and they don’t always perform in lockstep.
Nevertheless, there is a subtle shift, even in mentality, that is more favorable to buyers as opposed to sellers, who until recently reigned supreme. Since we are primarily buyers (and then we hold for the long term), a buyer’s market is a positive for us.
It is interesting to note, and one of the reasons I am posting this blog based on an article several weeks old is that while in January 2019 sales were flat, in February 2019 sales surged up, but then dropped only slightly. This is likely to continue to lower rates and sellers having to adjust expectations. Overall, we can see that while there is a shift towards buyers in many markets, the market is still hovering near a relatively stable point. With the low-interest rates and more friendly sellers, this becomes a positive for the investor.
We like to buy brand-new homes. Clearly, the sellers for us are builders. Some builders don’t want to sell to investors. Our market teams successfully convince the builders that it pays to work with our investors, as they get good volume from us. As the mood changes, these very builders may become more receptive to working with buyers, and perhaps even offer more incentives.