- Hey, why set up an LLC when all I can do is buy insurance,
it's much cheaper and easier?
Have you heard that before?
Well, a lot of attorneys will tell you that.
That's why in this video we are going to discuss,
do you need an LLC for your Real Estate investing?
Okay, let's get started.
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All right, so here's the thing that comes about
an awful lot.
I'll be talking to a real estate investor
and they have five or six properties
and they'll push back on me when I tell them
they should set up a limited liability company
for each of those properties.
And they'll say this
"Well, I spoke to my local attorney
and he said it's just too complicated to create an LLC.
It's going to be expensive to maintain
the limited liability company.
And I'm much better off just buying insurance
and forgetting about the entire structure altogether."
What do you think?
Well, you know what I'm gonna say.
Is that attorney a real estate investor?
Because of they are,
they're way out of line here.
That is not true.
In using limited liability companies,
yes, you're still gonna have insurance,
but they protect you against things that insurance
does not protect you against.
More importantly, when you create these structures,
it's more than about just asset protection.
It's also about planning, tax planning, business planning,
because you know the way I think on this,
that real estate investing,
you got to look at it like a business,
because that's what it is.
If you're gonna find success,
you need to take that business mindset to it.
So without those LLCs, if you own property in your own name,
it's all gonna flow down on your 1040 Schedule E
and they're all gonna get listed out there.
So anyone who looks at your tax return, namely underwriters,
they know you invest.
Now the problem with putting all of those properties
on your Schedule E page one,
is A, it could blow up your 1040,
make it much more thick, many more pages there.
So it's harder to get a loan through,
but worse yet it can mess up your debt to income ratio,
because you won't get full credit for all of your income,
cause they want to do a hold back for vacancies.
Now that happens to a lot of real estate investors,
and they wonder why they're investing taps out.
And it's because of the way their tax returns work.
But if they're using LLCs,
then we can change how that information hits a return,
set it up as a partnership,
bring it down via K1 and get you 100% for the income
and no hold backs for potential vacancies,
because it's how the underwriter has to look at the return
for evaluating your loan.
It's one of those things that if you're experienced
real estate investor, you treat as a business, you get it.
But what about the insurance context?
Like kind of went a little off there on that.
Here's what it comes down to.
Yes you still need insurance when a property is held
in an LLC,
but there are several things insurance does not cover.
And people buy insurance thinking they're fully protected,
not appreciating the risk that comes
with owning real estate.
Let me give you a few of these.
All right, environmental concerns.
So if you have a property,
one of the main concerns you're going to have
is going to be toxic mold, right?
So this is an issue that we have in properties,
a sick property with toxic mold.
Now I have plenty of clients that have dealt
with this already.
Attorneys come after them,
they say that the tenants have experienced respiratory
issues because there's mold in the property.
Well, there's mold in all properties
if you know where to look,
if there's some moisture around,
but attorneys will tell you it's toxic
if they can get a few dimes for their client.
But the thing about it is your insurance has an exclusion
in your policy that states it will not protect you
when there's an environmental contaminant,
which toxic mold would fall under.
So that's a problem.
How about COVID?
Right, if you read the newspapers, you know,
COVID is another issue that we have out there.
So that's not gonna be covered under your policy.
So if a tenant says, Oh, it's a sick building, or they,
you send out someone to go out and do some work
on the property.
They contract COVID from the individual that's coming out
to the property.
So your tenant contracts it,
or maybe the worker goes out there,
he contracts it from a tenant.
And so then you can be sued that way.
Other issues that we have,
let's assume that you reduced rent.
So my father used to do this on occasion.
He would provide the tenant reduced rent
in exchange for services.
So they said, all right, if you do this,
this and this on the property,
then I'll reduce your rent by half.
Now that's not uncommon.
People do that a lot with their properties.
But here's the issue.
When you engage in that type of scenario,
you're gonna void your policy with any claims
that they bring against you
because now they're treated as an employee of yours
because you're compensating them for services
or performing on the property and they're not licensed.
So you're not covered.
The other issue we have with that insurance does not cover.
Extended absence.
Okay, so what do we mean by that?
Extended absence of not having a renter in the property.
So let's assume that your prior renters just trash
the property, may move out.
And so now you start the rehab on the property
and this rehab project,
because materials are hard to find right now,
it takes you 75 days,
90 days to get the property fully rehabbed.
So during that timeframe, look in your policy,
see if any harm that occurs on the property past 30 days
without a tenant is covered.
Many policies do not cover certain damages that happen
to individuals on the property
if the property is vacant for more than 30 days.
And so people that buy these policies are shocked
to learn that when they're in the middle
of this rehab project, somebody gets hurt,
somebody sues, that they have no coverage
and thought, well, I was covered,
but the property was vacant for more than 30 days,
therefore you're not.
And so that's a concern that I have.
You're not covered under default.
So what do we mean by that?
Whenever you take out a loan, what do you do?
You sign a personal guarantee on a lot of loans
residential loans a lot of times they're gonna be
require personal guarantees.
Let's say the property you own a upside down now
because property values have declined in a particular area.
You don't have enough rent to cover the mortgage any longer.
Maybe you just can't even get tenants in that area
because they don't qualify.
And so you're sitting on this property,
you're bleeding out with maybe it's an even an Airbnb
and you're thinking I just got to get out
from underneath it,
and you want to walk away.
But you don't walk away because your concern
is that they'll come after you for deficiency judgment.
Well, insurance is not designed to cover that scenario,
is it?
So if you base your entire strategy on insurance
and you ever have a loan default, you're on your own,
and you're not gonna be covered.
Other types of lawsuits that come from real estate.
Contract claims.
All right, so you enter into a purchase and sale agreement
with a seller,
and you're looking for a 75 day close,
no financing contingency,
just subject to the inspection contingency.
And you go through this and you think, well,
maybe I'll close on it,
maybe I'm gonna wholesale it to someone else.
And during this time you decide you want to wholesale it.
Well, you're having a hard time finding a buyer for it.
Cause maybe there wasn't enough meat left on the bone,
whatever the case is,
so then you go back to the seller
and ask him for another extension for 45 days.
And so now we have this property under contract
for 120 days.
And then eventually, you either sell it to a wholesaler,
they take over,
they don't close or you can't ever find a wholesaler
and you just try to walk away.
And you think that your only risk of loss
is your earnest money that you put down originally.
Well, let me tell you this.
Think again.
Because sellers have the ability to sue you
for the decline in value of their property.
Cause when you tied that property up under contract,
let's say that I, this property,
I have it under contract for $250K,
but over that 120 days,
the property itself had declined in value, right?
So it declined in value.
And so now the market's in some markets depressed,
it's selling for $225.
All right, so that's a $25,000 loss to the seller
cause you agreed to buy it for $250,
you didn't close, because they had the property tied up
for that length of time,
they lost the ability to sell it someone else,
so they have $25,000 in damages.
Does this happen?
Absolutely, I have letters from real estate investors,
threatening letters from attorneys
laying out all the case law on how they can go after them
and sue them for these types of claims.
Another thing, dog bites.
So you rent out your property to a tenant who has a dog.
Perfect example of this.
One of my clients that is working with,
she rented out the property to this individual
that had a Rottweiler.
Rottweiler is chained up in the backyard.
The neighbors dog,
little yipper dog climbs over under the fence
and attacks her Rottweiler.
Now, what does a Rottweiler do?
What they like to do, bite.
So it bites a little dog,
and then the neighbor runs into the backyard,
climbs the fence, however the neighbor gets in there,
tries to pull the little yipper dog away
and gets bit herself.
They turn around and they sue my client,
the owner of the property,
because she rented a property to a tenant
that had a vicious animal.
In her policy, the Rottweiler was determined
to be or listed as a vicious dog and it's not covered.
So she's on her own for those types of claims.
So that's just some of them.
And it's things that people who don't invest in real estate
are not aware of these issues the way in which people are
gonna be sued.
I've been doing this for 20 years.
I've seen so many cases where the insurance company walked
away and left the client to handle the claim
on their own and their defense.
Don't put yourself in that situation,
use sound planning.
Put your properties into limited liability companies.
You still have to insure 'em, but by doing that,
you're minimizing your overall risk of loss
and keeping yourself out of being named in that lawsuit
and having to rely on the insurance company
to save all of your other assets.
My name's Clint Coons with Anderson Business Advisors,
take care.
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