I am on a popular forum called Bigger Pockets. I have seen the question of LLCs come up often. I have also seen people talk about it on a Facebook landlord group page that I also belong to. I had a question emailed to me about it today. That private message (thank you!) was the catalyst for this article. The attention that question received on the group page was enough to spurn a post.
I created an LLC when we first got started. The commercial/apartment complex that I worked for had a different company for every property. Through talking to the accountant and my coworkers, I thought this was a great idea. Well, hindsight is always 20/20 and is always right. Let’s just say that I dissolved it a year later — it was a waste of money and time. So hopefully my mistake will become a learning adventure for you.
5 Reasons a Real Estate LLC is a Bad Idea
1. Real Estate LLC is by state – If you operate in different states then a different real estate LLC is needed for each one.
2. Real Estate LLCs are expensive – An LLC is considered a company. You have filing fees, accounting expenses, and more work during tax time.
3. Insurance – I am a HUGE believer in Umbrella Policies. They add extra liability coverage in case something goes wrong. Finding insurance to cover our LLC was impossible. Our regular residential insurance carriers wouldn’t cover us because they don’t do commercial. On the other hand, we were too small for commercial coverage. Remember LLCs are by state. Although we own five houses, they are located in three different states.
4. Mortgages – Per most mortgages (check your own), if you transfer the deed to someone else, like your new LLC, you nullify the mortgage. When you signed the original mortgage as a personal homeowner you agreed to the terms of the mortgage. If you reassign that mortgage to your new real estate LLC, I believe you are opening yourself to a lot of risk. It is somewhat of a common practice to reassign a personal residential mortgage to an LLC.
It is not common that the banks will call your note for violating the terms of the mortgage. Calling the note means that the total amount is due, in full, immediately. Even though this is not a common practice by the banks today, I believe the banks will start going after those who violate the terms of the mortgage when rates start to creep back up. There may be a lot of red tape to cut through to call your note. However, I expect in 5-10 years, banks could start going after those mortgage violations to clear off these 3% loans when mortgages are 8+%. I am not willing to take that risk.
5. Piercing the corporate veil – If you self-manage, you nullify the veil. The point of an LLC is to be hands-off. If you are managing the house yourself, you nullify this separation of church and state, making it easy for people to go after you.
Personally the last two reasons were the reasons why we called it quits and dissolved the LLC. A huge part of our success is self-managing. We have plans on continuing to self-manage for the foreseeable future.
The other thing that scared me was our mortgages. Current low rates are a great bonus to mortgages. I don’t think that rates below 5% will come back. Since leverage is our thing, the last thing we wanted was for the bank to have the ability to come back and call are mortgages. While we had been told that wouldn’t happen, as a financial analyst, I couldn’t believe that they wouldn’t in 5-10 years. So to play it safe and not become a NY Times article about the landlord whose loans were being called, we decided not to do it!
On the other hand, I talked to another investor who told me the point of having a real estate LLC and/or trusts is to illustrate the poorness of an investor. So when a potential defendant went to a lawyer and wanted to sue you that the key was to look as poor as possible. If it looked like you had no money then you would be able to avoid the need for legal action!
So there are tons of opinions and methods. Currently, our method is to keep the houses all in our name. We stay out of trouble by doing these three things:
- High Umbrella Policy – this should cover any additional liability.
- Playing by the Rules – Following the rules as much as possible to prevent litigation.
- Using a Kickbutt Lease AND Enforcing It – We have a detailed lease and we enforce it.
Thank you for this post!!!!! Definitely leaves a lot to mull over as we start our REI adventures. My main concern is the liability aspect of it and how to not be held personally liable. I do agree with your reasons to dissolve it though b/c those risk factors alone – banks calling note, nullification of self-managing and the insurance risk are enough to steer me in your direction. Again, my main reason for thinking about doing it was the protection of the limited liability, but you have definitely given me more to think about…thanks.
I have your same concerns. I have been looking at a few other options. If we decide to go a different route I will definitely post it 🙂 Right not we have a large umbrella insurance to limit liability.
Wellllllll I just registered for an LLC on Tuesday. And after the fact, talked to my accountant about it. I know, real smart…. He basically said the same as your article. “You can achieve the same thing with insurance.” He said there will be more paperwork involved. But also if I want to have an LLC I need to treat it like an LLC. Meaning it doesn’t work unless I give life to the LLC. He also said I will need to get mortgages under my own name then transfer or donate (or something) to the LLC. I plan to have only one state to be concerned with, therefore only one LLC. The thing is that so many RE investors have told me I need an LLC, so that’s why I was excited to get one. You know, like, I’m official now! 🙂 You’re article gives me concern about my decision.
Lynn, I TOTALLY understand where you are coming from. To be honest, I set up a LLC for the same reason, everyone else was doing it! Unfortunately I learned the hard way. Be VERY careful to review all the legal implications before you give it “LIFE”. It was really easy for us to close because we hadn’t pursued it much beyond opening the account.
Sebastian Baker says
Great article. You consistently give some of the best advice on biggerpockets.
Thanks for the awesome comment. You know how to make a girl’s night!
David Johansen says
I am so glad you wrote this article! I have thought a lot about this and have done some research and have come to the same conclusion that you presented here. But I was still debating if I was making the right call. Most of the people whose opinions I have read about this issue posted some of the points you presented but not to the same level of detail. None of the articles/posts had all of the info you prezented here. Thank for helping me avoid the mistake of getting an LLC too early:)
Glad you liked the article and it was able to help you!