Thanks. By foreclosed, do you mean a forced bankruptcy? What exactly are the mechanics and requirements of foreclosing on that interest–does that require sloppy maintenance of the LLC and “piercing the veil”, or the $11,000 forced judgement that you were talking about earlier? This would be very helpful to know.
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Involuntary bankruptcy is a different topic. That is useful when you want to pierce a single member LLC.
I am talking about foreclosing on a mortgage, just like any other lender. The equity stripping in this case involves a friendly company holding the mortgage to the property. If the creditor manages to get the LLC interest or get a lien on the property, then the friendly lender initiates a foreclosure and the junior lien gets wiped out and the property is taken out of the LLC. The creditor ends up with nothing.
BLL, sorry, you lost me. Could you clearly give examples of equity stripping and how it can benefit an investor? Could you do it as if you are teaching it to a 3rd grader? :biggrin
You seem to be highly in tune with the more cutting edge creative real estate techinques and your expertise is invaluable.
There are 2 ways to strip the equity out of properties. The first is the traditional mortgage. You borrow money and the lender gets a lien on the property. Creditors don’t get paid unless there is equity after the sale. That’s good when you just start out as there is no equity, but mortgage balances go down over time and soon there will be equity. There is also property appreciation. How do you protect this equity? What if you bought the house for cash and have no mortgage?
That is the 2nd kind of equity stripping. You create an entity. I prefer c-corps, but some people use LLCs. It doesn’t change the concept, but there are tax and liability issues for choosing one over the other. This entity loans money to the entity that actually owns the property and has a first position in any property disposition. Just about all the time, these loans are demand notes with no payments due. As the accrued interest grows, it increases the amount due and protects future appreciation to some extent.
Let’s take the first one and see what happens if you have a judgment that exceeds your insurance limits and the creditor is coming after the property. He puts a lien on the property and waits for the mortgage balance to drop. He might be able to force a sheriff’s sale and get any money after the mortgage balance is paid. You get what’s left.
In the second situation, the lender is friendly to your situation and can demand that you pay the loan. Since you don’t/can’t/won’t, he forecloses and gets the property. The creditor’s lien is removed as part of the foreclosure and the property is now out of his reach. He had a claim against the property owner, not the lender, and has no claim against the lender since they are two separate entities. Now, you have the property (owned by the lender) with no lien and the creditor is left with nothing.
Thanks BLL. In the second situation, with the demand note, does the entity doing the lending have to have some kind of state business purpose for existing? Is “lending” the purpose? I wonder if a judge would see such as arrangement as a sham if he/she thought existed only for the purpose of equity stripping properties held in another entity? Thanks.
The business purpose is making investments, which happens to be securing real estate.
He just might, but the plaintiff has to prove it, and that isn’t exactly easy. The loans also must be real. Real money must change hands and a closing must be done.
That is the main reason I use a c-corp. The owners of the corp are different from the property owners and the payments, if any, can be used to fund benefits programs for corporate employees. The property owner makes interest payments which are tax deductible. However, the corp must declare it as income. The corp funds a benefit program (retirement, health, etc.) and gets a deduction that offsets the income. If the program is ERISA-qualified, then corporate creditors can’t touch the money ever. The law is so strong that OJ kept his NFL pension.
This is the only part I am not completely clear on. The Lender (your investment company) makes a loan to the debtor and a demand that the debtor repay the loan with interest. The Lender then has to foreclose on the debtors property. How does the creditor’s lien get removed as part of the foreclosure? Are they not the primary lien holder? Do they get paid first from the proceeds of the sale?
I think I don’t understand the primary vs. junior lien holder laws well enough.
The lender has 1st person. The judgment creditor, the person who sued you, has 2nd position and doesn’t get a dime until the lender gets paid 100%. When the lender takes back the property via foreclosure, the 2nd position lien is wiped out. The trick is to make sure the loan balance is higher than the market value of the property.
In the end, you have a free and clear property in an entity with no pending lawsuits. You can set up a new LLC and have the lender sell the property to this new LLC with another demand note, or you can set it up like a traditional mortgage where payments must be made.
Thanks. So I guess the goal is to discourage them and make it more likely that they’ll accept a settlement?
Yes, but just in case they get pushy, you have the means to deny them anything.
This is very interesting. I’m trying to figure out what kind of deals I come across would be good for this.
What would be a good scenario for using this technique? A house with tons of judgments the homeowner cant get out from but they own the house outright? If there is a mortgage on the property there is no way you will get to be 1st to be paid, right?
Free can clear properties you own or those you will buy with cash. You can also use equity stripping to secure equity from a down payment and future appreciation.
These liens will be superior to your mortgage since they were placed first.
Yes, but remember the purpose is to settle on your terms. When a creditor sees he won’t get to the assets, he will take whatever you give him.
In this case you would have to already have another company with the debt and interest with no payments setup on that house prior to the judgment or whatever coming on it. Correct?
How in this situation?
What is an example of when this would be of use?
It is clear that you have mastered this form of creative real estate. Thanks for the examples!
I read that the LLC can be pierced for being under-capitilized? Does this mean when you strip out 100% of the equity, or does under-capitalized mean not funding the LLC in the first place? thanks!
I believe what he’s saying is create an entity (LLC or c-corp), fund it, and then have it lend money to another entity which actually owns your property. So there’s a lien on the property and it’s unattractive to someone suing you. But it’s a demand note so you only exercise it at the point when they get a judgement and try to foreclose on the entity that owns the property.
Ok, I see. So it is useful for protecting your property prior to anything happening but can not necessarily be used in the purchase of a property to your benefit.
Stripping out equity is not under-capitalization. Under-capitalization is not funding the LLC with enough cash to operate.
yes. Place the mortgage before any liability occurs to get the friendly lender a 1st position.
You buy a house with cash and then strip out the equity. It’s like a cash out refi.
You buy a house with 30% down and 70% financed conventionally. That 30% and future appreciation along with mortgage pay down is available to your creditors. Your friendly lender loans enough money to cover the 30% and appreciation.
I’m glad to help, but I am far from a master.
Correct.
ok, thanks