Newbie RE investor here, advice needed.
Someone told my wife that we should form a new LLC for each single-family home we purchase as an income-generating rental unit. He says that if we were to ever get sued by the renters for some reason then this would limit our exposure to that LLC only. Sounds logical I suppose, but I have never heard that before.
Thoughts?
I am an investor; not a lawyer. That being said, you could start a new LLC for each property but it would be a lot of extra expense and hassle to do that. You would have to pay fees to establish each LLC and then the annual fees for each of them after that. You should also have separate bank accts for each LLC too. So you can do it that way or just have one LLC and good insurance coverage. My wife and I have one LLC and carry the maximum liability amount for our properties. You could also put some properties into one LLC until you reach a certain total value…like one million. Then you could start another LLC for more properties. I’ve heard of people using that strategy before too.
If you are managing the properties yourself, a LLC will not limit your liability. You will be personally sued for whatever negligence you personally incurred as property manager. An LLC cannot shield you from that.
An LLC provides protection when you are using a management company and are not involved in operation.
We were planning on using property managers for all properties. So I guess an LLC would have value in that case.
Justin’s suggestion sounds good, a new LLC for each new rental property does seem like overkill to me. Thoughts?
What you risk in a lawsuit is your equity. If you have 2 properties in a LLC with a total value of $350K, but you have 50% equity position, your risk is at $175k. If you have 10 properties in the LLC with a total value of $600,000, but you are only looking at a 20% equity position, your risk ratio is reduced to $120,000.
You just need to weigh the cost of establishing a LLC for each property vs the cost of the investment.
Thanks John good info
What johnevanmiller said is correct. What you should do is look at the total risk management strategy for your enterprise. It is not just the business entity selection. It also includes the insurance, financing position, management style as well as selection of business entity. First of all you must manage your properties in a prudent manager where you are not negligent you are not likely to be sued or if you are sued you are not likely to be found negligent in court. Second you need to lawyer proof yourself. For example if you are sued any lawyer that the plaintive is going to get will do research on you. If you don’t have anything to recover the lawyer won’t take the case. Any lawyer is going to look at any cash you have sitting around, and not the houses and property you have but as johnevanmiller said the equity in them plus any liability insurance you have. That is what they can recover (that is how they get paid). You need to manage risk by keeping the properties leveraged so there is not a whole bunch of equity sitting on any of your properties, and insurance so that they will go after the insurance and not your personnel assets and sweep any large sums of cash into retirement accounts. The entity is last because any lawyer worth his salt will be able to get past the business entity and get to your personnel assets in short order.
The short answer is that having multiple LLCs will further limit your liability. The members (owners) of an LLC can only be liable for their equity in the entity, as John suggested.
But to better address the specific point of the question, say you are a 100% owner of the LLC. If an LLC owns one property with a value of $150,000 (the assets), a creditor could come after the LLC and use the $150,000 to pay off business debts. Creditors cannot come after your personal assets, unless in extreme cases such as fraud (this is called “piercing the corporate veil”).
Now say the LLC owns 5 properies each with a value of $150,000 for a total of $750,000 (again, these are the assets of the LLC). If there is a lawsuit arising from an accident that occurs on one of the properties, a plaintiff could claim negligence and the entire $750,000 in assets would be up for grabs.
If you had setup 5 LLCs, one for each property, the liability risk would be separated. Given the high risks of the real estate business (an injury that occurs on your property could cost you $750K in defense and indemnity), and the litigious nature of our society, you have to factor all that in to your decision. Everyone has a different risk appetite…
i spend less than $500 a year for $3 Million umbrella liability policy with all my houses listed. That way I get to use conventional mortgages (cheaper), and I have , what I’m hoping is enough protection.
It has been said on here before, how you manage your properties and liability insurance are you best defense
Yep. I know a guy who owns many, many strip malls around Dallas / Fort Worth, and he has everything in his own NAME. He doesn’t even use a single LLC or Corporation! But - he has more insurance, cash and lawyers if needed to defend himself for any sort of legal action taken against him. Plus he is only in the commercial real estate business…which in Texas is kind of like the Wild Wild West - you can pretty much do what you want, when you want, in that line of real estate investing here. Within reason of course! LOL. E.G. If a tenant is late on his rent, feel free to slap a padlock on the door, keep all the contents of the place and sue his @@@ for the remainder of the rent.
Personally, I have a whole bunch of LLCs. And I will hold multiple properties within each LLC…I think right now my biggest LLC has 14 properties in it, and I will continue to strategically add more to it. However I will have an individual insurance policy on each single family property, and an umbrella policy for that entire LLC itself to back it up. That should cover just about anything that I will ever encounter in the business.
Your discussions of equity position ignore the value of the rental cashflow.
Even if you have zero equity, losing monthly cashflow is not an insignificant loss.