Splitting Liability- LLC/Commercial Loan Required?

Question

Hey BP!

My partner and I are looking to buy our first rental property within the next 6 months and are looking for some clarification. We are ready to take some action!

We are looking to get started with a 2-4 unit multi-family and are wondering the best way to do it. We agreed upon a 2-4 unit property since I have learned they are typically easier to finance, since they aren't considered commercial.

We both agree that we would like to split the liability equally so that we both have the same amount of skin in the game. We were thinking about simply forming an LLC and using that to buy the property. After doing some more research, I'm finding out more of the pros and cons of using an LLC within REI, and now I'm wondering if there are any other options.

We like that an LLC would cover us in case something would happen. I have a house that has some equity, that's my main concern. But, I don't like that we would have to use a commercial loan to buy our MF, even if it's a 4 plex or less. I'm just not too familiar to the terms of commercial RE.

Does anyone have any suggestions as to the best way that we could buy a property using traditional financing but still be equally liable? Of course, we would like to be as covered as we can as well.

I have seen where people buy a property using their personal info and then move it to an LLC, but we don't want to risk the due on sale clause getting triggered on us.

Finances: Together we will have enough money for the down payment and rehab work to get the property rent-able for our market. I have a credit score in the 700-725 range. He isn't sure on his at the moment.

Area: We are looking in the Cumberland / Frostburg Maryland area. We would rather stay closer to Frostburg, since there seem to be a higher quality tenant pool there. We have also tossed around the notion of going farther away to places like Martinsburg Wv, but are wanting to stay close if we can.

Looking forward to start meeting people at the RE meetups! -Dakoda

Matt Vaughn · Answer

I would just put both names on the loan in a conventional loan as @Chris Seveney suggested.  It sounds like your primary interest is to make sure you're both committed, and this structure will do that.  Now, both of your personal assets will be at risk, but it's hard to get away from that at the start.  If you have an LLC with zero assets and you guys have zero experience, then I bet you'll struggle to secure a loan from an LLC anyway.

Last, I'd definitely write down some terms that you both agree to and sign them so that you're clear on expectations and repercussions if one side stops pulling their side of the bargain.  Plenty of posts about this in the forums.

Chris Seveney · Answer

@Dakoda Spencer

You cannot have both. If you wish to buy in your names as co borrowers you can and get conventional financing but you will be personally liable. You can get umbrella insurance on the property to cover you, but at the end of the day your personally liable.

If you do an LLC, it has to be legitimate and funds cannot be intermingled between personal and LLC. With an LLC you gain asset protection but your financing is different. Note I am not an attorney or accountant.

Joel Owens · Answer

Just as an aside you might want to alter the loan covenants some in regards to your guarantee provisions prior to closing.

The lender might charge a few K more than normal in lender legal fees for their attorney but might be worth it.

A lot depends on your annual income from a job or business and what your current liquidity and net worth is.

Example if you are buying a 200k property and each putting in 20,000 but you are worth 1,000,000 and make 200,000 a year with your job and business then ratio is lower for the investment risk you are making.

In the loan docs you might want a (burn off) of your personal guarantee once LTV of the property reaches a certain level. Additionally only try to guarantee the portion of the debt for your ownership share. Banks like to get both owners on the hook fully for the debt. This way in case one partner goes bankrupt or insolvent the bank looks to the other partner to make good on the whole debt. This is exactly the reason you do not want to agree to such a provision.

I have seen in the past for example where 3 partners bought a property for 6 million. 2 of the partners made bad choices with other investments over a 5 year period 10 years into the loan. One partner had net worth increase substantially. Of course the lender wanted that investor to make everything good with the whole loan even though they made a partial investment in the property.

Do not take it at face value that the loan covenants cannot be negotiated. Lenders do that to get everyone to agree but if they want to do the loan certain items are negotiable.

No legal advice given.

Wayne Brooks · Answer

If you used an LLC and a commercial loan, you're both likely signing personal guarantees anyway, each for the full amount of the loan, not half.

Splitting Liability- LLC/Commercial Loan Required?

Most Popular Reply