Investor · Campbell, CA · Member since 2016 · 6 posts · 2 votes
Hi everyone, I'm new to multifamily investing and my realtor sent me a few fourplexes on separate lots in the Chicago suburbs. I'm thinking about buying 4-6 of these fourplexes. I'm debating if I should get one commercial loan for all the buildings or separate residential loans for each?
With a residential loan, I can get 30 year fixed, and better interest rate than a commercial loan (3-5 year fixed, and shorter amortization). However, a residential loan requires me to borrow personally, rather than using my LLC.
I like the better rate and terms with a residential loan, but I'm also worried about the liabilities that may come with it. Can someone please advise? Thank you so much!
You are hitting on the right pros and cons of either approach. My friend just purchased 3 adjacent quads on separate lots and choose commercial for the liability protection (LLC). He got 5 year fixed rate, 20 year amortization at 4.25%; so, he was fine with the loan terms and the cash flows. I have a 7 year fixed rate commercial loan, 25 year amortization, with no balloon (converts to a variable rate after 7 years). Incidentally, my loan is with a bank in Illinois. If you get above $1mm for many properties, you are looking at very favorable commercial terms and 30 year amortization in some cases.
Another pro for residential financing...provides flexibility if you ever want to sell the quads individually.
You are hitting on the right pros and cons of either approach. My friend just purchased 3 adjacent quads on separate lots and choose commercial for the liability protection (LLC). He got 5 year fixed rate, 20 year amortization at 4.25%; so, he was fine with the loan terms and the cash flows. I have a 7 year fixed rate commercial loan, 25 year amortization, with no balloon (converts to a variable rate after 7 years). Incidentally, my loan is with a bank in Illinois. If you get above $1mm for many properties, you are looking at very favorable commercial terms and 30 year amortization in some cases.
Another pro for residential financing...provides flexibility if you ever want to sell the quads individually.
@Mike Dymski, thanks for your input! I did a search on BP regarding this topic and saw some posts mentioning umbrella insurance. Would it help mitigate liabilities if I were to go with a residential loan?
I got 3-5 year fixed, 20 year amortization from a local bank, the rates were 4.35% fixed 3 years or 4.65% fixed 5 years. Sounds like you and your friend were able to get better terms. Would you mind sharing some contacts?
@Brandon Turner, I believe I heard in one of your podcasts, where you purchased a fourplex and borrowed a residential loan, but later you converted it to a five-plex and moved it under an LLC? Can you please share how you were able to do that? My broker was telling me changing the title 'violate the loan documents and thus the protections you were hoping to gain, are invalidated.'
My family has too many auto incidents to qualify for umbrella coverage; so, I can't help there. I carry high personal liability limits on our cars and properties that are in my personal name.
Mike Dymski can you PM me as well. I'm getting involved in the development business as well. My family has been in the rental business for affordable housing, buying homes with cash - now we want to develop and I need help from someone with experience.
I think what your broker means regarding violating the terms of your loan is that when you "move" it under an LLC you could trigger the due on sale clause of your mortgage because the property's title/deed is no longer in your name.
Umbrella insurance just adds additional liability coverage above and beyond what your normal home and auto insurance would cover. Your home and auto insurance has a max, umbrella insurance just extends that max and is useful for large claims and lawsuits.
If your LLC doesn't have any assets or equity, I'd imagine that you would have to personally guaranty any loan you receive, even a commercial loan unless your down payment is sizable. If that is the case and you have to personally guaranty the loan, then an LLC would not provide you protection from the bank as a creditor. However, if you can get a commercial loan with a marginal down payment and no personal guaranty of the loan, I'd like to know where I too can get such a deal :)
@Elijah F. Non-recourse loans, at 80% LTV, 10 year fixed rate, 30 year amortization, interest only for 1-3 years with low rates are common in apartment lending for stabilized complexes $1 million and up. Fannie and Freddie guarantee these loan products because they have historically experienced low loss rates and to promote their social and economic agenda. It's a lot easier for apartment deal sponsors to raise capital if their investors do not have put their personal balance sheets at risk on the deal.
There are topics on this post that create a lot of spirited debate on BP...due on sale clauses, land trusts and asset protection. In the end, there are many successful investors purchasing properties in both their personal names and through LLCs and they feel they have good asset protection.
Elisa Zheng , while I buy in my LLCs, I know 25+yr investors who buy in personal names with $1mil-$5mm umbrella policies.
I am even thinking about adding an umbrella policy on top of the LLC protection.
Think of asset protection as layers of an onion. Plus if it helps you sleep better, the few hundred for the umbrella policy is worth it.
Thanks so much everyone for sharing your insights!
@Elijah Frost, yes, that's exactly what my broker meant. And yes, the commercial loan requires me to personally guarantee the loan. Since I personally guarantee the loan, does it mean I'm on the hook if I'm sued (by a tenant for example)? Would an umbrella insurance protect me from these liabilities? I'm really trying to justify buying with a residential loan for the better loan terms...
@Percy N., if I do use a residential loan, I'll definitely get an umbrella policy to protect myself. I'm even thinking about setting up a management LLC as another shield. I'm just not sure if the umbrella insurance can replace the protection from an LLC...
When you personally guarantee the loan it means that the mortgagee can seek payment from you if the loan is defaulted on. Your guarantee is expected since your LLC probably doesn't have the ability to cover the value of the loan on its own.
The umbrella insurance covers only liability, not loan default. If your LLC is sued, the claimant can seek damages from your LLC. The umbrella insurance will cover claims up to the coverage amount. Anything above that will come from the LLC, i.e., any assets held in the LLC.
You buy umbrella insurance to protect your assets in the LLC in the case of a liability lawsuit. When determining if you can be held personally liable in a lawsuit, a test to pierce the corporate veil will probably occur. This is why its important to clearly distinguish your LLC as a separate entity from you by keeping assets, records, expenditures, etc... separate.
I am not a lawyer nor an insurance agent. This is just a brief summary of some things I have been taught and learned by consulting with others. Ask your own lawyer and insurance agent for a more complete explanation. :)
X number of 4plexes purchase at the same time is a portfolio loan - - seek portfolio lenders. If you can make this work, by all means go this way. Your experience in rentals and funds for down payment and capital reserves will be major factors here.
I bought a single 6-plex with a commercial loan, 70% ltv, and got it w/o recourse(the lender and numbers all play a part here so seek multiple loans).
Related to insurance the only difference between a commercial loan and a conventional is the former can be bought in an LLC while the latter can't. This means that the owner of the property of record is the LLC in the former case and yourself in the latter. So if something happens they will bring an action against either the LLC or you depending on the ownership type. Here is the issue, if this is your only reason for having an LLC there is an expense to setup and maintain an LLC. Further, an LLC does not always provide protection. If someone can "price the corporate veil" it could provide none at all. I would talk to a good lawyer and see if the expense, trouble and risk that it doesn't work is worth it.
As for the financing question, I think a lot of it depends on the dollar value and if you can get non-recourse. If you can (which is unlikely unless its high dollar value) a commercial loan seems interesting. If not, a conventional loan is tough to beat if you can qualify for it on that many properties (keep in mind that you need to meet DTI, income etc.)
Another thing to look at is the cash flow and your assets. On a commercial loan, the rate typically resets at some point typically at best in 5-7 years. Worse most have a balloon (meaning its due) at some point normally 5 - 10 years though it may have 25 year or 30 year amortization (which refers to your principal payments not the due date of the loan). If at that point you can't refinance because either the market goes down, the interest rate can't be borne by the property etc. it can be a major problem whereas a conventional loan has is due in 30 years and rates don't change. one other thing to look out for is that many conventional loans for multis require 25% down until the 4th property and 30% after further the rules get tricker after the 4th property so you need to be careful you get someone who knwos what they are doing here if you are going over 4 properties.
@Elisa Zheng Elijah Frost hit it on the head... you will sign on the loan and personally guarantee your assets as far as the loan only, even if owned in an LLC, usually the person signing on the loan should have a Net Worth equal to the loan amount. This is a recourse loan, there are Non-recourse loans for larger loans above $750k where you arent personally liable for the loan under "certain terms" during a default. BUT, it is totally different from being sued by tenants or slip and fall... that is just having good insurance to protect you. So, 2 different things... wish you luck in your adventures!
You are on point with the pro's and con's like a previous poster said. If it was me, I wouldn't purchase under my name. If it was some SFR's, I might have a different response, but seeing as how they are multi-family (even if they are under 5 units each), I'd put them in an LLC. Terms won't be as good on the bank loan but if done right, protection is there. And of course, NOTHING is 100% foolproof in protecting you, but an LLC would be the way I'd go in your situation.
Buying under a LLC does provide a level of protection and most investors prefer to do business under a LLC. Using a LLC will require a gurantor on the loan as well. There are a few non recourse options available for blanket loans starting at 500K, term are from 5 to 10 years with stiff penalties if you refi out before the 5 or 10 yr term. This penalty is called yield maintenance. There is also the 3/1, 5/1. 7/1, and 30 yr fixed rate options available un a LLC.
Thank you @Charles Worth @Todd R. @Justin B.@John Broussard for sharing your thoughts. Please let me know if you have any mortgage brokers that you would recommend. Thank you so much!
There are already alot of good answers here, but I'll add my two cents specifically on the commercial vs residential financing.
If you are in no hurry, I would suggest the residential financing because you are more likely to get a longer amortization time period (30yr mortgage) which should make the cashflow on the properties better.
Given you are looking at taking down several properties at once, a commercial loan would offer the most flexibility and likely speed to purchase, but the terms likely won't be quite as good. Examples: slightly higher interest rate, and or shorter amortization period.
You could always use the commercial financing to acquire the properties, then switch to residential if you think you will hold on to them for a longer period of time.
This post is very informative. Elisa, is this your first purchase?
I was wondering if this would apply if you are buying only 1 property (multifamily) and it's your first property. I'm prepping to start investing the end of this year. Thanks everyone!