Costly Asset Protection Mistakes Investors Keep Repeating

[Stuart Udis]

Here are some of the costliest asset-protection mistakes I see investors make. Most mistakes start with misunderstanding how protection actually works, and many are reinforced by well-intentioned but inaccurate Bigger Pockets forum advice. Here are the recurring issues I see most often. These are not listed in any particular order. 

1. Waiting until a portfolio hits a certain size (often 10 units) before titling real estate into an LLC. Restructuring a portfolio later from retitling properties, updating insurance, revising leases, notifying lenders, and cleaning up years of past operations is far more expensive and disruptive than forming the correct entities upfront.

2. Creating extra entities to act as the manager to sign leases, collect rent, or communicate with tenants. If the manager entity has no real business purpose, it’s treated as an alter ego. It offers no meaningful protection and can actually cause complications with insurance coverage when issues do arise.

3. Failing to maintain and operate your entities correctly. This starts with following the operating/partnership agreement. 

4. Forming LLCs in states that are recognized for anonymity This does not prevent liability or lawsuits. The deed holder which is publicly listed in the local recorder of deeds is all anyone needs to identify the real estate owner and file a claim. 

5. Forming LLC's in states with favorable charging order protections. Understanding how real estate disputes are often resolved, means these protections are rarely relevant. Why fight the unnecessary fight as a defendant or creditor when there's real estate where a judgement/ lien can be attached clouding title until paid off?

6. Forming an LLC in Delaware to benefit from the "stronger case law" or business-friendly courts is rarely useful for real estate investors. If your business involves owning rentals or renovating and selling property, nearly every claim will be handled in the state where the property is located, not Delaware. In most situations, the Delaware courts will never be the proper venue.

7. Entity structures that restrict or limit which banks or lenders are willing to work with you. I am not referring to loan products that require real estate to be titled to your name such as FHA financing. I am referring to lenders who will lend to real estate titled to entities but won't finance your transactions because your entity structure is unnecessarily complexed or your organization documents look like they were prepared by a 3rd grader.

8. Carrying incorrect or insufficient insurance or operating your real estate business in a manner in which coverage will be excluded.

9. Buying umbrella insurance believing it's a cure-all without understanding when the coverage actually applies. Many assume umbrella policies cover any major loss or claim, but umbrellas coverage is surplus general liability coverage meaning the primary coverage must be exhausted and generally only applies to substantial personal injury claims if applicable. 

10. Hiring vendors or contractors who are uninsured or improperly insured. This is one of the fastest ways to inherit someone else’s liability. If a contractor isn’t carrying valid general liability and workers’ comp, any injury or damage can fall directly on the property owner. Often your own insurance coverage carries exclusions if hiring uninsured vendors or performing tasks that require permits. 

[Henry Clark]

OP I would expand on operation procedures and rental contracts.   Although they may not prevent liability issues, they will mitigate exposure.

1.  Snow ice removal

2.  Annual mitigation. Fire and carbon monoxide testing and battery replacement.

3.  Dryer and fireplace inspection cleaning

4.  Contract documentation regarding why you do and don’t accept tenants.

5.  Contractor vetting process as mentioned above.

6.  Tenant insurance requirements so it is clear cut about bug, water damage, offsite housing,  etc