No LLC for benefit of better mortgage?

Question

Wow! I've never seen a more difficult way to pick a forum "topic". I'm a web designer by trade and was stopped cold...

I have a question which REALLY I suppose no one but me and my lawyer can answer but I think some feedback from some super smart BP'rs would be helpful!

As many of you know, when a 1-4 unit property is held in one's own name, better financing is/can be had. For example, I can get 30 year fixed for 30 year financing for 10% down and decent interest rate (less than 6%) which would give much more security and better cash flow. (i.e. not having to worry about rate increases every 3-5 years). This is "non owner occupied" too.

My lawyer isn't keen on us having any properties outside the protection of our LLC though. He and I are both clear that good practices and insurance are #1 but the LLC does have a purpose.

Have any of you come across this dilema before? What are your thoughts? Would you take a little extra risk for having a FNMA type 30 year residential style loan?

Thanks for any feedback, regardless of how detailed!

Frank Chin · Answer

So your question is LLC or no LLC. But I think the bigger question is do you self manage or not self manage.

I owned rentals, SFR's to triplexes for nearly 40 years without an LLC. My dad owned a small commercial property for nearly 50 years without an LLC, though he looked into it in the 1980's and his lawyer told him to forget it.

As to mitigating risks, the main one is insurance, good landlord insurance with umbrella, preferably $2 million or greater. Some people feel more comfortable with LLC on top, so if it makes you feel better go for it.

Now, I said I don't use LLC's in my rental business. But I at one point have businesses in LLC's, S Corps and a Real Estate management company in a C Corp., and file all the tax returns for it. So I know and use them, but not to mitigate risk.

I had a business in an LLC that I purchased from a retiring owner who had it in a S Corp. Unfortunately, a customer of his was seriously injured during his tenure and the plaintiff's attorney sued the S Corp and him personally, for $3 million. The reason I know about it is his employees I kept during the buyout and had to go to court and give depositions, and had to take time off.

I checked with my attorney on this, whether the LLC protects me, and he tells me plaintiffs attorney always sues the owner, along with the LLC or S Corp. I read some replies people posted to these questions, and they said "yeh, so what, they sued me personally, but it was thrown out". To that I say "good for you", the poor guy's case dragged on for a while, and in his case, the judge didn't throw it out.

And why was he sued? The answer is he showed up for work everyday and he personally managed the place, and his negligence was the cause. That's why I asked in the beginning if you self manage. If not, if you have a PM handling it, the PM who have his own E&O and liability insurance, and he'll be the one sued. In this case you are just an investor, then you're OK. If you self manage, failed to shovel snow, someone slips and falls, it's YOUR fault, not the LLC's fault.

To top it off, he was sued for $3 million, and the insurance only covered the S Corp for one million, and ironically not him personally. So I called my insurance agent who wrote the insurance for my LLC to ask if it covers me. She said it does, and the S Corp owner probably didn't use an insurance agent, or used an ignorant one. If he did, a sharp insurance person would know to have an endorsement in the S Corp policy covering the owners and managers if they're sued for negligence, along with the LLC. He even have to hire his own lawyer, as his insurance company said they'll cover attorney fees for the S Corp., not him.

Fortunately, the story had a happy ending. The plaintiff's attorney ask one of my employees if they know where the prior owner went, as they couldn't find him. He told them "he retired to Florida". When the plaintiff's attorney heard that, blurted out  (to himself) "looked like we're screwed".

Apparently, people who moved to Florida parked most if not all off their wealth in the homes, and is covered under it's homestead laws. His social security and retirement funds are also off limits under Federal law. I understand they finally settled with the one million provided for in the  S Corp policy. Lucky dude.

The S Corp didn't protect him, in the final analysis, homestead laws did.

Thomas S. · Answer

I believe the bottom line, in my opinion, is that a LLC is not necessary or needed with adequate insurance and responsible land lording.

A LLC will not protect irresponsible investors. It will not hide investors from the light of day. It will not keep their identity secret.

Lynn McGeein · Answer

I think if you search the forums for some form of "LLC or not" you'll find a zillion threads on the topic as it's a topic with many and varying opinions.  We decided against the LLC route after finding exactly what you did, that loans are cheaper and longer without one, and we wanted to lock in low rates for 30 years, so we went the umbrella insurance route.  Experience, however, taught us through the years that if you have teenagers who total cars, even if not their fault (mostly), your umbrella insurance can be dropped rather quickly, and then you're basically paying higher individual property liability insurance rates until you can get it back.  There are those who purchase in their own name, then transfer to an LLC, not caring about the due-on-sale clause issue.  If I could pay off the mortgage if called, I might go that route, but we don't keep that high of an emergency fund so I won't risk it.

No LLC for benefit of better mortgage?

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