Rental properties and law suits

Rental properties and law suits

Cupertino, CA · Member since 2017 · 28 posts · 8 votes

Hi All,

 I was doing some networking over the weekend with a person who made big in the Commercial real estate (retail) and he suggested me that, first advise I can give you is, don't deal with people/ rentals. Because one lawsuit by tenant your entire portfolio is in trouble. I have heard this same tone from another person with whom I was trying to pitch and get funding. You are planning to invest in all these rentals (Single and multi-family) what if some tenant files a law-suit on us?

My questions:

1) What will be typical scenarios where tenant files law suits?

2) So is it better to buy only in landlord friendly states

3) Should we protect all assets under LLC?

4) What if we have multiple single families in different states?

5) Do we need to take umbrella insurance?

If we do all these and it eats our cash flow, what is the point? For a medium to large multi family we can cover these costs, but small portfolio of rentals in different states, i am thinking its hard to manage these stuff.

Any pointers? suggestions?

Thanks for help,

Rama

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Carl FischerPro Member
Rental Property Investor · Ambler, PA · Member since 2015 · 2k+ posts · 1k+ votes
8y

@Rama Krishna

You need an asset protection plan  as @Ashish Acharya said a single post is not the answer. 

First from the funder/lender point of view -they are the bank and are in first position and will get paid even if you get sued. Some people use the lender (equity stripping) as asset protection-no equity no reason to suit. 

Insurance, Trusts, property management, single and multiple member LLCs, C Corp, equity stripping, etc provide protection, ananymity, separation of assets, etc which are key in a multi faceted asset protection plan. Disconnect properties from each other to the extent that makes sense to you -there is not one answer fits all.  

Some Tenants will suit for anything and everything-trips/falls, illegal leases, discrimination, escrow handling, bed bugs, not answering phone, etc. especially if they have attorneys in the family. 

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  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · Sarasota, FL · Member since 2017 · 5k+ posts · 3k+ votes
    8y

    @Rama Krishna , 

    Yes there is always a risk. But it shouldn't stop you from investing. You just got to manage the risk.

    1)  If you are nice to tenants, lawsuits are not that frequent. If you think about it, you are going to sue someone that treats you wrong. If you are never wrong to tenants, they will most likely not bring suits for random normal stuff.  Also,  just because they sue you does not mean you are going to lose. You have to do your part on maintaining a safe environment and you should be safe.  There are various scenarios. 

    2) If that was true, everyone would be investing only in few states. With that logic,  you likely have less competition and better deals with the tenents friendly states. It's good for you. 

    3) This is more complicated than just one reply. What I have usually seen is investor separating out their asset by risk profiles and putting them in various LLC or even series LLC. However, just putting them in LLC does not do any good unless you are very careful about not piercing the corporate vile. There are various other post on that.

    Also having multiple LLC will cost you even more since you are in CA.

    What I have seen is Investors will usually put property with riskier tenants win one LLC, but not to exceed more than a certain threshold, let's say 2M in value. That way even in worst case, you just lose that. If you create LLC for each property, you will overdoing it.

    A different LLC for each state. Different LLC for a different class of neighborhood. Various ways to structure this with your risk tolerance. If this keeps you up at night, spending more money is may be worth for you. Some people are not concerned and do not go overboard with this.

    Even if you have a perfect entity structure, you should always get an insurance that fits your portfolio. 

    4) Same as above, just separate the asset out by risk profile. 

    I am sure you will get more valuable replied. 

    Good Luck 

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  • Bjorn AhlbladPro Member
    Investor · Shelton, WA · Member since 2017 · 6k+ posts · 6k+ votes
    8y

    I love residential it is not terribly complicated and can offer a solid return. People will always need a place to live whereas I have seen office and industrial space sit empty for a decade. You can get sued in any business! We live in a litigious society with waay too many lawyers. Even Abe Lincoln complained about that!

  • Carl FischerPro Member
    Rental Property Investor · Ambler, PA · Member since 2015 · 2k+ posts · 1k+ votes
    8y

    @Rama Krishna

    You need an asset protection plan  as @Ashish Acharya said a single post is not the answer. 

    First from the funder/lender point of view -they are the bank and are in first position and will get paid even if you get sued. Some people use the lender (equity stripping) as asset protection-no equity no reason to suit. 

    Insurance, Trusts, property management, single and multiple member LLCs, C Corp, equity stripping, etc provide protection, ananymity, separation of assets, etc which are key in a multi faceted asset protection plan. Disconnect properties from each other to the extent that makes sense to you -there is not one answer fits all.  

    Some Tenants will suit for anything and everything-trips/falls, illegal leases, discrimination, escrow handling, bed bugs, not answering phone, etc. especially if they have attorneys in the family. 

  • Rental Property Investor · Round Rock, TX · Member since 2016 · 1k+ posts · 971 votes
    8y

    Your questions, my opinions:

    1) What will be typical scenarios where tenant files law suits? Plenty scenarios - like @Carl Fischer said, "anything and everything-trips/falls, illegal leases, discrimination, escrow handling, bed bugs", mold, fraud, etc.

    2) So is it better to buy only in landlord friendly states? Is better and easier, at least till you become an experienced landlord.

    3) Should we protect all assets under LLC? You should have an asset protection plan in place once your equity and tolerance risk requires it. 

    @Ashish Acharya

    My opinion/recommendation would be to apply the "2% rule" - the cost of setting up and maintaining your asset protection should be less than 2% of equity you are trying to protect. Let's say, it costs you 1.5K to get your structures in place (holding LLC or Series-LLC, with or without land trusts, with or without separate operations LLC) and 0.5K per year (for maintaining the LLC properly, bookkeeping, lawyer and CPA, etc.) for a total of 2K. You should have 100K or more in equity to protect before it makes sense to spend that money - compare that with how much you spend in annual insurance for the same property/equity.

    @Ashish Acharya gave you good advice on the various ways distribution per LLC should be.

    4) What if we have multiple single families in different states? It will complicate things, and be expensive if you are in CA (but there are ways to deal with that too, you need to consult an expert), but the same principles apply.

    5) Do we need to take umbrella insurance? Yes, you do, but that is just another tool/layer in your asset protection strategy. Insurance is not going to protect you at all times.

    There is no absolute answer and unique tool/strategy in anything real estate. You need to learn how to use all the tools available to you (financing, insurance, management, etc.) and to understand how they fit together in your toolbox, as none will give you everything (e.g, insurance is required and it will cover you for many situations, but not always; asset protection (LLC) is litigation insurance and complements regular insurance, by minimizing the target and making it unappealing).

    If you are a new investor, probably you will not have a lot of assets and/or equity to worry about (but even that is relative and subjective to each person tolerance to risk) so I would not worry about that till you pass that risk threshold (in my opinion 100K+ in equity, maybe 50K if you are really risk adverse). Regardless, you need to implement insurance and proper management procedures, regardless of how many assets and equity you have. So, learn about that first - and a good point to start is a Nolo book (https://www.amazon.com/Every-Landlords-Property-Protection-Guide/dp/1413307000/) mentioned in the doc, it will explain about insurance, how to evaluate insurance, and then about property management, property code, proper leasing and all the way to LLC and hiring.

    Think of it as levels of protection. Kinda like, one house, get good insurance and umbrella policy. Two houses, make sure you don't have holes in your property management. Three houses and 100K equity, start looking into strategic asset protection. Four houses, establish holding LLC and separate operations into a management LLC. Then couple it all with your estate planning and protection from outside attack.

    You can do that from the begining, but might be overkill (since you'll have to learn to properly manage an LLC and there will be some costs associated). Of course, you'll be much better protected, but will it be neccessary if you don't have much equity to protect?

    Things change if you have a profession where you need to worry about asset protection from the beginning. 

    I can send you my notes from the rather lengthy research into the question of asset protection.

  • Rental Property Investor · Round Rock, TX · Member since 2016 · 1k+ posts · 971 votes
    8y

    Here, a whole thread on your question #1: Asset-protection does-it-even-matter.

  • Cupertino, CA · Member since 2017 · 28 posts · 8 votes
    8y

    Thank you, everyone - This info will help me start thinking in this direction. Its a lot of digest though!

  • Cupertino, CA · Member since 2017 · 28 posts · 8 votes
    8y

    Hi All, I heard yesterday about Series LLC where you can subdivide LLC for each property and liability is only for that series within the LLC. Is that true?

    https://www.nolo.com/legal-encyclopedia/what-is-series-llc.html

  • Rental Property Investor · Round Rock, TX · Member since 2016 · 1k+ posts · 971 votes
    8y

    Yes, if your state supports them, and you plan on having multiple properties or doing flips, Series-LLC is a good way to solve the multiple LLC question.

  • Joe SplitrockPro Member
    Moderator
    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    8y

    @Rama Krishna I am curious why this person who made it big in commercial retails believe there is less risk in owning retail property? In retail, there are hundreds of different people on the property on a daily basis. All it takes is one person tripping or slipping on a sidewalk and they have a lawsuit. I don't think this person has any factual basis for their claim that retail is subject to less lawsuits than housing rentals. I could be wrong, but logically it doesn't make sense.

    As others have mentioned, there are asset protection strategies, which can be applied to either commercial or residential real estate.

  • Cupertino, CA · Member since 2017 · 28 posts · 8 votes
    8y

    @joe - If a person trips or slips on a sidewalk will it be the responsibility of a specific tenant or the owner of the commercial property?

    Yes - you are right - lawsuits can happen anywhere.

    Thanks

    Rama

  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    8y

    just from my perspective of 40 years at this over 500 houses owned rented at times and sold.

    I have only had tenants go nuts over security deposits.. and thats simple give it back LOL.

    maybe i am lucky.. but for me its good insurance is what we need.

    also if you have multiple members of an LLC that are true investors and you keep your books clean that does have some protection.

    the Hubby and wife or single investor who thinks an LLC or multiple LLcs will protect them.. that wont happen if the worse comes to pass.. they get pierced as alter ego.

    believe me you will get sued personally.. and you will spend an inordinate amount of money trying to isolate you from the litigation.. best to let your insurance company handle those costs right?

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