When to put properties into LLC

[Nicholas A.]

I own some single family homes and soon to be some small multi family real estate. I want to put them into an LLC, but I don't know when. I heard the banks wont care if you do it and still pay them so they dont invoke their due on sale clause and expect payment right away.

When is best practice to do this? Please list any caveats I need to be aware of.

[Ryan Coon]

Hi Nicholas, this is a great question and one that many investors ask as they start to expand their real estate portfolios. While the decision of when to use an LLC for investment real estate is ultimately a personal choice, the benefits of using one or several LLCs is difficult to overstate.

Probably the biggest and most glaring problem of not using LLCs to own your investment/rental real estate is liability exposure. If, heaven forbid, a tenant or guest gets seriously injured on one of your properties and decides to sue you for damages, then any and all of your assets (both personal assets and investment assets) are exposed to this lawsuit if you are not using an LLC or similar tools for asset protection. I've worked with investors who have built a portfolio of real estate only to lose everything to just one or two lawsuits and have to start over.

Using LLCs can help you to silo or quarantine risk. For example, if you have 5 investment properties, and each one is in it's own LLC with robust Operating Agreements, then you can effectively limit your exposure to any single lawsuit to just the property involved. The LLC can act as a legal barrier to prevent liabilities for assets within the LLC from exposing assets outside of the LLC. Consequently, I think it's hard to argue that it's too early to get one or more LLCs setup if you already own investment real estate. In fact, in my experience, it is the investors who have only a few properties that benefit the most from utilizing LLCs because they have less ability to absorb the loss of 1, 2, or 3 properties to a single incident than investors who have dozens of properties.

As to lending, if the loans are backed by Freddie Mac or Fannie Mae, then you can generally transfer the properties directly into an LLC without creating issues because both Freddie and Fannie have issued guidelines allowing the the transfer of the properties to an LLC. If these are commercial loans or otherwise not backed by Fannie or Freddie, then you are correct that as long as you are paying the loan consistently and on time, it's unlikely that the lender will even discover the change because they have no reason to dig in and audit the account. The lender is getting exactly what they wanted and expected out of the deal. That's not to say that there is zero risk of the lender discovering the change and making a fuss about it, but the risk is generally very low.

Note: This information is for educational and informational purposes only and does not constitute legal, tax, or financial advice. No attorney-client, fiduciary, or professional relationship is established through this communication.