When to put properties into LLC

Question

Ryan Coon · Answer

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.

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Ryan Coon · Answer

@Nicholas A. Generally the residential loans are less worrisome because most are Freddie or Fannie and this gives you a lot of room to transfer to an LLC. Commercial loans on the other hand, which may be what you have for multi-family properties, can be a different story because you don't have the luxury of relying on Freddie and Fannie guidelines. However, in my experience commercial lenders are often more willing to entertain transfers to LLCs so you may be able to simply ask for permission rather than play the "better to ask for forgiveness than to ask for permission" game.

At the end of the day, however, the ease with which you can handle the change depends far more on the specific lender and their policies than anything else, and there is a large span of variance between lenders. You may consider trying to see what others experiences are with the specific lenders at issue.

Nicholas A. · Answer

Thank you for your in depth reply. I will search for the fannie/freddie guidelines on allowing properties to be transferred into an LLC. If you have them handy, feel free to send them over.I really wanted to focus more so on the risks of this. Are there caveats like certain banks dont allow this or certain states or types of properties or anything at all that would affect whether or not this can be done? Are there time limits on when this can be done?  I am essentially looking for anything that can be a caveat here. If I got called to pay off the entire property at once, I would be completely screwed.Before I take any action I want to make sure I have all the details and don't run into any problems.