All Forum Posts by: Edward Schenkel

@Arion Dedushi - sorry you are dealing with this. I think a certified letter is appropriate and cite the laws the tenants are violating and the sections of the leases. Most leases have a provision that provides if a tenant violates a law, it is grounds for an eviction. This is something you should also consider if the problem is not resolved after the letter. I would be happy to chat further. Ed

@ Ed Moran, yes supplementing with an umbrella policy is perfectly fine especially if you are risk adverse. I have some clients who do that. I think the umbrella policy is a good choice for bigger properties, e.g. commercial, where you have customers and more people in general on the property, hence a bit more likely to have a lawsuit at some point and time.

I Have Multiple Investment Properties. Should I Create A Separate LLC for Each Property or Hold All Investments in One LLC?

Clients frequently ask me about how they should hold their investment portfolio – should they create a separate limited liability company (LLC) for each individual investment property or simply hold all of the properties in one LLC? It is a good question to ask, and a good problem to have, meaning you have a lot of properties to have to address this specific problem. Here is my answer: It depends on how adverse to risk you are, but at the minimum I would suggest creating a few LLCs if you have ten or more properties.

From a strictly legal perspective and to minimize potential liability if there was a lawsuit, the solution is to hold each property in a separate LLC. This way, if a tenant at a specific property slipped and fell, the proper defendant is the one LLC that owned that particular property, and the maximum exposure is the asset of that one LLC – the one property. Conversely, if all properties (for example, 10) were held by just one LLC, a plaintiff could go after all of the properties to satisfy any judgment. Therefore, holding each property in one LLC limits liability if there is a lawsuit.

However, while the separate LLCs are the best choice from a legal/liability perspective, from an accounting and administrative standpoint, the multiple LLCs will likely result in higher administrative costs. For example, you will need separate accounting books for each LLC, which will likely increase your accounting fees significantly. Similarly, you pay registration fees each year for multiple LLCs instead of just one. In states like California, such registration fees are very high. Therefore, setting up separate LLCs will mitigate liability, but it will also increase your administrative fees, perhaps significantly.

I recommend that clients determine how risk adverse they are before deciding on how many LLCs should hold their properties. If they are very risk adverse and find increased administrative costs acceptable, then they should create a separate LLC to hold each property. However, if the client is ok with risk and wants to save administrative fees, then perhaps holding the portfolio in one LLC is acceptable.

I typically recommend that clients select an option somewhere in the middle, an acceptable balance between mitigating liability and an acceptable increase in administrative fees. Accordingly, if for example, a client has 10 properties, I may suggest setting up three LLCs, perhaps grouping the properties as property type (e.g. all residential properties will be held by LLC ABC and the commercial properties will be held by LLC XYZ). This way, there is some mitigation of liability exposure if there is a lawsuit, but administrative fees do not increase as significantly. Of course, the option that works best for you depends on how you feel about risk.

Originally posted by @William Keasling:

@Edward Schenkel I would like to say thank you very much for all the information you have provided in this thread. I have read it from top to bottom. Threads like yours are the exact reason I love getting on Bigger Pockets. I have learned more in your thread than I did in some of my college classes.(sorry to all of those professors). Anyway I am an amateur investor from Oklahoma, and I have a possibly dumb question for you. So far I have only dealt with SFR. Here in Oklahoma I have seen duplexes that are being split, and one side will be put up for sale. My question is when the property gets dived as such do property taxes and square footage of lot get dived as well? I'm not sure how common it is for duplexes to be split and sold individually. Thanks again for all of the free knowledge, and I will continue to follow your threads.

@William Keasling, I do not think I understand your question. When you say when duplexes are split, do you mean converted into condos? Maybe there are laws in Oklahoma I am not familiar with. If this is the case, then the property taxes should also be reduced accordingly as well, I would think. 

@William Keasling - no problem. I enjoy teaching and answering questions!

Should Real Estate Investors Have Operating Agreements for their LLCs that Hold Their Property?

Many investors hold their investment properties in Limited Liability Companies (LLCs) which is always recommended to protect yourself from individual liability. For example, if a tenant sues for an injury, the proper defendant would be the company, and not you individually, and you therefore have protection. The next question to ask is whether you should have an operating agreement for your company.

An operating agreement is an agreement among the members of a limited liability company that spell out the Members’ managerial rights and duties, along with provisions concerning adding new members, contributions, distributions, and so forth. Some states require an operating agreement while others do not. Typically, an operating agreement is used if there are two or more members but you can also have a single member operating agreement as well in anticipation of adding other members. An operating agreement is recommended, especially if you have more than one member.

What are the benefits of having an operating agreement? The following are three benefits to having a operating agreement.

1.Reducing Problems and Disputes Between Members

The most practical reason for the company to have an operating agreement is to mitigate problems between the members, thus reducing the chance of litigation. A good operating agreement will clearly spell out the managerial duties and responsibilities of each member and will also provide provisions relating to the procedure for adding members along with the procedure for a member who wants to leave the company and receive a buyout. The operating agreement will also contain provisions concerning distributions, use of contractors and attorneys, and so forth. Having a detailed operating agreement that spells out the relationship and responsibilities between all members will mitigate the chance of having problems later. Therefore, it is a good idea for a company to have an operating agreement.

2.Breaking a Tie Vote

An operating agreement can also be very useful in providing a procedure for breaking a tie vote. For example, what if, in a two-member company, one member wants to sell a property and the other does not? There is a tie vote. However, the operating agreement can provide a procedure for breaking a tie vote so the disagreement is not escalated. Perhaps the operating agreement will call out that they attend mediation. Another alternative is that the members select an objective person to break the tie vote. These are just several examples of how an operating agreement can help break a tie vote and prevent disputes.

3.Some Banks Require an Operating Agreement before Financing

It is also a good idea to have an operating agreement because some banks will require you to have an operating agreement as a condition to providing financing. Banks will see an operating agreement as mitigating risk for the company to have problems, and therefore less risky to loan money. While not all banks require an operating agreement as a condition to provide financing, it is good to have one in place in case a lender will require it.

What is a Triple Net Lease and What Are the Basics that Investors Should Know?

A “Triple Net Lease” is a type of lease that every investor should be familiar with, particularly investors who invest in commercial real estate. An investor who owns a commercial building may find him or herself negotiating a triple net lease with a prospective lessee. In fact, an owner should insist on a triple net lease as this type of lease is advantageous to the owner. Alternatively, an investor may be a lessee on a long-term triple net lease for land or a large building. Outlined below is a summary of a triple let lease along with three important things that all investors should know about these types of leases.

What is a Triple Net Lease?

The triple net lease is a type of lease, typically used in commercial buildings, that places responsibility on the tenant for three expenses in addition to the rent. These three additional expenses are the building maintenance, insurance and property taxes. This arrangement is typically preferable for the landlord since the tenant(s) will help defer the expenses of the building. Below are a few important things every investor should know about these types of leases.

1.The Maintenance, Insurance, and Property Taxes Can Change Every Year so the Triple Net Lease Should Account for This.

The taxes, maintenance, and insurance can go up or down each year. Clearly, as the landlord, you are more concerned about being protected if these expenses go up each year. Therefore, it is important, and also customary, to include a provision in the triple net lease that allows you to raise the Additional Rent (which is a common term for the triple net expenses of maintenance, insurance and taxes), which will allow you to raise the expenses that the tenants are responsible. For example, if your annual taxes are increased by the City, such a provision would allow you to raise the Additional Rent to account for the real estate tax increase. However, it is also customary for the Tenant to insist on a cap, or maximum, that such Additional Rent may be increased, so this may be a negotiation point at the outset of the lease. The take away is that all investors that use triple net leases should have a provision in their leases that protects them when the triple net expenses increase.

2.CAM Charges. What Are They? What Should Investors Know?

Common Area Maintenance Charges, or CAM charges, are utilized in triple net leases with multiple tenants. CAM Charges are one of the expenses in the Additional Rent charged to commercial tenants, and are composed of the tenants’ proportionate share of the work and maintenance performed in the common areas of the property. Each tenant is responsible for their pro rata share of the property’s total CAM charges, which is typically equal to the tenant’s rented square footage of the total, rentable square footage of the property.

A common example of a CAM charge is snow removal and salting for a shared parking lot. Since all the tenants and the customers and clients use the shared parking lot, it is a common maintenance expense, and all tenants will share the benefit in having a parking lot free from snow, ice, and other debris, and therefore share proportionately in this cost.

CAM Charges can include different things so it is important to understand them. Typically, CAM charges are defined in the Lease, but may or may not include things like management service or HVAC repairs. All investors involved in triple net leases should understand that CAM charges may include different things in addition to the standard snow removal, cleaning, and common area maintenance. As the landlord, it is beneficial to negotiate the management fees and HVAC repairs in CAM charges, if possible. As the tenant, clearly the opposite stance is in your best interest.

Moreover, CAM Charges can change from year to year so, as the Landlord, it is important to have a provision in the Lease that allows you to increase the CAM charges if the expenses increase.

3.Tenants Generally May Review Landlord’s Financials Re Additional Rent

A triple Net Lease is advantageous for a Landlord because it passes most of the maintenance and operating costs to the tenants. However, Landlords should also keep in mind that in most triple net leases, the Tenant has the right to review the Landlords financials relating to the taxes, insurance, and maintenance fees to make sure they are accurate and account for any reconciliations. Therefore, all owners of commercial properties with triple net leases with tenants should understand that they likely will need to allow the tenants to review their books from time to time.

What is a Due-on-sale Clause and Why Does it Matter to Investors?

Many investors have asked me a variety of questions concerning a clause that is common in mortgages and promissory notes called a “due-on-sale clause”. A due-on-sale clause is a clause in a mortgage and/or promissory note that provides that a default may be declared and the loan may be called due (repaid in full) upon sale or transfer of ownership of the property secured by the mortgage without the bank’s consent. In other words, the bank has the right to demand full payment of the note if the property is transferred without the bank’s permission (this does not include a traditional closing where the bank is paid off and the lien released at closing).

Why should a real estate investor understand be aware of the due-on-sale clause in a mortgage? For several reasons. First, as an investor, you will want to make sure you are protected by keeping the property in a limited liability company so you are shielded individually if there is a lawsuit. This means that you may need to transfer your investments, which are currently held in your name, into a limited liability company (or companies). If there is a due-on-sale clause, such transfer may technically violate the clause. Accordingly, you should be aware that if you transfer the properties in a company without the bank’s consent, there is a risk the bank could declare that this is an act of default and call the loan. However, this is low risk since the bank’s primary concern is receiving the monthly mortgage payment and that the property is not wasting away. Also, if the bank did complain, you could transfer it back. Still, to be safe, it is recommended you either purchase the property in a corporate entity or that you obtain the bank’s consent before transferring the property to your company, even if it is a sole member limited liability company where you are the sole member.

Second, a good reason to understand the due-on-sale clause is so you can negotiate it out of future deals, or at least negotiate room to transfer to companies where you own an interest. As an investor progresses in his or her career, he or she may find a good deal that involves seller or alternative financing. This means that you will have more bargaining power to discuss the terms you want in and out of the loan documents. Being aware of this clause means that you can either take it out, allowing you to freely transfer the Property to your companies or partners, or draft a due-on-sale provision that is more flexible and suitable to your needs.

Five Commercial Real Estate Contract Provisions that Commercial Real Estate Investors Should Know

Commercial Real Estate can be a great investment. However, commercial deals are often more complicated than residential. Everything from the due diligence to the contracts are more involved. That is why any investor who is contemplating a commercial investment should understand all the nuances of these types of deal before getting started. This post will talk about some of the different types of real estate contact provisions in commercial deals that every investor should understand before getting started.

Due Diligence Clause

Due Diligence is important in any real estate acquisition, residential or commercial. However, in commercial, due diligence encompasses many more things and is more complicated. Accordingly, it is essential that the due diligence provision in commercial contracts is drafted broadly to allow the investor to inspect more than just the physical condition of the property. An investor should be entitled to conduct due diligence on zoning, environmental (including phase 1 and phase 2 testing), tenant leases, owner contracts, and the financials of the property. The clause must be carefully drafted to allow you to get out of the deal if any of one these are not satisfactory so it is important to consult with counsel before signing.

Permitting Contingency Clause

Unlike residential acquisitions, you may have plans to add an addition to the commercial property, construct a new building on the parcel, or move a new anchor tenant to the property soon after the closing. These plans may require some sort of zoning permit from the City or Town for your plan to legally materialize. Accordingly, it is important to determine if such a permit is needed. If important to your investment, it is essential to have a continency clause in the contract that makes it clear that the closing is contingent on obtaining the permit. If you do not include this clause, you may be obligated to purchase a property without the ability to bring your vision to reality.

Financing Contingency Clause

As with a residential deal, Commercial real estate contracts should have a financing continency provision if financing will be used. However, financing contingency provisions in commercial deals may be more involved as there is creative and nontraditional financing often utilized in commercial deals that are not typically used in residential transactions. Therefore, it is important that the financing contingency in commercial deals is carefully drafted to reflect the particular financing that is being used. For example, if there is a combination of two private lenders combined with owner financing, it is imperative to describe all financing sources in the contingency so that the deal is expressly contingency on obtaining all of the necessary financing.

Estoppel Certificates

A commercial deal will often involve the sale of the property with tenants in place. Accordingly, it is essential for the Buyer to confirm that the leases are in full force and effect; that there is no default on the lease payments; and that both the tenant and current owner are in compliance with the lease and there are no violations. Estoppel Certificates will allow the Buyer to close with an assurance that the tenants are not behind on the rent. Accordingly, a provision that entitles the Buyer to estoppel certificates is imperative.

Seller Representations

Seller representations and warranties are important in any real estate transaction, but particularly in commercial because there are different issues involved such as potential environmental concerns and different zoning issues. The Seller representations should be clear, and specifically note whether they are to the best of Seller’s knowledge and which representations survive closing. Common Seller representations and warranties include that the property is in compliance with the zoning and building regulations; that there are is no environmental contamination; that the leases, contracts, and financials provided to the Buyer are complete and accurate; and that the Seller (if a company) has the authority to enter into the contract.

In summary, commercial real estate can be a great investment but it is important to know all of the different issues before signing a contract for a commercial deal. Please ask any questions you here about commercial real estate contracts. 

Top 5 Issues that Every Real Estate Investor Should Know Before Investing in Vacant Land

Investing in vacant land may be an excellent investment if the investor is aware of the risks and can knowledgeably assess the issues unique to developing vacant land. I have helped real estate professionals purchase and develop vacant land and the following is a list of the key issues that every investor should be aware of before buying and developing vacant land.

1.Zoning and Subdivision Regulations. What Can I Build?

Before purchasing and developing vacant land, a prudent investor should research, with the help of an attorney, the zoning and subdivision regulations to fully understand what they can and cannot build on the land. Subdivision regulations will likely impose restrictions on how many lots can be carved out of the vacant land and possibly certain other requirements like requiring open space. Moreover, zoning regulations govern what types of property can be constructed and the uses of such properties. It is imperative to understand what can be built there before moving forward with the acquisition to understand whether the planned development is feasible. For example, if you would like to construct an apartment building on the lot, make sure that the zoning regulations allow this. Working an attorney sooner rather later may save you a big headache down the road.

2.Will You Need Any Type of Permit for Your Planned Development?

Your intended project, no matter how big or small, may require some sort of permit to make it become reality. For example, if you want to construct a building of a certain size or use, it may be permitted but you may also need to obtain a special permit, which will require additional legal and professional fees. If the permit is imperative to what you want to build, you should know this ahead of time so you can make the deal contingent on obtaining the permit. It is better to know before you sign rather than after you close whether you need a permit for your project.

3.Sewer and Utilities

Prior to purchasing vacant land, another important component to understand is whether the land is connected to the sewer line and utilities. If not, this could impose additional cost on your budget. Moreover, the ability to connect to the sewer is important to understand which could increase the development potential and value of your property. If the land is not connected to the sewer, a septic system will not only increase the cost of your development but may limit the square footage of development potential. Accordingly, it is important to understand to what extent the land is connected to utilities to assess the development potential and costs of the project.

4.Environmental Concerns

Environmental Concerns are always an issue when purchasing real estate. However, they are more of a focus on vacant land, especially in commercial areas, when the land is going to be dug up and developed. If you are contemplating purchasing vacant land, particularly in a commercial area, you should strongly consider consulting with environmental professionals and conducting environmental testing to make sure there are no hazardous contaminants on the land. If you discover such contaminants after the purchase, you will have a big problem on your hand.

5.Due Diligence Provision in Land Acquisitions

Due to the unique issues involved in purchasing vacant land, it is important to have abroad, carefully drafted due diligence provision, that allows you to conduct due diligence on zoning, utilities, environmental and so forth. The standard due diligence provision in a residential real estate contract is likely insufficient. Before you sign a contract for land, make sure you review the due diligence clause carefully and make sure it includes your right to conduct due diligence broadly. 

If anyone has any questions about vacant land feel free to ask!