Love Austin Homes Investing Blog

Hi,
I am a new investor and have done a few flips with my own money. Now I would like to learn about leverage and use a bank loan and buy a rental property – with the intention of holding it for 5 -10 years.

Oh, yeh I do have an LLC that I have run all real estate investing through in the past. Yes, I paid cash and there were no issues holding the property in the name of the LLC.

Here is my question – Why are the banks telling me they will not lend money on property held in an LLC?

Am I structuring this properly?

How do other investors do this?

I understand a commercial loan is at a higher rate, is that what the banks need to assume I am doing? One loan officer mentioned transferring the property to the LLC after closing. Is that what you do?

Ok….that was more than one question… I am genuinely baffled.

Barbara

ANSWER

Barbara,
Corporations, such as LLC’s, have to get commercial loans. These are available from commercial lending institutions, but usually at 2-3 interest points higher than personally guaranteed loans.

Buy your properties in your own name and then transfer them into an LLC or other entity. I suggest you have a separate entity for buy and hold properties, than your ‘flipping LLC’. Presumably you are using an LLC to flip properties for liability protection, and thus you logically don’t want that entity to have assets in it long term.

You may also consider an LP (Limited Partnership) or FLP (Family Limited Partnership)­, which costs a little more to set up, but may save you in taxes due to the franchise tax imposed on LLC’s that make profits. This is what I do. Coombs Property Holdings, LP has a nice ring to it. Some people also suggest creating a new entity for every 1-3 properties. Frankly, I think this creates far too much paperwork, tax filing, and overhead, especially after you own 10, 15, 20 properties…

Some people bring up the concern about having a loan called due if the deed is transferred (The ‘Due on Sales’ clause found in every loan agreement). While this is legally possible, no matter what you do (and I’ve done some crazy stuff) it’s much more likely that you will win the lottery than get your loan called, as long as you are making the payments. So, if you are one to worry about such things, just buy a lottery ticket each time you get a loan and each time you win, use the winnings to pay off the mortgage

Another trick people use to disguise the transfer of ownership of a property into an entity, is to use a trust. You can move a property into a trust and then transfer the interest in the trust to your entity. The trust itself offers no liability protection, and indeed the lender can still call the loan (because the deed is still being transferred)­, however, some people believe that this extra layer of shielding of ownership may make it less likely that the lender will find out that a deed was transferred (mostly because the beneficial interest in the trust is not recorded). I don’t personally use trusts, because they also creates more paperwork, you have to assign a trustee, etc. but I have considered this for other reasons.

Additionally, don’t forget about insurance – the topic the so-called experts seem to gloss over when dealing with these issues. You will need to make sure that your policy is changed to a corporate policy (or a policy that will cover a corporation) from a personal policy when you transfer ownership, else you are insuring something you don’t personally own, which is a waste of money… The corporate policy may cost a little more. The property will probably no longer be covered under your own personally liability umbrella. You’ll want to get the balance of the original personal policy refunded to you (explain all this to your insurance agent before you buy). The problem with all of this is that it does create additional paperwork, and a paper trail documenting that the deed was transferred. Does that matter – no, buy lotto.

Finally, from time to time you may have to provide the new insurance declaration to your lender. Have yourself, and your LP/FLP, and the lender all listed as insured by the policy, and you should be fine. If you escrow for insurance (I don’t recommend this), you will want to file the new insurance declaration with the lender many months before the policy payment is due, so that they pay the right policy. Unfortunately, for some reason, lenders always screw this up and pay the wrong policy anyway, causing me to have to repeat this step, so you may need to do this last step a couple of times…

Regards,

Phill

Sir,
You always seem happy to help newbies in real estate business. I can really appreciate this. Helping others. Your information has been “right on” in most cases.

I have been in the real estate business all my life. I’m 63 years tired. I live in the hill country. On Lake Buchanan to be exact. In my past I’ve been very active in investment Real Estate but am too far from the Austin market to become actively involved. Too young to retire, but do want to slow down. So I have been toying around with the idea of becoming a “hard money lender.” This is a problem, because I’ve never been involved in this type of lending. I have bought several discounted mortgages in the past, but never loaned out money.

To keep it simple, I’m looking for a Mentor, someone to teach me the business, hold my hand, lead me thru a couple of deals. I don’t want to get burned. Been there done that. Can’t find much information, and no books or tapes. I guess the business is too state specific.

I operate using LP’s and LLC’s so i am familiar with how they work. I’ve never seen a partnership agreement as you mentioned above. I would be very interested in reading such a document or examples of such a document. It would give me some guidance in what issues need to be addressed before checks are cut.

Any suggestions as to where I can get some information would be greatly appreciated.

Thanks in advance for any guidance in this area.

Thank You
Philip

ANSWER

Philip
I do these frequently with other investors. Partner find deals, I fund them, we split the profits.

I use a simple Limited Partnership Agreement that we customize for each deal. It defines the responsibilities of each party, what is considered as profit and expense, and how profits/losses are to be divided, etc. It also has other boilerplate needed in limited partnership agreements.

The actual buying and selling is generally done in the name of the person/company funding the deal, or in an LLC created to hold the property (if it will be held for a long time), or in an LP created to flip properties (this is what I use). Most people don’t care who’s name the property is in, they just want their fair share of the profits.

CONTINUED

Regarding you question on lending:

Philip,

I’ve come to know a lot of people that do various types of lending. Most fall into the category of ‘hard money lenders’ and ‘private money lenders’.

Hard Money lenders get higher interest rates, but also have to work a lot harder for the money. The work is in the form of responding to lots of calls from yahoos and newbies that want to borrow money on shaky deals, and having to do a lot of homework and sorting though a lot of deals in order to find the ones worth funding. Most of the private individuals that I know that have gone this route, have either backed away from this to become private money lenders or given their money over to established hard money lending institutions, like Funding Partners, among many others. Jules Caplan is an example of a local investor that also does hard money lending. Jules has lots of stories about the frustration of running down deals from people that exaggerate values, underestimate repairs, and simply don’t know what they are doing.

Private money lenders work more through relationships with a smaller number of experienced investors. Private money lenders can do recourse loans (where the borrower in personally liable for the money), can choose to work only with borrowers with good credit, and sometimes even choose to invest at lower LTVs for lower risk.

For example, I’ve got perfect credit and a personal net worth of more than a couple million dollars. That said, I can’t personally afford to finance all of the projects that I manage. I prefer to buy at 70-80% (minus repairs) and then fund about 20% of the project myself, so that my own money goes 5x as far. This means I need to borrow 80% of the project costs, but the lender is only loaning money at 50% or so loan-to-value to someone with experience, perfect credit, and personal liability (and their one $$) in the deal. This is about as easy and low-risk as a loan can get. For this sort of loan, I might pay 10% interest, but no points. Obviously, that’s not as good of a deal to a lender as a hard money loan, but it’s also virtually risk free and work free.

So, are you looking to be more of a hard money lender or private money lender?
Phill

Another approach to avoiding a lender from calling a loan on a property that has been sold is to title the property into a land trust, and have your LLC be the beneficial interest of it. Titling a property into a land trust
> for estate planning purposes is a specific exception to the due on sale clause. The land trust itself does not technically isolate legally liability from you personally. The LT provides identity separation between you
and the property. If the beneficial interest of the LT is held by your LLC, the liability protection would be limited to the assets of it.
Lawrence

ANSWER

Lawrence,
Lands trusts don’t offer liability protection, only identify protection. Transferring the beneficial interest of a trust to an LLC will put you at risk with the due on sale clause, just as transferring ownership directly into the LLC would. That said, using a trust makes it more difficult for the lender to figure out what is going on. That being said, lenders almost never call performing loans due anyway…

All of these are fun tricks of the trade that learn about in RE books, but as a practical user of all of these techniques, I have come to also take into consideration the administration of such vehicles. The trust requires paperwork, a trustee, etc. The LLC requires articles, annual filings, possible tax filings, and, if you really want to get the liability protection, regular officer meetings – including documented meeting minutes, etc. Technically, you should even keep a separate set of books for each entity. Once you have 10-20-30 properties, and try to maintain all of this, it becomes overwhelming.

Another approach is to minimize your entities, and get a personal liability umbrella insurance policy for enough to more than cover your assets.

Phill

I would like to set up 2 business entities, one for flips and one for long term properties. Can anyone give some advice/insight on how they have done this. Also, any referrals for an accountant and attorney would be appreciated.

Thanks,
Ashley

ANSWER

Ashley,
This is a very complex question. I have paid multiple lawyers and accountants to help me with this. The problem you get into is that the lawyers answer the question in terms of how to limit your liability “Put everything into separate LLCs…blah blah blah”, while the accountants answer the question in terms of how to save on taxes “Don’t use LLC’s because of franchise tax and bookkeeping overhead…blah blah blah”.

To help sort this out, I did go to Adrian Van Zelfden, because he’s a lawyer and accountant (though really an accountant), and he was helpful initially, however, unfortunately he is no longer doing much in real estate, so he basically told me that that there are several better guys in town than him to help set up and do taxes for real estate businesses.

One thing I suggest is that you need to draw up a 5-year plan that says what types of transactions (and how many of each type) you plan to do.

If buying rental properties, consider how these will be bought (subject-to, personally guaranteed loans, business loans), and how these will be held. Things get quite complex if you buy something with an entity and want the entity to get financing. You’ll quickly discover, for example, that an entity will pay 2-3% more for a mortgage and 50% more for insurance, which may make this option uneconomical long term. Buying things in your own name brings about liability issues, which brings up the topic of insurance… and what it covers, and what, no matter what they tell you, it does not cover… You can also move things back and forth into entities, but that raises several other issues.

If flipping properties, consider how many tax returns you want to generate (which are required for some types of entities), and consider the dreaded “IRS dealer” status you risk getting if you do things the wrong way. Oh, and don’t forget employment tax – 15% right off the top, depending again on how you do it all…

Take your 5-year plan and map these transactions into different entities and see what the ramifications are. There is no perfect solution – just tradeoffs between liability protection, cost, tax efficiency, insurance requirements, etc.

Regards,
Phill Grove

> Hello – I’m an investor and new to the area. Does anyone
> know of a good local attorney who is an RE investor and understands the
> business (contracts, etc.), who understands entity structures (LLC’s, L/P’s,
> etc.), and who is accessible and is reasonably priced? If so, I’d
> appreciate some names and numbers.
>
> Thank you,
> John

ANSWER

John,
I use Charlie for most of my contract and property manager work. He has written many of my ‘creative’ contracts and helped me through a lawsuit. He will create an LLC or LP for you fast and cheap. He is also good with evictions and foreclosures. I’ve put one of his kids through school.

I also found myself in need of a lawyer to give good advice on how to set up my companies. It seems the lawyers gave me advice on limiting my liability while the accountants game me advice on saving money (mostly on taxes). Unfortunately, the advice from lawyers and accountants is often contradictive. So, finally, I found an accountant with a law degree and hired him to do my taxes and set up my corporate structures. His name is Eugene Adrian Van Zelfden Jr.

Update: Unfortunately, Van Zelfden told me he was no longer doing real estate.

Phill

I was told by a title company that if you close in your own name then deed it to the LLC that you lose your title insurance. I’m not sure exactly what they meant, so please consult your RE attorney or favorite closer about closing in your own name, then later deeding to an LLC.

It might mean that the LLC won’t have title insurance…I suppose you could fix that by buying another policy or that there is no title insurance coverage between the time you purchased and the time you deeded…again I’m not sure, so check with your advisors.

Also, on a side note, I mentioned a few lenders we are working with in a previous email (for our own portfolio), so far Paul Duhamel has been very responsive and Tim Booth’s company has not been. I’m not saying just yet that Tim’s company cannot deliver, but hold off on calling them until I can give a report to the group about our situation.

Thanx,
Angelique

ANSWER

There are several problems I know about transferring a deed to an LLC

1) I too was told by my title company that any existing title policy is void upon any sale of the property. Indeed, only the very last title policy obtained on a property is active at any one time. When you deed the property to an LLC (or anyone else), you are effectively selling the property to the LLC, even if no money is exchanged. Therefore, the title policy is void, and the property is uninsured against title issues – unless you buy another policy – yikes! UPDATE: This is not as bad as it sounds, the old policy still insures up until the title was transferred.

2) Also, because the property has essentially been sold, any loans on the property are at risk of being called because of the due-on-sales clause is virtually every loan agreement. While it’s true that lenders virtually never call loans, it’s still a risk.

3) Finally, when you buy property insurance for a property held by an LLC, you now have to buy a corporate policy rather than an individual policy. These typically run about one and a half times the cost of normal insurance.

Phill