Afford Anything - Ask Paula - Should I Keep My Properties in an LLC

Episode Date: July 17, 2017

#86: The real estate questions keep coming in, so today I’m answering questions from three Afford Anything listeners: Heather is ready to buy her first rental property. She wants to acquire about one house per year, following a buy-and-hold strategy. Salome and her husband are renting out an unused room in our house on Airbnb. We're interested in venturing into buying rental properties later. Then Caren talks about coming across several real estate investing clubs, or memberships, in which the organization pulls together a list of various contractors and property managers. What are Paula’s thoughts and experiences with these types of things? For a full list of show notes and resources, visit http://affordanything.com/episode86 Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every decision that you make, every dollar that you spend is a tradeoff against something else. So the question is twofold. Number one, what are your highest priorities? What do you value more than anything else? And number two, how do you align your day-to-day actions in order to reflect those goals and those priorities? Answering those is a lifetime practice. And that's what this podcast is here to help you achieve.

My name's Paula Pant. I'm the host of the Afford Anything podcast. every other week I answer questions that you, the listeners, the community have submitted. And every now and again, I consolidate several real estate related questions into one episode. That way, if you're interested in real estate, you can continue listening. And if not, you can drop off here and we'll meet in the next episode. So today, I'm answering specifically questions that you have sent in about real estate. Our first one comes from Heather.

Hi, Paula. This is Heather. Thank you for your podcast. I'm very inspired by you. In fact, I have created a fund and am ready to purchase my first rental property. I'm planning to start a business similar to yours where it's a buy-and-hold strategy, long-term rental, and hopefully I'd buy one a year for, I don't know how many I'd do, but start with one. My question is, when there are personal assets at play, where in terms of the my husband and I are savings. I'd love your advice on how to structure the purchase of a rental property. Would you do LLC? What are the pluses and drawbacks of that? Would you do it in your own name and have a certain amount of liability insurance? Is there another structure that I'm not aware of? We are able to purchase the properties we're looking at in cash. However, my husband strongly prefers in terms of the amount of our portfolio he'd want to put towards this right away.

He'd prefer to finance it with 25, 30% down. But I'm just mentioning that optionality in case it changes any advice you have. Obviously, we will speak with a lawyer about our specific situation, but you've been amazing and inspirational to me, so I really wanted to get your thoughts. Thank you. Heather, this is a really interesting question because the question on its face on the surface is, how should I structure this? But if you zoom out, the broader question that I think you're actually asking is, how can I minimize liability? And here's what I mean by that.

So your specific question is, all right, so how do I structure this? Do I put them in an LLC? Do I hold them in my own name? So the reason that I say, hey, let's zoom out is what's the goal of asking why you're structuring it. The goal is you want to figure out how to minimize liability, right? So let's start there. Let's look at the menu of options that could potentially reduce liability. And that menu of options include holding properties in an LLC could potentially reduce liability. Having a large umbrella liability policy could do so. This is a big one. Making sure that everything in the house is code compliant. Like for example, let's say that the house has an outdoor deck with an old set of stairs in which the rise or the run of the step is no longer up to modern building standards.

If someone falls down those stairs, they could come after you for having shoddy stairs that aren't compliant with municipal building codes. So making sure that everything in the house is code compliant, that could minimize liability as well. Another thing that could minimize liability is using only licensed, bonded, and insured contractors so that if you do have to defend any of the work that's been done on the house, you can point to the fact that you used a legitimate contractor rather than just some guy on Craigslist. So I realize I sound like I'm veering off topic right now, but the point that I'm trying to make is that I just named four different options that could potentially allow you to

reduce liability. So an LLC is one. The large umbrella liability insurance policy is another, making sure that your property is code compliant is a third, and using licensed bonded and insured contractors is a fourth. Those are four ways to reduce liability. And so the question really becomes, if your goal, I'm assuming, if your goal is to minimize liability, the question becomes, what are the pros and cons of each option? And what tradeoffs are you willing to accept? So to go back to your original question, which was how should I structure this, what that question is asking is, what are the pros and cons?

of structuring a property in an LLC. And when we zoom out and we talk about minimizing liability, we talk about the pros and cons of holding properties in an LLC with regard to how they fit into the overall liability reduction motif. Does that make sense? I feel like sometimes when I talk into the microphone, like, here's the thing. I'm like totally alone in an empty house,

just talking to myself in a microphone. So because I'm not getting any kind of like feedback, you know, there's no, nobody's like, no facial expression, no vocal intonation. I have, sometimes I just have no idea if I'm veering into crazy talk or not. So I hope that what I'm just saying, I hope that what I'm saying right now is sound sensible. To cut a very long story short, if your goal is to minimize liability, personally, I mean, okay, this is not legal advice. So those are, you know, standard disclaimers.

Personally, the first thing that I, myself, rush, to do is make sure that I have a solid umbrella liability policy in place. That's number one, because those are cheap and they can really save your butt. As to the specific LLC question, there are a bunch of pros and cons. Like if you want to secure financing for a property, it's going to be a lot easier to secure that financing if you buy that property in your own name rather than through an LLC, assuming that you're getting conventional financing. If, on the other hand, you're buying a property in cash, then that's no longer a con. So if you're buying the property in cash, then sure, you can create an LLC, have the LLC hold all of the funds, and then purchase that property through the LLC, absolutely.

If you do get financing for a property and you buy it in your own name, you can, after the purchase, assign of the property. into an LLC through what's called a quick claim deed. So that's another option as well. But you see here, we're getting into a whole bunch of pros and cons where whether or not you opt for LLC designation is no longer merely a function of liability reduction. It's also a function of how will you qualify for financing? And are there property taxes in your state that are assessed when a transfer is done through quick claim deed? Now, here's the thing. If you, if you, file a quick claim deed, you expose yourself to a different type of risk. And this type of risk is known as the due on sale clause. Many conventional mortgages have a clause in it called the

due on sale clause. What it states is that if the property is transferred to a different owner, the entire balance of the mortgage becomes due. And what that means is that technically, if you were to transfer the ownership of the property from your own name into the name of your LLC, then according to the way that many mortgages are written, and of course your mortgage may vary, that event might trigger the due on sale clause, which means that the bank or the lender would have the ability to call the entire mortgage note whenever they want, which in layman's terms like they can, make you pay the whole thing back right away if they find out. Now, that being said, there are

many investors who are just kind of flippant about the due on sale clause because it's rarely enforced. And again, you're comparing pros and cons. You're looking at tradeoffs. It's the very kind of heart and soul of afford anything is deciding which is your priority and then figuring out what's more important to you. And in this case, what you're really doing is you're figuring out which type of risk you're more comfortable with. There are many investors who say, you know what, I'm more comfortable putting my properties into an LLC and I'm willing to risk invoking the due on sale clause in order to do so. Likewise, there are also many investors who feel the opposite, who say, you know what, I don't think that transferring my properties into an LLC will adequately

reduce liability enough that the supplemental risk, the due on sale risk, is worth it. And therefore, for that reason, I choose not to quit claim my properties over. So that's a choice that you've got to make, right? At heart, this is a risk management decision. That's part of the reason why I can't give you a simple answer, because I can't decide your risk tolerance or your risk comfort level for you. I can give you the facts, maybe some of the information, basically I can give you a framework. And within that framework, you've really got to decide what tradeoffs you are willing to accept. Which type of risk are you more comfortable sitting with? And you know what? This is what makes it hard. When somebody leaves a comment on the blog or when I'm at a conference and somebody very

casually says, like, what, do you hold your properties in an LLC? The question that they're asking me is what do I do personally with my own properties, but the question that they're really trying to ask, you know, the question that I know that they're getting at is what should they do with theirs? And again, there isn't a simple answer that I can give because it's, I mean, it's complicated, as you can see. It depends on what type of financing you're getting. It depends on which type of risk you're more comfortable sitting with. Because, you know, if you do get conventional financing and you have to buy it in your own name, all of a sudden, now you have to make a decision that weighs two different types of risks against each other. Those are all things that you need to

consider. And those don't get neatly summarized into the question that I often get at, you know, like, I'll be at like a cocktail party at a conference. And people are like, so do you hold your properties in an LLC? And I'm like, I don't want to mislead them, right? Like, I don't want to give them a quick, flippant answer. But I know that there are so many more factors to consider than what one random person who's holding a cocktail at a party has done. So sometimes I'm not sure exactly how to convey that into like a quick cocktail party soundbite. At any rate, I guess what I'm really saying is that when you ask what's the best way to structure a deal, there are multiple factors that you would want to consider.

liability reduction being one of them but not the only one. Yes, in many cases an LLC can reduce liability, but if that is your primary goal, don't forget to look at other options for that as well. Again, this is not legal advice. This is not insurance advice. This is this is just some person on the internet speaking into a microphone. So please take this with a grain of salt, take it as you will. But that is the framework that I would use if I were you in determining whether or not, you should structure your properties with an LLC. Okay, I'm going to cut myself off there. Thank you so much, Heather, for asking that.

And best of luck with everything that you're doing. This stuff tells nicely into our next question. Hi, Paula. This is Salome from Cincinnati. I love your show and have been listening to your podcast obsessively. My husband and I are thinking of getting into the rental property gig, but we kind of are dipping our toes into it by trying to. buying Airbnb first on a room in our house that we don't use.

So my question to you is, would you recommend doing or setting up an LLC first before starting that or starting one up pretty quickly after getting in that gig? Or what are your thoughts on using or setting up an LLC? Love to hear you and keep up the great work. Thanks. So this is really interesting. This is the LLC question again, but it comes from a slightly different angle because you're renting out an unused room in your own house on Airbnb. And so specifically for the Airbnb portion of what you're doing, here's the framework that I see, right? You don't need financing

because we're talking about a room, an existing room in your existing house that you already own. So if you were to set up an LLC, complications like financing the quick claim deed, the due on sale clause, the transfer tax, those complications are no longer there. And so the drawbacks are, number one, a minor amount of cost that's associated with registering the LLC and setting it up and maintaining it. And number two, the hassle in terms of paperwork and administration. You'll need to set up a business bank account. You'll need to set up bookkeeping. You need to keep all of the funds separate. Otherwise, of course, the judge could potentially pierce the corporate veil. So you'll want to make sure that you have all of your paperwork and your systems in place so that you can defend that this

is a legitimate LLC. So for your Airbnb enterprise, the drawbacks of setting up an LLC are minimal. That said, however, you know, we've explored the cons and those cons are minimal. That said, I don't know how much benefit you're going to get either. I don't know what those pros are. Again, I personally would certainly prioritize having an umbrella liability insurance plan. In terms of the benefit, if having an LLC for your Airbnb room gives you added protection with minimal drawbacks, then why not? But again, this goes back to what goal are you trying to achieve? What is the purpose of having an LLC? Are you asking this question because you want a structure that will allow these funds to be kept separate from your personal funds?

Because if so, then yeah, this is a fantastic. solution for that goal. Are you asking this question because you're concerned about liability and you're concerned about getting sued? Because if so, this is one of many, many options that are out there on the table. And again, I have to give the disclaimer, the irony in all of this talk about liability reduction. I've got to give the disclaimer that absolutely none of this is legal advice, consult with a legal professional before you do anything. Like, this is absolutely not professional advice whatsoever. this is for entertainment value only. So those are all of my various disclaimers.

I want to give a shout out to Bluehost. If you're interested in starting your own blog, check out Bluehost. They're a company that offers hosting, which is basically the term for the space on the internet where your blog lives. Absolutely fantastic if you are getting started as a blogger and you need hosting and a domain name. You can learn how to set up a Blue Host account in five minutes or less by visiting a afford anything.com slash start a blog, where I've got a full set of detailed instructions, step-by-step

guide, including screenshots of every step along the way, plus a YouTube video. Check that out, afford anything.com slash start a blog. Our next question is about real estate investing clubs. Hi, Paula. Thanks for all the great work you do. I'm really enjoying your podcast and can't wait for your course to come out. As I've been learning about real estate investing, I've come across a couple of real estate investing clubs or memberships where the organization pulls together nationwide services like contractors and property management companies and they provide those services either free to the user like or the investor and then the service give provides a kickback to the organization owner so it appears to be free for people to use but

it also feels a little too good to be true because they provide a lot of insights and various different tours where you can go and see new neighborhoods and buy in these neighborhoods and see things on site. It just feels a little bit too good to be true, but maybe I'm being too skeptical. I'm wondering if you can provide any insights on experiences you may have had with these organizations and whether or not you would recommend them or anything to look for in terms of red flags when evaluating a membership like this. Thanks so much for your time. I really appreciate it. Interesting question. So here's the thing. As you mentioned, many of these organizations get commissions from businesses that they refer clients to, businesses that they refer business to.

And what that means is that they're not necessarily issuing the reference because they believe that they provide the best service for investors. They're issuing the reference because they have a stake in the game. Now, what does that mean for you? It could go either way. It could be that the companies that they're referring you to, the contractors and, you know, those businesses and those workers, it could be that they're great and that they work with a lot of investors and they, you know, do their job well. Or it might not be. Frankly, I don't really see the difference between using some company or contractor whom they recommend versus one that you find on Angie's list or one that you find just generally from contacting a bunch of other investors in your

community and inviting them out for coffee and then asking them who they use. Regardless of which way you're going, you know, if you're using Angie's List or word of mouth or reading Yelp reviews or getting those recommendations from clubs and organizations, I mean, regardless of what methodology you use to choose whom your third party vendors and contractors are, it's still ultimately up to you. to do your due diligence, to get multiple quotes, to see how well they seem to understand the scope of work, to suss out whether or not the recommendations that they're giving you are the type of recommendations that would be suitable for a buy and hold investor, as opposed to, you know, the recommendations that a

contractor would give to a primary homeowner, an owner occupant. I guess fundamentally what I'm saying is that it's up to you to have judgment about the situation. And so I'm not sure what you're really getting by joining a real estate investing club. I mean, sure, you get some networking opportunities, right? You get to meet with other investors, wholesalers, just lots and lots of people who are in the industry, some of whom are smart and knowledgeable and wise, some of whom are shade. You know, like in any industry, you get all kinds. Real estate is no different.

So you'll get to network. You'll be exposed to all kinds of people. some will be great, some will be neutral, some will be red flags, big walking red flags. And yeah, and that's what you're getting. You're getting that networking. You're getting that exposure. Personally, just if you'd like to know more about me. So my experience of it, there was a group in Atlanta, Georgia, called Georgia RIA, the Real Estate Investors Association, R-E-I-A. I went to a few of their meetups. And honestly, in my personal experience, and I'm not saying that this is true of all Maria, groups, but the meetups that I went to were just sales pitches. They just had some guru come and pitch a seminar, like just pitch a seminar, basically, was really what happened. And I remember after going

to a few of those thinking, wow, why am I wasting an entire evening of my life just sitting through a sales pitch? This is not what I want to be doing. So I stopped going to their meetings, but the one amazing thing that I did get from that is that I learned about many of the subgroups that formed one of which was a subgroup of investors who specialized in a particular section of Atlanta. And what these investors would do is they would, most of them were flippers, most of them were not buy and hold rental owners. But what they would do is they would purchase a house that was almost always a fixer upper. And the whole group would get to tour that house beforehand so that we would all go and we'd see the before. And then that person who is typically a flipper would renovate the property and then invite us all.

back and we would tour the house and we would see the after. And that was absolutely invaluable because I was learning a lot about how to renovate a property at that time and, you know, getting to see those real life before and after examples as well as meet the people who were doing that. That was fantastic. So I guess the point of me telling you that story is that the benefit that I got from going to those organizations, going to a real estate investor club, wasn't the organized meeting itself. It was a almost informal, not exactly informal, but it was, you know, it was a breakout subgroup that came from that, where I found the biggest benefit for me. And I guess the broader point that I'm trying to make is that give it a try. Like if you,

you know, if there's an organization out there that you think you might want to join, and this is regardless of whether we're talking about real estate or any other industry, if there's a group that you think you might want to join or a conference that you might want to go to or a class that you might want to take or whatever, give it a try. And if you like it, then stick with it. And if not, then drop out, you know, ask for a refund or move away for, like, you know, stick with it if it works for you and don't if it doesn't. But just remember two things. Number one, fire fast. In other words, if it's not working for you. don't waste too much time on it.

If you go there and you give it a try and it's just not jiving, you know, move on. And number two, use your judgment because there are a lot of people who will say a lot of things and it's up to you to decide whether or not that whether or not what you're hearing is actually going to push you in the direction that you want to go in. And, you know, that's true of every, that's true of this podcast as well. Don't listen to something just because I said it. Use your judgment. By the way, this is kind of a tangent, but on the topic of using judgment, one thing that I've come to realize is that in almost any situation in which a person is a novice, the biggest risk oftentimes is when you don't know what you don't know.

For example, I just bought a camper trailer. Cool. 15 foot single axle, I think are approximately 1,250 pounds, factory weight. I'm totally new to the world of owning a camper. And there's a lot that I need to learn. And I was talking to somebody about this recently, and that person said, well, what do you need to learn? And I started naming specific things. You know, I was like, well, I need to learn how to reverse it.

I need to learn how to back it up. You know, I need to learn how to hook up the propane to the stove. I need to learn. I started naming very, very specific actions. But I realized that the reason that I was naming those specific actions wasn't because those particular specific actions were just the pieces of knowledge I was missing. They are, but it's beyond that. It's broader than that.

The real knowledge that I'm missing is judgment. I don't know what I don't know. Ultimately, I need to be knowledgeable enough about campers that if I were, stuck somewhere in the sand or in the mud and alone, I need to learn how to be able to assess the situation and then deal with it accordingly. That's the level of competence that I ultimately need to get to. And I'm not there yet because I've only owned this camper for about a week and a half now. That's what I mean when I say that I need to develop judgment. It isn't about knowing how a solar panel connects to a camper. I mean, yeah, sure, I need to know that. That's a specific

thing. But it's not about that. It's about being able to have a framework in which I can make my own decisions. And so oftentimes on this podcast, when I'm answering questions about LLCs or about, you know, X or Y or Z, sure, I'll answer the specific question. But what I really hope that you're getting from this is beyond just that specific. What I really hope that you're getting from this is an increased ability to assess situations for yourself and develop the judgment to be able to deal with issues as they come up accordingly. And if I can facilitate that in you, then I've done my job. That's far more important than any specific tactic that I could ever hand you. So with that being said, I'm going to end there. I am currently, as of the time

that I'm recording this outro, this conclusion, I am at the World Domination Summit in Portland, Oregon. And I've just finished giving a three-hour-long workshop on how to afford anything, which admittedly is an audacious claim. But, you know, I think the workshop went well, despite its title. And I would love to share that with you. So coming up sometime in the next, I don't know when, I will, I don't have a recording of the talk that I gave, but I will go through the slides. I'll put the slides on YouTube and I'm going to record myself. talking through that. So that's going to be available at some point in the future, hopefully the near future, because hopefully I'll get my act together. But in the meantime, I, yeah, just WDS is great. This is a

fantastic conference. So I'm very excited to be here. Back in 2012, I tried to get a ticket to come here. I was a brand new blogger. I tried to get a ticket. It was sold out. And I remember being very upset that I couldn't go. It was a huge disappointment. And now, fast forward five years, And this is my first time attending this conference, and I'm here as a presenter. And that, it blows my mind a little bit. Like if the 2012 version of Paula could see me now, man, she wouldn't believe it. And I'm not just, I'm not saying this to pat myself on the back. Well, I guess I kind of am.

But I'm saying this because, you know, I do in part feel a little bit of imposter syndrome. Like, wait a minute, I haven't changed. My audience has grown, but I fundamentally am the same person who I was, years ago. Hopefully I'm a little bit wiser, hopefully I'm a little bit more mature. But I think a lot of imposter syndrome comes from this understanding that, like, you haven't changed. It's just that other people's perceptions of you have. And that's something that I've been grappling with while I'm here. So that's one of the reasons that I share that story. And another reason that I share it is to offer some encouragement to anybody out there who is at the beginning of any journey, whether you're

a beginner blogger, a beginner podcaster, you're a beginner entrepreneur, you're starting a new side hustle. Everybody starts somewhere. And as tempting as it can be to overestimate what we can do in a day, we often underestimate what we can do in a year or in five years. So to anyone there, to anyone listening who's at the beginning of a journey, keep at it. Because yourself, five years from now, will look back on yourself today and just and be floored. So thank you all so much for listening. It's been such a pleasure to chat with you via the magic of the internet and the magic of the podcast microphone. If you enjoyed this podcast, please go to your favorite podcast player and leave us a review.

Those reviews are super helpful. Tell your friends, subscribe to the podcast. Check out our YouTube channel, YouTube.com slash afford anything. on Twitter at Afford Anything, Facebook.com slash Afford Anything, and Instagram slash Paula Pant. My name is Paula Pant, appropriately enough. Thank you so much. Have a great week. So before I record, I do these vocal warmups.

And of course, there are the normal things to say, like, how much wood could a woodchuck, chuck, if a wood, could chuck wood, and she sold seashells by the seashore. But one thing that's happened as a result of doing these vocal warmups is that now I listen for unusual phrases that I adopt as new vocal warmups. So, for example, I've picked up Costco can of clam jam, Costco can of clam jam, Costco can of clam jam. It's hard to say. Try it.

Try it five times fast. And the latest one that I picked up is superbly palatable. Superbly palatable. If you want to, if you're a podcaster and you want to check how well your PB filter is working, indubitably palatable. Superbly palatable.