Monday, January 21, 2008

Buying an investment property, should you form an LLC?

A reader writes and asks:

My wife, My brother, and I are considering purchasing a multi-unit property to rehab and rent. Should we form an LLC? On the same topic, we will all be cosigning on the loan. Given current market conditions, is there any hope that we can go bigger and only put 10-15% down?

It sounds like a good idea, doesn't it? The Limited Liability Company will indeed protect you from liability - which is always a good thing when owning property that tenants occupy. Liability from lawsuits brought against you would be limited to the value of just that one property - not your total net worth. A definite plus if you own more than a handful of properties. But the LLC presents a few obstacles, too, which can be difficult to overcome.

If you take ownership of your property in an LLC, financing will almost certainly need to be commercial financing. This may mean stringent credit requirements, higher interest rates and at least a 25% downpayment. On the other hand, if you purchase a 2 to 4 unit building in Chicago, and one of you is willing to live in one of the apartments (at least temporarily) you may qualify for conventional financing with lower down payment requirements and interest rates that are customary for home buyers.

In the situation described above, with family members purchasing a smaller investment property together, your interests can probably be protected with much simpler solutions.

Probably the smartest way to go would be to purchase the property as either joint tenants or as tenants in common (depending on how you want the property to transfer if one of you were to pass away) without all the complicated hassles of forming a corporation. Then, take out an insurance policy on the property to cover its damage and destruction for replacement value, and a liability policy for $1-million. Do this for each building you purchase.

Then, add an umbrella policy that covers additional liability against accidents or negligence by you, your employees and your contractors in the amount of another $1-million or more - depending on how much of your net worth you need to protect. The umbrella policy that covers these situations also covers your liability against unforeseen situations that may not even have anything to do with your real estate investments. The best part is that these umbrella policies are usually extremely affordable.

The umbrella policy that covers both Steve and myself for an additional $1-million in liability only costs $200 a year - an outstanding bargain.

Give me a call if you would like to speak with our Allstate Insurance agent here in Chicago about checking out these options for yourself.