LLCs are often used in real estate investing to eliminate personal liability for investors. Learn more about this and other benefits of using LLCs to invest in commercial real estate.
The dictionary defines liability as, “the state of being responsible for something, especially by law.”
Restaurant owners can be held liable for food that makes their patrons sick, doctors can face malpractice liability from suboptimal outcomes, and even attorneys can be sued by their clients if they aren’t satisfied with the representation that they received.
Let’s face it, we live in a litigious society. The last thing anyone needs or wants is investments that bring them more liability.
Unfortunately, we’ve seen many inexperienced real estate investors do just that. Unnecessary liability can be introduced through ill-advised practices like:
- Holding title in your name
- Obtaining full recourse lending
- Deferring maintenance
- Failing to remediate environmental hazards
- Employee discriminatory practices
- Violating tenants privacy
- Failing to comply with federal, state, and local housing laws
One of the many advantages of a limited liability company when investing in real estate is the elimination of personal liability. In the event of a lawsuit, the LLC is held liable, not the investor.
Investing and Management Practices that Reduce Liability
First and foremost, liability is significantly diminished when you bring the excellence of execution to your daily operations. It’s important to find real estate investing professionals who do this for a living. You don’t want weekend landlords, dabblers, or holders of a hodgepodge of unrelated assets.
Focus is key here. You’ve probably heard the phrase, jack-of-all-trades, and master of none. That’s a problem when it comes to investing in real estate. Learning by trial and error in this space is expensive. You want to know that when you’ve invested in real estate, you’ve invested with an expert who does this for a living. It should be someone with deep industry knowledge and experience. Anything less is putting your money at risk.
And because real estate is a team sport, their in-house team members should have expertise in acquisitions, operations, and disposition. They should also have affiliated partners such as attorneys, property management, brokerage, CPA’s, and others who are connected to the target market and are industry leaders in their respective fields.
Since all real estate is local, an extensive understanding of the state and local markets they target is crucial. Reducing risk means investing in markets with favorable landlord tenant laws and properties without the added environmental risks of lead, asbestos, and other potential hazards that can render a property difficult to keep full and unable to resell.
Even the debt one secures on a property matters. Investing in safer asset classes like multifamily real estate and having the requisite track record to qualify means that one can enjoy non-recourse debt. This matters because with non-recourse debt, the lender gives up the right to hold the owners personally liable should the property default. That means they can’t come after any of the investors or their assets in a worst-case scenario. Working with a top-notch syndicator with strict underwriting guidelines makes such a scenario incredibly unlikely. But nevertheless, why take the extra risk of full recourse lending if you don’t have to?
How LLCs Eliminate Personal Liability for Real Estate Investors
To remove the legal liability, the best commercial real estate investors use a certain legal structure, known as an LLC, to hold the property. As the name implies, a Limited Liability Company (LLC) is a powerful legal tool for limiting liability and is often used by real estate syndicates to allow investors to engage in fractional investing. In fact, our investors are owners in the LLC and as such are referred to as “members.”
LLC law specifically stipulates that no member of the LLC is personally liable for the obligations of the LLC. Therefore, a member cannot be sued in connection with any matter concerning the LLC. That law shields our investors from legal liability just as non-recourse debt shields them from debt liability. It’s good to know that you are safe from liability when you invest with us.
Another advantage of a limited liability company is that they’re taxed as ‘pass-through’ or ‘disregarded’ entities, which means that any capital gains or income generated by the LLC is ‘passed through’ to the owner or members of that LLC. The ability to report the LLC’s profits and losses on personal tax returns can easily result in a hefty sum of tax savings every year.
In contrast, a regular company is taxed first on its net income and then again on dividends when distributing profits. In the realm of real estate, an LLC allows owners to avoid double taxation on rental income and property value appreciation.
Other Benefits of Forming an LLC for Real Estate Investing
While eliminating personal liability and reducing taxes are the two major benefits of starting an LLC, there are numerous other advantages that can be utilized by smart investors.
An LLC’s operating agreement allows for a lot of potential flexibility when it comes to the distribution of profits to its members.
Unlike other corporations, LLC’s can be managed by its owners or even third parties.
With an LLC it is possible to pass real estate onto heirs without executing a new deed, and more importantly, avoiding the taxes and fees that come along with that process.
The Importance of Adequate Insurance
Now how do we keep the business safe? After all, there is no ironclad failsafe method that can prevent a business entity from being sued. I don’t care if you are Coca-Cola, Apple, Disney, or General Motors any company can be subject to litigation. This is why it is critically important to follow a set of business best practices.
Any business worth its salt minimizes its liability through excellence of operations, strict adherence to applicable federal, state, and local laws as well as maintaining relationships with highly qualified and competent legal counsel.
And of course, every business entity, regardless of the industry they operate in, is wise to carry adequate levels of insurance. Certainly, you wouldn’t operate a vehicle without car insurance or own a house without having homeowners insurance.
In our world, we carry a slew of insurance that includes things like commercial property coverage, general liability insurance, business interruption or loss of income insurance, as well as commercial umbrella insurance.
37th Parallel Members Are Free From Personal Liability
By taking a conservative, professional, proven business approach to apartment investing, we create investments free from personal liability for our investors. Furthermore, just like any other top business, regardless of sector, we utilize best-practice standards and robust insurance to minimize the company’s liabilities.
You can sleep well at night knowing that your money is invested in high-quality commercial multifamily real estate with professional asset managers who have eliminated all debt and legal liability for you.