Ep. #45 - LLC Obsession... Protection or Paranoia?

So before I started recording this episode, I had to check to see just how many LLC's I have - It's a lot... I've now reached double digits! So am I obsessed with LLC's? Hopefully not, as its an obsession that can waste a lot of money, but more importantly - it can waste your time. So don't become Obsessed with LLC's...

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Intro...

Welcome to Episode #45 - LLC Obsession

So as you start to educate yourself on different aspects of Rental Real Estate Investing, you're certain to encounter the debate on the merits of / the need for an LLC (or multiple LLC's) - to protect you from getting sued in our litigious society.

So let me preface this with an in-episode disclaimer (so that you don't have to wait until the end as normal) - to remind you that I'm NOT an attorney (and I don't play one on TV or here), and so you should seek the advise and console of an attorney local to you on any and all legal matters. Do what they say, as my advise is ultimately worth exactly what you're paying for it.

Now with that said... Far too often, those who are new to Rental Real Estate Investing get hung-up on forming their LLC - before they can do anything else. It becomes an obsession and they can't move forward with anything until their precious LLC is in place.

They are primed to believe (often by those who stand to profit from this belief) - that without a shinny new (and expensive) LLC established to stand as a brick wall in between them and the perceived pitch-fork carrying horde of Tenants (who of course each tripped and fell on their property) - that they will be sued for everything they're worth and end up homeless and crying in the street or gutter or whatever.

So they pay (often far too much) to have their LLC created for them. And with their proverbial brick wall now in place for protection, they now feel empowered to proceed in business. But the thing is... As you get further into things, you'll learn that other than matters of eviction and security deposits - it is exceedingly rare to actually get sued or end up in court as a Landlord. The tripping or slip and fall tenant is largely a myth. It's anecdotal, but I've spoken to several Rental Real Estate Investors at the many events I attend - and I've yet to met one who got ever got sued.

Turns out, its largely a myth that Tenants (or their guests) will slip and fall on your property (fake or real) - and then take you to court. Not that it can't happen, and not even that it doesn't happen (so not full Unicorn status) - but certainly Zebra rare. When some would have you think stampeding horses trampling you on their way to court - if not for the protection of that LLC brick wall of course.

Now know that one of my favorite quotes is... "Just because I'm paranoid, doesn't mean they're NOT out to get me." - so I like to have all the protection I can get (Tenant lawsuits being Zebra rare or not). As long as its not full Unicorn or Bigfoot status (non-existent), then I like having the added protection of an LLC. It just irks me when I see the LLC becoming an excuse (or an unnecessary obstacle) to those starting out trying to get their first deal done or first Rental Property owned and occupied.

There is a place and a need for an LLC in Rental Real Estate Investing. That's why I'm into double digits with the number of LLC's that I have. But I also have a double digit property / unit count. But my first 4 properties (so two full years into the business) - were each purchased directly in my personal name (along with my wife). I had no LLC then - at least not for that.

What I had was a corporation. In 2015 (before I had bought my first property) - I created Blue Chariot, Inc. So Blue Chariot was initially created as an S-Corp, before I knew that was not ideal for holding Rental Real Estate. So I eventually changed Blue Chariot, Inc. to Blue Chariot, LLC - and this became my short-term hold entity (for Flips and Wholesaling and New Builds). I continued acquiring properties, and later I created Blue Chariot Properties, LLC - as my long-term hold entity (for Rental Properties).

So I do now hold properties within entities (LLC's) for liability protection (and other reasons). But to this day, I still have my first 4 properties held in my personal name. And I sleep just fine at night. Why? Because I know that having an LLC is NOT the first line of defense against lawsuits.

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LLC or not, your FIRST line of defense against lawsuits is how you operate your business. A funny thing about human nature... People tend NOT to sue someone they like. That same thing often extends to people they respect or whom they appreciate. Do you know what is the primary determining factor of which doctors are most likely to have malpractice lawsuits filed against them? You'd think it would be determined by the doctor's intelligence and skills. Surely greatly skilled doctors get sued less than doctors of lessor skill - right?

Wrong... Bedside manner is the number one determining factor of which doctor's get sued for malpractice. If the patient likes a doctor and feels that he / she listened to their needs and gave freely of his or her time - that doctor is very unlikely to get sued (even in cases where there was a mistake made and a negative outcome resulted). On the other hand, a disliked doctor is far more likely to be sued, even in cases where no mistake was made.

So the take away from this is that HOW you run your business, HOW you treat people, and the impression people have of you as a PERSON - will all go a long way to determine if you ever end up in court and thereby may benefit from being protected by an LLC in that court. Being liked / respected / appreciated is your first line of defense against a lawsuit. And that all stems from how you conduct and run your business.

And in the Rental Real Estate Business, you can be liked and respected by just having (and sticking to) your clearly established (but also reasonable) polices as to how you handle your properties - and then always treating others kindly and with respect - because you GET what you GIVE.

Want to get a punch in the mouth? You need do nothing more than throw a punch at someone. There are certain negative things you can do or say to another person, that will guarantee a negative response right back at you. The same is true of positive words and actions, although the response is not always as direct and immediate as for the negative. None the less, there is a response, and it will keep you out of court. Again, you get what you give. So if you want kindness and respect, then treat others with what? Kindness and respect.

How I treat people is one reason why I don't worry about getting sued, and its also one of many reasons that my tenants stay for so long. I also have some really nice houses at a fair rent, but who wants to deal with a Landlord who's a jerk? So I'm not a jerk, because jerks end up getting sued. And as far as I know, I can honestly say that I've never done dirt or intentional (even un-intentional) harm to anyone. So my slate is clean and I don't see anyone trying to sue me.

So your first line of protection against law suits is being a good operator. Not having an LLC.

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Your second line of protection is property and liability insurance, including a personal umbrella policy. I won't go too far into these in this episode, as Rental Property, Business and Personal Liability Insurance really deserve an episode (or few) all to their own. But just know that many things which could result in your ending up in court, may actually be covered by one or more insurance policies. So having good (and the right) insurance is a protection that stands in line right behind you as a good operator (and person) - but before your LLC even comes into play.

This is why I'm comfortable having rental properties in my personal name, as I operate my rental business properly - such that I'm good even with people for whom I decided NOT to renew their lease for some reason. And if I ever did have to evict someone (hasn't happened yet) - it will be due to a clear violation of the lease that no attorney would touch, even if by some means the tenant did want to take me to court.

And then you still have yet another line of protection that comes into play BEFORE having an LLC does. And as I see business, assets and debt, that third line of protection is maintaining a low equity position in your properties.

So what does that mean? I run into other Landlords all the time who are to be congratulated for having a rental property (or few). In some cases they may have several - and their laudable goal is to pay them off as quickly as possible. Nothing wrong with that... And you'll even meet those who buy their properties with 100% cash, so they have them paid off from Day #1. Again, nothing wrong with that.

BUT... For me... I'm only in my mid 40's. And while I certainly do want to own free and clear Rental Properties when I retire maybe sometime in my 60's - as why would I retire before then, when I enjoy what I do and I've already been self-employed for 18 years. So until then (God willing), I've got another 20 years or so of income from other sources before I've got to worry about maximum income from my rentals. So for that reason, I don't really care to have them paid off now or anytime soon. I'd rather use my income to buy as many rentals as I can now and in the coming years, instead of using that income to pay off fewer properties earlier.

But back to my point... Owing money on your rental properties is actually a protection for you. If you owe money, then you have lower or less equity. Now you likely started out with a 20% equity position if you purchased with a conventional loan, like most Rental Property Investors. Then as pay-down occurs on one side and appreciation (hopefully) on the other - that equity position quickly starts to grow, to the eventual destination at 100%.

But the lower your equity position, the less lightly an attorney is to take on a case against you when the merits should be questionable (you're a good person and operator - right?) - and the prize for winning is minimal, because you owe a lot to the bank / lender on the property. The lender gets paid first, so even if an attorney could sue you, win and force a sale, they'll have little to nothing left after court costs and attorney fees - so why bother?

On the other hand, if you own this (let's say) half-million dollar property free and clear - that's a nice honey pot for an attorney to go after, even if the merits of the case are questionable. Maybe they can get you to settle to avoid the cost of defense. And this would be true whether you have an LLC in place or not. But protecting yourself with a $400,000 mortgage against that $500,000 property, removes that honey pot - and likely gives you more resources to go buy another $500,000 property or few.

And that for me is where the LLC really comes into play. That is why I have a double digit count of LLC's. If I'm owning multiple properties with values of several hundred thousand dollars each, I do NOT want them all to be held within the same entity or in my personal name.

I use LLC's to limit my equity exposure. I look at the amount of equity present within each property, and I thus segregate those properties into certain entities based upon the total equity present. As result, each LLC is limited as to the amount of total equity present within the property or properties held within that specific LLC.

This is a legitimate use of multiple LLC's, and they are created and held in such a way so as to become "disregarded entities" for tax purposes, but still effective at liability protection. But I cannot stress enough, that I got to this point over the course of many years. I did NOT do what many do who are considering or just starting in Real Estate Investing - which is to agonize over their LLC creation and spends thousands (somethings tens of thousands) on some complex out of state LLC structure. Money they could have used to just buy a property or two in their personal name, and worry about the LLC later.

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And so my final point about LLC's relates to in-state versus out of state. As you start your Real Estate Investment journey, you'll encounter all sorts of information and advice about using out of state LLC's, such as Nevada. I think Wisconsin is another that is often stated as a state with great LLC protection. This gets legal far beyond what I'm comfortable doing here, but certain states limit LLC liability to what's called a "charging order".

And as I understand it, this ultimately means that a person cannot get more out of the company than the owner's themselves get. So if you never have a profit and never distribute a dividend to yourself, then the winner in court of a charging order against your company also gets nothing - or the same as what you take out of the company.

Now that requires an entire debate itself, and you'd certainly want to check your state to see if and what sort of protections they offer for LLC's. But in my state of North Carolina, I didn't see a lot of what's called "piercing the corporate veil" - or in other words, allowing a judgement in court to attach to the personal assets of the company owner, instead of limiting any judgement to the assets of the specific LLC named in any lawsuit.

From my prospective, it appeared that outside of instances of fraud and deliberate misrepresentation by the owner, the LLC protections largely stood solid here in NC. And if so, I see no reason to pay additional annual fees (and possibly taxes) to have out of state entities. Then having to pay North Carolina to register those "foreign entities" here inside the state. This just seems like needless waste, if you follow the first three rules of...

1. Be a good operator (and person)
2. Have Property, Liability and Umbrella Insurance
3. Limit your equity position in each property and within each entity

If you do these 3 things, then (I think) you're fine to operate in your personal name (as I did with my first 4 properties) - until you really do need an LLC. And then, just go with your state LLC process, unless your state really does have a precedent of attaching the assets of the owner even without the presence of fraud. Because you're not going to be committing any fraud - right!?

So Don't get obsessed with your LLC. You're not going to win a prize. And to not move forward with your business endeavors for fear of getting sued ultimately just becomes another excuse not to act. Do you really have that much to lose anyway? I know I didn't when I got started. But hey, if you've got the money to spare, then by all means spend it on an elaborate LLC structure. I'm not really talking to you anyway. I'm talking to everyone else who is just trying to build their empire and I want to remove this obstacle to your even getting started.

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Outro...

Disclaimer