Real Estate Investor
Real estate investors need to consider two levels of protections.
First, protect yourself from suits as the owner of the property related to the property (i.e. from tenants, contractors or others) (“Inside Liability”). Second, you want to protect the value/equity of your ownership interest in the property as a shareholder/member from a creditor coming against you personally, and not related to the property itself (“Outside Liability”).
Most real estate investors own their property through an entity. Corporations don’t protect you from Outside Liability (see Another Example below). LLCs do, but this protection only works if you have an Operating Agreement that takes advantage of all the protections afforded to LLCs and its members by state and federal law. Many agreements either do not contain, or inadvertently waive, some of those protections. If possible, the LLC should be formed in a state which limits the enforcement of judgments to a charging order (known as a Charging Order Protected Entity or COPE) or owned by a COPE.
In addition, an investor should not own too many properties in a single LLC, thus putting the entire group of properties at risk from one complaint. Although you may not want every property owned in its own LLC, there is a balance that must be considered between the cost and paperwork of several entities, and losing your hard earned equity. If you live in a state that offers a Series LLC, this is certainly something to consider.
Even with the protections of entity ownership, investors often leave equity in the property exposed to a judgment by Predator Attorneys. The good news is that we can remedy these issues.
You and your wife own a 15-unit apartment building through an LLC that you bought a few years back for $600,000. You have $175,000 in equity in the property and a loan from a bank of $450,000 which you and your wife have personally guaranteed.
You and your wife also own a small strip center that was purchased for $600,000 through a corporation. You have $175,000 in equity in the property and a loan from a bank of $450,000, which you and your wife have personally guaranteed.
A tenant in each building claims that they slipped on the stairs and have severely damaged their back. A sympathetic jury awards each tenant $2 million. Your LLC/corporation each as $1 million in liability coverage. The insurance company pays off, leaving $1 million in liability against each entity. The Predator Lawyer will most likely record a judgment lien against the property (which will last for 10 years with the option to renew for another 10 years), but often these liens are not foreclosed unless there is substantial equity in the property. The threat is always there and when you sell the building anytime in the next 10 (or 20 as the case may be) years, the proceeds of the sale will go to the judgment creditor, not you.
Not a great outcome, but at least with the LLC or corporate structure in place, the judgment is not against your personal assets. At least you still have your house, car and personal bank accounts.
Had you come to us for advice, most likely the Predator Lawyer would never have gotten the judgment. He would have seen the Barriers we put in place and given up.
Your teenager causes an accident resulting in a $2 million judgment against you and your wife, the owners of the vehicle. You have a $1 million umbrella policy, leaving $1 million in exposure. The Predator Attorney discovers you own the apartment building and the strip center. At first he is excited. However he looks at the apartment ownership and realizes that it’s owned by a COPE. If he gets a judgment against you, all he can do is get a relatively unattractive charging order against your ownership interest in the LLC. He decides not to pursue this. It’s not worth his time and expense.
However, he sees that the strip center is owned by a corporation. You and your wife are the shareholders. The judgment creditor can get a turnover order for your shares of stock. He can liquidate the corporation and sell the strip center and walk away with your equity. Equity which could have been yours with one of our protective strategies.
A corporation is not a good vehicle to hold title to any risky assets (meaning risk of being sued in relation to the activities there), such as real estate. The judgment creditor can get an order to have your shares transferred or turned over to him.
One Last Example:
A judgment creditor for real estate investors is often the lender on a deal gone south. Let’s assume that due to the economic downturn, you have trouble keeping the strip center rented and you default on the loan. Your lender forecloses, sells the property for $300,000 and comes after you for the $150,000 deficiency under your personal guarantee. They know you own the apartment LLC. But since the bank knows they can only get a charging order against the LLC, they don’t pursue it and the property is safe.
Since you came to us for advice, you have also take all the steps for protecting your personal assets (Basic Level Protection), minimizing any effect of this judgment on your family.
If you want to set up Barriers to protect your Nest Egg, click here to Contact Us to set up a free, 30-minute confidential consultation.