"Should I put my property in an LLC?" is one of the most common questions. There is not a simple yes or no answer.
So I've got two experts here with me today:
- Joe Massey, Senior Loan Officer at Castle & Cooke Mortgage
- Peter McFarland, Senior Business Advisor and lawyer at the Business Innovation Group
We discuss the three main ways for putting properties into LLC's:
- Get a loan in your name and hold the property in your personal name
- Get a commercial loan in the name of an LLC
- Get a loan in your name, and after closing, transfer title to an LLC.
We discuss the pros and cons of each option. Plus we go down some rabbit holes to dive into the details.
Listen to the podcast, watch the YouTube video or read the transcript below (there are some transcription errors!)
Connect with the Presenters
Finding properties: contact Chris Lopez at chris@Denverinvestmentrealesate.com or schedule a consultation with him to create your investing strategy.
Lending: contact Joe Massey at email@example.com or (303) 809-7769
Legal and entity creation: contact Peter McFarland at firstname.lastname@example.org or (720) 922-1120.
Chris Lopez: Hey, everyone. Chris Lopez here, and today we're doing a short educational segment on one of the most common questions, and that is, should I put my property in an LLC? That's not a simple yes or no answer. There's a lot of pros and cons and a lot of things you've got to take into consideration. I've got two experts here with me today to talk about those pros and cons and things that you need to keep in mind. The first is Joe Massey, who is a Senior Lender at Castle & Cooke, so Joe, good morning.
Joe Massey: Good morning, Chris. Always great to see you.
Chris Lopez: My second guest is Peter McFarland, and he's a lawyer at The Business Innovation Group. Good morning, Peter.
Peter McFarland: Hey, Chris. Hey, Joe.
Chris Lopez: I think the best way we'll go through in doing this is there's basically like three ways people can go through or three options they have when they buy a property, and we're assuming that you're buying a property with a loan to finance it, because that's where things get more complicated you want to talk about.
Option #1: Get a loan in your name and hold the property in your personal name
Chris Lopez: The first option is to get the loan in your name and then hold the property in your personal name. Joe, talk about the loan set on that.
Joe Massey: Sure. Pretty straightforward. This is the way all of our financing works for residential mortgages. Chris, you come to me, you want to buy a property, great. I'm going to ask you some personal questions. Where do you live? Where do you work? Your personal name. You take title in your personal name. We close on the loan in your personal name. A lot of people get nervous about that because you're assuming all the risk. If someone falls, gets hurt, whatever, you're assuming all of the risk in your personal name.
Joe Massey: Now, as a lender, we need to have this loan in your personal name because we're giving you the loan. What I recommend in that situation is that you get a large insurance policy, an umbrella policy for greater than the value of all of your personal assets. Make sure you're working with your insurance professional on that, and that's going to help cover you in one of those instances. Pretty traditional route, pretty normal.
Chris Lopez: When you're talking about financing, you're talking about the traditional 30-year conventional FHA…
Joe Massey: Just a regular [crosstalk 00:01:54] 30-year fixed rate loan, investment property, et cetera. Yeah, just a regular mortgage just like we do all day every day.
Chris Lopez: Peter, I'm going to pump this over to you because the L word of liability came up. What are the considerations there from the legal liability aspect if I'm buying a loan in my name and I'm buying a house in my name and keeping it in my name?
Peter McFarland: Well, I think liability really is the biggest drawback here from a lending perspective, and not to put words in Joe's mouth, I think it is by far the most straightforward to do this. The problem is is that when you come to liability protection, you are relying 100% on the insurance company. There's gaps in coverage, for instance. Different policies will cover certain types of harms but then there's outs for the insurance company in certain areas for certain types of harms or dollar limits or other things that you have to keep in mind.
Peter McFarland: Also, the question of, how much insurance is enough insurance? Different types of harm may carry different levels of liability, different amounts of potential judgments, and also depending on what your portfolio is valued at, you need to think about how much insurance do you really need to be carrying. That's a really difficult question to answer is how much insurance is enough insurance.
Peter McFarland: If you're going to go the route of insurance, you're in some ways leaving yourself a little bit more open than some of these other options, and the main other option that I would consider would be putting it in an LLC, which of course is now going to complicate the discussion and particularly from a lending perspective. What you've done by just adding an LLC into the mix has now created another layer of protection and [crosstalk 00:03:45]-
Chris Lopez: Well, let me cut you off here, because that's [crosstalk 00:03:46]-
Peter McFarland: Absolutely.
Chris Lopez: That's going to dive into one of the other points, and I know that gets into very interesting discussion there because I'm going to just [crosstalk 00:03:52]-
Peter McFarland: I'm trying [crosstalk 00:03:52] to give you the segue way here.
Option #2: Get a Commercial Loan in the name of an LLC
Chris Lopez: Well, perfect. You set me up. Before we dive into that, talk about another option because this is a more straightforward one and that is getting a commercial loan from a local bank, and then they will lend directly to the LLC. I can start my 123 Main Street, LLC, go to First Bank or whatever other local other ones and they will loan to 123 Main Street, LLC.
Chris Lopez: Joe, going back to loan side, tell us what a commercial loan is and that brief process what those terms are like, and we'll talk about the LLC.
Joe Massey: From a high level, if you're getting a regular mortgage from me, it's in your personal name, you're getting a commercial loan, that bank is going to lend directly to the LLC. Now, this is not something that I personally do any longer, but I've done it in the past. I was a commercial lender for a number of years, and the difference is you're going to see the loan is to the LLC. The bank is going to want to see some history on the LLC, cash flow. Is it a brand new business? What is it? They're also probably going to have requirements for larger down payment, shorter amortization, likely a variable rate, and likely a higher interest rate.
Chris Lopez: Those four bullet points, go back and give some examples if you can. Higher down payment, what are we looking what?
Joe Massey: Higher down payment, you're probably going to need a minimum 25, maybe 30%, depending on the history of the LLC. Shorter amortization, most commercial loans are going to be 20, maybe 25-year term, best case but it's certainly not going to be a 30-year fixed period. Usually going to be fixed for three to five years, whereas a mortgage like you get with me might be fixed for 30 years.
Chris Lopez: Start with the fixed rate, so three, five years, what happens after those?
Joe Massey: It generally becomes adjustable and can begin to change. There may also be a balloon at the end of three or five years and you have to refinance out, so that's where you would want to talk with your commercial lender, and then fourth, higher interest rates. Interest rates on a mortgage are always going to be your lowest cost of borrowing money, whereas a commercial loans, higher risk for the bank because they don't have you personally liable, personally on the hook, so they've got to make up for that risk by charging you a higher interest rate, which could be anywhere from a half to 1 to 2% higher than a traditional mortgage.
Joe Massey: Those four points combined equals a higher monthly payment and thus less cash flow in your pocket, but it comes with a super big positive, liability protection. Right, Peter/
Peter McFarland: Yeah. Thank you, Joe. Absolutely, yes. Really, when advising my clients, I always bring up this option because there's no kind of best approach here, but in my opinion, this is a really good approach and the huge positives of the liability protection kind of outweigh some of the negatives that you're talking about, the higher rates, the higher payments, whatever. This approach to me, it really is worth considering because now you've paired your liability protection not only with insurance, but now you have this layer of the LLC.
Peter McFarland: The LLC is giving you what they call the LLC or the corporate veil, and so if somebody slips and falls or there's a harm there, what they're going to do is they're going to sue the LLC rather than you personally, and so the assets of the LLC may be open for judgment, up for grabs so to speak by that tenant, but they're not able to pierce through that LLC and reach to your personal assets, your personal residence, your car, your retirement plan, whatever it may be.
Peter McFarland: Now, insurance is out there. There's potentially easy settlement money, whatever, but now you also have this barrier, and then you're better in compliance I guess, and this gets into our maybe next point, but you're better in compliance with what the lender is looking for-
Joe Massey: That's right.
Peter McFarland: And so liability also then from the standpoint of you as the borrower flowing to the lender is mitigated as well because the lender knows what you're up to and has underwritten the loan with the LLC in mind.
Joe Massey: That's right.
Option #3: Get a loan in your name, and after closing, transfer title to an LLC.
Chris Lopez: Great, and that brings us to option three, which is a blend of those two, which is getting a conventional loan through Joe or another conventional lender that's a 30-year fixed rate in your name, and then after the property closes, you can quitclaim the property into an LLC.
Chris Lopez: Joe, what potential issues are there?
Joe Massey: Sure. The first thing I've got to say is I work for the lender, so I have to represent what are the lender's interests, so I want to be clear on that, but I also know what happens in the real world. When you close on the transaction, in the note and in your deed of trust there's what's called a due-on-sale clause, and what that clause says is that if you transfer the property to another person or another entity, we the lender reserve the right to call that loan due, which for anyone that's not familiar, that means that we call us and say, "Hey, you borrowed $300,000, we want it all back right now." We basically expedite the foreclosure process because you've transferred the property.
Joe Massey: Now, you have the right to do that. You have the right to transfer that property because you own the property, but we the lender have the right to call that loan due when you've transferred it without our knowledge and without our consent.
Chris Lopez: Just to clarify, you used the word "quitclaim", and that is actually just a common way to basically quickly take the name from Chris Lopez and transfer it to an LLC at 123 Main Street, where it actually you don't have to go through the whole sales process and it's just some paperwork.
Joe Massey: Exactly. You're just transferring it to your LLC that you own.
Chris Lopez: Now, Peter, going back to we're in an LLC option, what are the pros and cons?
Peter McFarland: Well, before I get into that, I may also suggest looking into and talking to your attorney or title company or whoever you decide to accomplish that transfer because quitclaim is probably the most common way that I see this done, but I actually don't draft quitclaims. I draft warranty deeds, and the reason is because your title insurance is actually a lot cleaner that way-
Joe Massey: That's right.
Peter McFarland: And it doesn't create potential clouds on title in the future. Look at your options [crosstalk 00:10:01]-
Joe Massey: Talk about that for them because this is new for me, so I just assume everyone quitclaimed because I've never done this personally. Talk a little bit more about that.
Peter McFarland: Well, sure. In Colorado, we actually have several different types of deeds. The most common that we see are quitclaim deeds, special warranty deeds, and warranty deeds. Quitclaim deeds, basically what you're saying is, "Whatever interest I own in the property, it is now yours." I could actually give you… it would be perfectly legal for me to give you a quitclaim deed for my interest in this building. Now, I don't own anything in this building. I have no ownership interest in this building, but I actually could do that because what I'm saying is, "Whatever my interest is", which is zero, "Is now yours." There's that.
Peter McFarland: Special warranty deed, basically there what I'm saying… well, we'll start with the warranty deed, actually. The warranty deed, what I'm saying is that I actually have good title in the property, that I actually own it. There are a lot of warranties that you make, but that's really the biggest one is that I actually have a claim to ownership in this property. Special warranty deed is backing off a little bit from that, and basically it's saying, "Look, I have good title in this property, but I'm not really sure what happened with an easement kind of back 20 years ago or something", and so I'm telling you that I have good title to this property but there's this one thing I'm not really sure about and you should be aware of it and I don't make any kind of claims or anything related to that issue.
Peter McFarland: There's kind of a way to back off of that, but at any rate, if you go with the warranty deed, your title insurance is much happier because basically… subsequent purchasers are actually much happier as well because what you have is a continuous chain of all of these warranties going back to all of the prior owners and everybody kind of lining up in a line says, "I have good title to this property. There is no encumbrances that I'm aware of that you're not aware of. That there's nobody else that's going to claim that they own this property and you can trace that back for years and years", and in some cases generations like all the way back to when the State of Colorado actually owned the piece of property. That just makes the chain of title much cleaner and much better.
Chris Lopez: Gotcha. This is good. Let's just say I get my loan through Joe and I talk with you, so you can tell me… help me figure out what way I want to transfer title from my name to 123 Main Street LLC, and then what are the pros and cons to doing it that way from a liability standpoint?
Peter McFarland: Well, from a potential tenant, your liability is not necessarily any weaker. A real common question that I get, and we were talking about it a little bit before this, is, "Okay, if I do the transfer, is that a way for somebody to pierce through my LLC veil?" Chris, you brought that up earlier, and the answer there I think is still no because what we're going is kind of looking at the totality of the circumstances and looking at all of your LLC and all of your corporate formalities. If you've done everything else you're supposed to do, for instance, you have a dedicated business bank account, you haven't co-mingled your bank account. You're really good about holding your annual meetings and you keep minutes. You've never let your LLC go on administrative dissolution with a secretary of state. You continually file your periodic reports. You kind of live up to all of these formalities.
Peter McFarland: That's going to kind of counterbalance any other kind of "failing" of your formalities. I think this one particular transfer is such a tiny little detail relatively speaking in the life of the LLC, but also the other really important things that an LLC should be doing that, but I don't really view it as a really big problem. That said, you do still have liability. The difference is that the liability is not to your tenant because your tenant is now on the other side of the LLC veil. Your liability is to the lender-
Joe Massey: That's right.
Peter McFarland: And that's because you have done this transfer that Joe mentioned and you are in violation of that due-on-sale, due-on-transfer clause. It's a matter of kind of… when you're balancing the different approaches, it's a matter of weighing your liability and kind of looking at, who are you liable to? In my opinion, that's why I always bring up that second approach that we talked about where you actually have the loan underwritten in the name of the LLC because it may be more expensive, but to manage your liability really in that complete sense, it's almost the best option because now you're not open because you've engaged in this transfer.
Chris Lopez: If you use this third option, I'm getting the loan in my personal name and then transferring title to the LLC, it really limits my liability from a tenant from a personal standpoint, and assuming I do all the usual stuff you're supposed to with LLCs and S corps and that kind of stuff, I do that stuff correctly, I'm very well protected. Now, kind of going back to I've got my liability more opened up to the lender, what are the downsides to that? Joe, you mentioned… I understand I am violating the contract I signed with the lender-
Joe Massey: That's right.
Chris Lopez: And you guys find out about it. Do you foreclose on me in a day? Am I able to possibly refinance? Or do you even know?
Joe Massey: Sure. The reality, this happens a lot and the way I describe it is everything is okay until it's not okay. You transfer the property to your LLC, you continue to send us a check every month. To be real frank, we're probably not looking. We're probably not paying attention as long as we get a check every month. Let me tell you when there becomes a problem. All of a sudden, we stop getting checks in the mail. Something has changed in your life, you're not making payments on it anymore. We're going to start looking at that loan. "Hey, what's going on?" We're going to do some research. "Hey, wait a minute. This property was transferred two years ago to an LLC. We need to call this loan due right now and exercise our foreclosure rights before this gets any further down the rabbit hole."
Joe Massey: In my experience, I've never had a loan called due because of a transfer to an LLC, but again, like I said earlier, I work for the lender. I can't tell you that it's okay. I have to tell you that there is this clause and we have the right to do it. I think your liability is probably limited to your ownership of the property and the amount of the loan. From a liability standpoint, think about that. If you have the ability to pay that loan off in full, okay. We're going to call it due and you send me a check for $300,000. Cool, we all wash our hands. We'll see you later.
Joe Massey: You don't have the ability to pay off that loan or you don't have the ability to refinance it, that's where that can become a very big problem, and even though that LLC may now own it, you are still personally liable on that loan. We're going to foreclose, go through all of those processes, and that's going to create issues on your credit, your future ability to get a loan, et cetera.
Chris Lopez: Let's say I do the same thing as committing loan fraud where I say… we talk about house hacking where I'm going to buy a house as a personal residence. I'm going to move in there and I've heard of people where they say, "Oh, I'm living in there [crosstalk 00:17:08]-
Joe Massey: But they're not [crosstalk 00:17:09]-
Chris Lopez: But they really don't, and that's a big no-no because that's loan fraud. Is that same level of fraud? Or do you even know?
Joe Massey: I'm not an FBI agent, so I don't know. I don't know. I wouldn't say that it's necessarily fraudulent, but I'd say it's outside the terms of the contract that you agreed on with us.
Question: Does Hiring a Property Manager Limit my Liability?
Chris Lopez: Peter, I've got a couple of more questions for you because we're talking about liability here. How does it work? I buy my property? I get my loan, trans the property to my LLC title. I've got two options. I can hire a property manager or I can self-manage. I'm assuming if I hire a property manager that keeps things on… helps the liability up and up. If I self-manage, what type of liability risk does that add in there because I'm now self-managing the property?
Peter McFarland: That's a really good question. I think… trying to think the easiest way to answer this. Basically, when you're looking at civil liability, which is what we're going to be looking at with any kind of I guess what we call tort lawsuits. Torts are just kind of a fancy legal way of saying like a personal injury or for some reason you owed a duty and for some reason you didn't live up to that duty. You kind of have to split where your harms are coming from and what hat you're wearing when the harm actually arises because if there's a problem say with the underlying property, there was a dangerous condition for some reason in the yard that you didn't mitigate and your tenant for some reason falls into that harm, that liability is going to come to you as the property owner, as the landlord.
Peter McFarland: I guess when I say that, really the property owner, not necessarily the landlord. If the harm comes in how you're dealing with the tenant, if there's a problem with collecting the rent and you go over there and for some reason there's a problem with say the management or kind of the act of being the landlord and dealing with the tenant, then you're going to get sued kind of as that active landlord. Does that kind of make sense? That distinction?
Chris Lopez: It does. Let me ask you a nuanced question here because I remember we actually had this 4-plex in Englewood on contract. Did the inspection. We ended up not closing the property, but there was a… I'm not kidding, there was a big old hammer laying on top of the roof, and it was like one of those big 20 oz. hammers, that big framing hammer-
Peter McFarland: Oh no.
Chris Lopez: And we were in there. One of the tenants said, "Hey, can you get that removed", thinking we were the current owners or property managers. We said, "No." Let's say I buy my property, transfer to an LLC. I'm self-managing. If the tenant says, "Hey, there's this harm out there Mr. Landlord, Mr. Property Manager", and I don't address it and then something bad happens, I'm assuming me as a landlord will get sued and the property will get sued because that's just bad all over the place.
Peter McFarland: Yeah. Well, the distinction I was setting up before was kind of [crosstalk 00:20:09]-
Chris Lopez: I probably just went down a rabbit hole.
Peter McFarland: Well, no, no, no. It's actually good because it's good to use examples. I think it makes them more concrete. The distinction I was making before was going to kind of point back at what it looks like to actually have a property manager. Let's use your example, but let's keep kind of that distinction in mind. If it's you, you're the property owner and you're the property manager and you don't move that hammer, frankly as the attorney representing the tenant, I'm going to sue anybody and everybody and just see what sticks. Then, it's going to be on you to put up the affirmative defenses and say, "I'm not the proper person to be sued here. Really, you should be looking at the other guy." Well, in this case, there is no other guy, it's just you.
Joe Massey: You're the other guy.
Peter McFarland: Exactly. There's not really any way to shift that harm or shift the liability or argue about who owed an affirmative duty to the tenant to make sure that that was a safe place to be and the hammer wasn't there and whatever else. If you have a professional property manager on the other hand, you as the property owner… let's take the example a little bit further and say you didn't put the hammer there, you didn't even hire the contractor who put the hammer there, the property manager did because there was a repair that needed to be done or whatever.
Peter McFarland: The question would be, okay, I come as the attorney. I sue you and I sue the property manager and I'm just going to see what sticks. You guys can argue it out between yourselves, actually, and say, "I'm the property owner here, but I hired you to take care of this stuff. What's your problem? You didn't vet this contractor who left this hammer up there? The tenant comes to you and tells you this thing is up there and you didn't remove it? What's that about?" Then, you make the argument and say that you owe the duty, you're the one that needs to be sued here. You need to make good on this harm, and then you make that argument to the court and say, "Judge, dismiss me. I'm the property owner, sure, but actually this is such a gross kind of negligence thing that I had a contract with this property manager over here and the property manager was supposed to take care of it."
Peter McFarland: You make those arguments, and the judge may agree or he may not, but that may be a way for you to say, "Actually, I'm not on the hook here." That actually somebody else is on the hook.
Chris Lopez: It's always been my assumption… I'm going to ask the real expert, the lawyer. Does having a professional property manager help limit liability to me the property owner?
Peter McFarland: I think the short answer is yes, and the reason is because a lot of the client facing and the potential harms that's going to come out of… I say client-facing, tenant-facing, a lot of the potential harms that are going to come out of dealing with the people who are actually living in your property, that's all going to flow back to the property manager. Now, you as the property owner, ultimately you're still probably on the hook for many things. I don't know how far. It's going to depend on what the harm is and the judge and what mood they're in and a lot of other things when you make the argument that you should be dismissed whether you ultimately will be.
Peter McFarland: Even if it goes forward to say a civil lawsuit, you might have a jury and it's really common for a jury to actually assign percentages of liability in these tort cases.
Chris Lopez: Oh really?
Peter McFarland: Yeah [crosstalk 00:23:25] and so they may say, "Well, really the property owner and the property manager are liable here, but the property manager probably is 80% liable." There's something like that can happen.
Chris Lopez: That's very interesting, because I'm a proponent of property management. I know Joe is as well-
Joe Massey: I love my property manager.
Chris Lopez: And another reason to like property managers. Guys, this was great. We went over those three options, which are get the loan in your name, retain the property in your name, get a commercial loan that runs directly to the LLC, or get the loan in your personal name and then after closing transfer title from your personal name to the LLC.
Chris Lopez: Are there any questions or final thoughts you guys want to chime in on before we wrap this thing up?
Joe Massey: I'd say there's pros and cons to each one. I think it comes down to transparency. Be transparent with your agent, with your lender, and with your attorney about what you're wanting to do. Follow their advice, understand there's not one size that fits all for everyone, and make sure you understand what you're getting into.
Chris Lopez: That is a great way to sum it up I think. Well, Joe, Peter, thank you. Now, if anyone out there needs help finding the property, which is the fun stuff, you definitely contact me, Chris Lopez at denverinvestmentrealestate.com. Need help with lending, contact Joe, and Joe, how can people get ahold of you?
Joe Massey: You can call me anytime. 303-809-7769. Of course, my website, loansbyjoemassey.com.
Chris Lopez: He'll help you out with boring finance stuff, and then Peter, because people definitely need some legal advice and legal help, how can people get ahold of you in your office?
Peter McFarland: 720-922-1120.
Chris Lopez: What's the best website?
Peter McFarland: Oh, let's go bigprofitsolutions.com.
Chris Lopez: Great, and I'll put all these links in the show notes with the video with the podcast, with the text and all of that. Thank you for listening and we hope this helped you out.
Joe Massey: Thanks, Chris.