Real Estate 035: 5 strategies for Real Estate Asset Protection

Disclaimer: This post is not legal advice, and simply my thoughts when it comes to asset protection and my situation. Please make sure you talk to a qualified asset protection attorney for personalized legal advice.

When it comes to asset protection for buy and hold rental properties, there are alot of differing opinions when you ask experienced investors on various forums and speaking engagements. Many people talk about entity formation, and while I personally also have a structure in place, below are 5 other ways you can protect your investments from the threat of liability:

1. General maintenance of your properties

As a savvy real estate investor, you may be focusing on the numbers when buying, rehabbing, renting and scaling your rental portfolio. However, if you are purchasing properties with a lot of deferred maintenance you may be walking a slippery slope. By becoming a responsible landlord and staying on top of routine maintenance (e.g. removing large trees around foundation, caulking around the bathroom tub, ensuring tenants replace HVAC filters and cleans the gutters), you are taking good preventive measures. Furthermore, doing a thorough job vetting your team such as your property manager, third-party contractors, and real estate brokers/agents will make a big difference in your liability exposure. Some of these parties are an extension of you and your company, and you want to make sure that you are being represented accurately, especially when working on building a portfolio out of state. 

2. Cash Reserves

In order to ensure that you can protect your investments, you need to ensure that you have sufficient cash reserves to cover maintenance and capital expenditures, as no one will know for sure when these may arise. Maintaining reserves is a focal point of many lenders as such, investors who use leverage and borrow to build their rental portfolio may already be carrying a reserve balance. However, generally speaking, since there is no policing or "cash management" of your business by these lenders, it may be easy to start putting your hand into the reserve cookie jar when you think you have a lead on a great deal. It will become more important to stay disciplined and review your balance sheet when your portfolio grows to 10, 20, 30+ units. For example, you may be able to withstand 1 HVAC replacement at $5,000, but if it occurs at the same time across 5 properties, that is $25,000 that you have to account for (and trust me, I have seen it happen to my colleagues). If you have properties that generally have 10-15+ years of useful life on large CapEx items, you may consider reserving less than if you had rentals that have many properties with a roof, HVAC, water heater and plumbing that is showing signs of significant wear.

Reserves not only apply to capital expenditures and maintenance, but also in times of physical and economical vacancy. When the property is physically vacant, it means there is nobody living there, as such you may be paying the mortgage, utilities, and other fees associated with upkeep of the property until a new tenant is leased. In other cases where you have a non-paying tenant, or below market rents, you have an economical vacancy. On top of the mortgage that needs to be paid, now you may be dealing with damages to the property, eviction costs, and other legal fees associated with the turn.

There is no science when it comes to cash reserves, as such you may find investors use a percentage of gross income, or a flat dollar amount per rental unit. As you gain more experience, you will be able to adjust your risk tolerance and create contingencies to ensure that you are prepared for these unforeseen circumstances. Always hope for the best, but prepare for the worst. 

3. Lines of Credit

In addition to having an adequate cash reserve, a line of credit may be a great complementary tool that can protect your assets. As mentioned in previous posts, investors have historically used various financing methods such as a personal/business line of credit or a home equity line of credit (HELOC) to conduct their acquisitions. In the same manner, investors can use an unused line of credit as an emergency line to be used to fund the business on an as needed basis.

Establishing a line of credit can be fairly simple and low cost. Furthermore, they generally have lower interest rates when compared to consumer products such as personal loans and credit cards. Depending on the product, it is generally easy to borrow or "draw" from the line. I personally opened a HELOC for this very purpose and keep a balance less than $5,000. My main use of this line is for emergency funds as I believe in the velocity of capital and putting my money to work in efficient vehicles such as real estate. As such, I am basically taking the $30,000 I would have placed in my savings account and deploying them in my business, while having a $40,000 HELOC to draw down from in case of an emergency.

One very important caveat is that if the market takes a downturn, the banks may choose to "freeze" the lines of credit, and not allow the investors to draw down new funds from the line. As such, you want to make sure that you are not 100% dependent on the line of credit as a safety net and find yourself trapped, if and when the banks decide to freeze the line.

4. Umbrella Insurance

You may have heard of an umbrella insurance to supplement your landlord policy that is attached to each property. An umbrella insurance policy provides protection beyond your primary residence, auto, and even civil lawsuits. A huge benefit of getting umbrella insurance is the affordability compared to the comprehensive coverage it provides. For example, investors have typically been able to get $1-2 million dollars of coverage for as little as $3-500/year. 

In a litigious society, it is important to protect your life from predatory lawyers and their lawsuits. However, there are certainly drawbacks when it comes to umbrella insurance. As with any insurance policies, umbrella insurance has deductibles that directly correlate with the level of premiums being paid. For example, the $2 million dollar policy mentioned above carries a $15K deductible, which means that in a situation where the policy holder is found responsible for $115K payout, the first $15K of the liability will be out of pocket before the insurance company pays out the remainder of the $100K settlement. Most investors will set a reasonably high deductible as they use these policies as an additional safety net outside of the landlord's policy and other forms of asset protection.

5. Use of Legal Entities - LLC

Investors often use a limited liability company (LLC) to hold their rental properties. Like the word says, a limited liability company limits the liability exposure to within the LLC. By creating an LLC, you are creating a wall that defends your personal assets from business liability. If your LLC is setup correctly and there is a judgment against your business from a creditor, they can only take the assets within the LLC and not reach into your personal assets such as your primary residence, cars, cash, and other valuable property.

There are a few important factors when using LLCs to hold your rental property. Although they may limit your "inside" liability (e.g. tenant slip and fall, landlord negligence, etc.), it does not limit exposures from "outside" liability such as a car accident, and or other lawsuits caused by faulty acts of the owner of the LLC. Please consult with a qualified asset protection attorney to identify strategies to limit "outside" liability exposure.

Further, there are costs and administrative tasks that come along with owning rental property in an LLC such as maintaining separate checking accounts, annual minutes, LLC filing fees, registered agent fees, and tax filing fees. Be sure that you educate yourself and seperate yourself from the business as if it is determined that you have commingled funds or did not treat the LLC as a separate entity, you may lose your liability protection entirely through what is called "piercing the corporate veil".

In conclusion, there is more than one way to protect your hard earned investment properties, and investors need to understand how each of these strategies fit in their toolbox. As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!


Book Review 012: Rich20Something by Daniel DiPiazza

In his book, "Rich20Something", Daniel DiPiazza discusses how he left a low-paying job he despised, became a millionaire entrepreneur and wrote this book in his 20s. He provides actionable tips on how each reader can create their own success by leveraging their talents and following the "Go! factor" recipe for success.

Main Ideas:

  • You no longer have to pay your dues.

  • The game has changed – and you can make your own rules.

  • Money is easy, thanks to the Internet.

  • Writing and sharing valuable digital content is an excellent way to build your brand.

  • Use “nonlinear networking” to cultivate contacts who can help you achieve your goals.

While working at a chain steakhouse restaurant scooping butter for $2.17 an hour, Daniel DiPiazza knew that he needed to find a more meaningful job that also had a scalable pay structure. In 2011, after earning $10,000 from only working five hours, he soon launched three consulting companies worth $100,000 each without any start up capital. DiPiazza tells us that by disowning any limiting beliefs and unlocking our own potential, we can drastically improve our life and career.

Here are "three new truths" that he shares with all readers:

1. “You No Longer Have to Pay Your Dues”

The great Jim Rohn once said, "You don't get paid by the hour. You get paid for the value you bring to the hour. You may often hear people in your circle say, "that's too risky" or "you can't do that". Well, if every entrepreneur and successful business person agreed with those words, they would have never gotten started. Times have changed since the days where going to college and working 30-40 years moving up the corporate ladder is viewed as "stable".

We saw in 2008 where many W2 workers, both blue and white collar lose their jobs when the economy tanked. Having a job is no longer "safe", nor should you equate "butt time" (sitting down at your desk working for the man) with experience. DiPiazza challenges the readers to be creative in how we identify and leverage our skills. As film, TV and video game producer Jace Hall explains, “you do not have to pass through point B to travel from point A to point C.” In this “generation of hackers,” be original.

2. “The Game Has Changed – and You Can Make Your Own Rules”

Whether you realize it or not, there are many successful people who have identified the new game and have started to make their own rules. This game allows people to leverage other people's time, knowledge, and money to reach their own goals. The rules of the game are not taught in college, in fact, college teaches us to become better workers, when we are no longer in the industrial age, we are in the information age. To play the game to your advantage, embrace the most valuable tool there is: knowledge. Knowledge comes from thinking outside the box, believing in yourself and knowing how to persevere.

Be the person who can identify a challenge in different environments and offer solutions to the problem. Becoming a critic is easy, execution is hard. DiPiazza tells us to consider taking on broadening experiences such as these, in lieu of or in addition to college: Explore the world, establish a business, volunteer, learn a foreign language, create art, play a competitive sport, master something you love or write a book. You’ll need to do something that excites you and that you can leverage for success.

3. “Money Is Easy, thanks to the internet”

The internet has certainly connected us, and it has also made starting business with little to no capital fairly attainable. Back in the 1800-1900s, money was tight; the coal, steel and oil barons controlled the markets; and women and minorities weren’t part of the equation. Today, although common wisdom holds that making money is difficult, money is really everywhere. People can earn income doing things with little risk and big reward, thanks to the Internet. For example, you can start a blog using free software, or buy and sell products around the globe.

As mentioned previously, execution is the most difficult challenge entrepreneurs will face. If you’re good with managing your time, your persistence will pay off. DiPiazza tell us to break big goals into bite size chunks. For example, to make $1,000,000 in a year, you need to generate approximately $2,700 daily. Think of how many people you can help each day. You could bring in $1 each from 2,700 people – or $10 each from just 270 customers. Determine what you can offer and at what price.

By leveraging these three main concepts, we can break from the status quo and realize that others people's success can become our success. Instead of resenting the people on social media who seem to have everything you want, go network with them and figure out how you can recreate the same success. It’s not about the money, but the choices that having money will be able to give you.

Do you want to be able to retire your parents? Would you like to take two months to travel around Europe? Do you like to volunteer and build homes in rural areas? If you are focused on climbing the corporate ladder and paying the bills, you will not be able to see the things around you, the things that make you passionate, the things that fulfill you. Whatever season you are at in life, remember that conventional wisdom is no longer "safe" and that its not what you know, but what you think you know that may prove to be an obstacle in reaching your goals.

Hope you enjoy this book!

Click below to get your own copy. See our affiliate disclosure here

Real Estate 034: Real Estate Hard Money Lenders

In previous blog posts, we have discussed various financing strategies such as conventional lending, private money, home equity line of credit, and seller financing. You may have also heard the term hard money lending (HML) from Real Estate meetups and forums. When compared to a private money lender, hard money lenders are individuals or group of individuals that lend their money based on the value and cash flow of the subject property and not the net worth, credit history, or liquidity of the individual borrower. 

Hard money lenders are typically more sophisticated and have industry experience. As these loans are being made based on the asset, there is inquiries and reviews performed on the property through an inspection, drive by, and/or walkthrough, as well as the business plan, such as the rehab bid and ARV projections through an appraisal, Comparative Market Analysis (CMA) or Broker's Price Opinion (BPOs).

The benefits of working with Hard Money Lenders is that they are professionals that understand the needs of the deal. In a hot market, speed is crucial, and some hard money lenders are able to close in 7-10 days from signing the purchase agreement. 

When interviewing various Hard Money Lenders, they will generally give you a fee sheet that include their sample terms as follows: 

  • Amount Financed - Maximum purchase and/or rehab price

  • Interest Rate - APR (yearly) interest terms on the deal (Recourse vs Non-Recourse)

  • Origination Fee or Loan Points - Pre-paid interest where 1 point equals 1% interest of loan amount

  • Closing Costs - Escrow Fees, Document Fees, Notary Fees

  • Loan Term - Duration of the loan and any allowable extensions

Below is a sample pre-approval I received from my Hard Money Lender:

"Hello Bo, we have you pre-approved you at 90% of purchase price plus 90% of repairs, subject to appraisal requirements for a combined purchase price plus repair amount of up to $225,000.  Final approval is subject to review and approval of the property, budget, appraisal, and final funding source approval.  The interest rate is 10% fixed, interest only monthly payments, no prepayment penalty.  

There is a 2% origination fee for repairs under $50,000 and 2.25% origination fee for repairs exceeding $50,000 plus $385 processing fee and third party closing costs. (Higher pricing for loan amounts under $100,000). This loan term will be a six month loan with an automatic six month extension, so it can go up to 12 months in total.

The monthly extension fee beginning in month 7 is the loan amount times .0033 per month and is added on to the pay off at the end of the loan for any of the extension months used for months 7 through 12.  Attached is a preapproval letter for a purchase price up to $175,000, leaving $50,000 for rehab.  Please let me know if you have any questions or if you would like a letter that is property specific. Thanks!"

Based on my experience, I noted that the hard money lending process was as follows: 

Step 1  – Pre-approval. 

Step 2  – Place a deal under contract within the price range noted in the pre-approval.

Step 3  – Inform the HML of the subject property under contract and outline of estimated rehab costs (if any) along with ARV. 

Step 4  – Appraisal, CMA, BPO, or walkthrough of subject property.

Step 5  – Underwriting of deal and adjustments (if any) to purchase/rehab loan amount.

Step 6  – Final approval and closing.

Step 7  – HML puts the loan amount into escrow at the title company or the lender will schedule draws (varies from lender to lender) to be taken upon successful completion of the rehabs in various tranches. 

Step 8 – Complete rehab and obtain long term financing or sell to a buyer to pay off HML.

In conclusion, Hard Money Lenders are a great source of capital, especially for borrowers with experience, good deals and a need to close fast. 

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!