PROTECTING YOUR REAL ESTATE INVESTMENTS
Commercial real estate investors know that playing the real estate game comes with its fair share of risks and rewards.
Watching your investments and cash flow grow over the years is rewarding. Taking advantage of the various tax benefits of commercial real estate investing is also a plus.
But like all investments, where there is reward, risk is right around the corner. With real estate, potential lawsuits and property loss are the major risks for real estate investors.
Using proper real estate asset protection will help decrease your risk as an investor and limit your future liabilities. This is a critical part of the process for commercial real estate investments.
This post will walk you through the steps to protect your real estate investments.
WHAT IS REAL ESTATE ASSET PROTECTION?
Asset protection is the process and strategy used to shield your assets from being exposed to future risk like a lawsuit. In the event that someone decides to sue, you want to make sure your real estate investments are protected and aren’t at risk in the lawsuit.
There are various strategies that are effective in protecting real estate investments. By taking advantage of the proper techniques, you can ensure property investments don’t get subjected to undue risk if you end up on the wrong side of a legal battle.
WHAT ARE THE RISKS?
Risks to your real estate investments can pop up out of nowhere for various different reasons.
Examples of legal risk to your properties: Fires on the property, injury to a tenant, divorce, breaking and entering, etc.
It all boils down to the big risk of a lawsuit and putting your investment property in jeopardy. This is especially true when the property is held in the investor’s name.
If the lawsuit goes against you, your real estate investments could come into play and be used to cover the cost of the damages. This means there is a potential risk of losing any real estate investments that aren’t properly protected.
WHAT ARE THE KEY STEPS TO PROTECTING MY REAL ESTATE INVESTMENTS?
To kick things off, you want to make sure your investment property is properly insured. This likely means speaking with an insurance real estate professional to analyze the areas of exposure depending on the property type and use.
Nevertheless, you should have the maximum amount of liability insurance. This may be maxed out at $1 or $2 million per investment property.
Depending on the size of your real estate portfolio, you might want to consider a higher liability coverage or an umbrella policy. Some long-term investors opt to insure against the worst case scenario like floods or earthquakes, while other even hold home warranties to insure against future risk of maintenance.
In either case, insurance is a critical strategy for every investor in protecting their real estate portfolio.
The next step in protecting real estate assets is choosing the right entity structure for holding the investments. This is where it’s dangerous to hold property investments in your own name. This makes the property a personal asset and puts it at risk if a lawsuit goes south and damages are awarded.
Real estate investments are commonly held in a more formal entity structure such as a corporation, limited liability company (LLC), or a limited partnership (LP). Holding the property titles for your real estate investments in one of these types of entities will provide a buffer from any legal risk that comes your way.
Investment LLCs have become the preferred choice for most real estate holdings. Owners of an investment LLC are referred to as members and are personally shielded from any liability to the LLC. Furthermore, LLCs are less formal than a corporation and don’t require unnecessary subtleties such as minutes or bylaws.
Basically this means that only the assets held by the LLC are at risk. This becomes a powerful tool for real estate investors because they can protect remove any personal liability from affecting their investments.
Investors with multiple properties might even consider separate LLCs so the risk of one property is isolated and doesn’t affect the others. Select states offer a series LLC to accomplish this and protect individual properties within the same LLC.
Each state has their own legal rules regarding LLCs. Some won’t provide anonymity because directors and officers or members of the LLC are in the public record and can easily be found with a simply Google search. Select states like Delaware or New Mexico might provide more privacy.
Investors should consult with a lawyer with real estate experience to explore options for their real estate holdings.
If privacy and anonymity are important to you, consider using a land trust.
Land trusts basically serve as a grantor trust. This is an agreement between three parties:
- Grantor: Creator of the trust
- Trustee: Holds the legal title for the property in the trust
- Beneficiary: Holds the use and enjoyment of assets in the trust
One benefit from using a grantor trust is that you aren’t required to fill out separate tax filings. The property’s profits, depreciation, and expenses all get reported on your personal 1040 tax return, making this an easy investment opportunity.
But the primary reason to use a land trust is to provide a layer of anonymity for the investor. Here’s a quick look at how that works:
- A real estate property is purchased and signed over to the trust
- The investor designates a third party as the trustee
- The third party trustee is listed on the title instead of the investor
Having anonymity can come in handy if an attorney starts looking into your assets for any reason. You can minimize your asset exposure by having a third party serving as the trustee.
Note: The only party able to act on behalf of the trust is the trustee. For this reason, it might be prudent to designate yourself as the successor trustee in the event you need to take immediate action and the trustee is not available.
It also needs to be noted that the land trust doesn’t provide real estate asset protection alone. Liabilities associated with the property still trickle down to the beneficiary. Then if you are the beneficiary on multiple trusts, those could be in jeopardy as well.
To solve this problem, you could use the land trust in conjunction with another entity (hint: LLC) to get the full effects of this strategy and achieve maximum asset protection.
The same steps above apply, but once the title is vested to the trustee, the investor should transfer their beneficiary rights over to the LLC.
As you being to invest in real estate, you’ll want to make sure your property investments are protected and safe from any unforeseen legal exposure.
Because private real estate is a real asset, it can become a target for anyone and their attorney looking to pick a fight. Using the various strategies above will help shield your properties and minimize the risk of a future lawsuit or property loss