Blog | Real Estate

How to Hold Real Estate as an Investor

The best way to protect your assets

As you already know there is risk in owning real estate.

In doing so, you are dealing with tenants, vendors and even strangers who interact daily with your ownership of the property. And one of them can become injured (or can at least appear injured) and sue. While insurance is the first line of defense not every claim will be covered. Insurance companies have an economic incentive not to pay out on every single claim and may find reasons in their own loopholes not to cover you.

As well, you are operating in the most litigious society on earth. There is a litigation lottery mentality at work in our country. If you own assets there are predators out there willing to play the angles within the legal and medical system to take them from you.

But as we have also seen, there are tremendous tax benefits to owning real estate. The government wants us to own real estate. We just need a good way to protect it.

How to Protect Yourself and Your Real Estate Investment

You should consider holding your real estate in an entity for protection purposes. A properly formed and maintained entity can discourage an attack. Holding real estate in your own name invites attacks.

So, how are you best protected when owning real estate? The answer comes down to six words: Limited Liability Companies and Limited Partnerships. They are the entities of choice for protecting your real estate holdings.

Why?

Because limited liability companies (LLC’s) and limited partnerships (LPs) provide the greatest asset protection possible.

Unlike a corporation, where a creditor can attack your shares and control the company, in many states a creditor cannot assert voting control over your LLC or LP interests. They can’t force you to sell the property. They can’t vote in new management. Instead, they only obtain what is known as a charging order, which is a lien on distributions. This means the creditor has first dibs on any distributions from the entity. But because you remain in control, what if you decide not to make any distributions? The creditor gets nothing.

We will review how the charging order works after making one foundational point. It is not attractive for creditors to obtain a charging order when the result is that no distributions are received. In fact, knowing that your assets are held in LLCs and LPs may be enough to prevent a lawsuit from being brought in the first place. Lawyers know that lawsuits involve two battles:

1. Winning in court and then
2. Collecting

If they sense it will be difficult to collect against an asset they, in most cases, will rely on the insurance monies to satisfy their clients’ claims and not go after any of your assets held in LLCs. That is why it is good to have both an insurance policy and asset protection entities.

The Insurance Policy

The insurance policy is the first line of defense. It is the pot of red meat for the attorneys to go after. Most attorneys in these types of cases are on a contingency fee, meaning that they only get paid when money is collected. The attorney will advance all the costs of the case and put in their time at no cost to the injured party. When a payment is received, either by a pre-trial settlement or a victory in court, they get a percentage of the payment (usually 33% to 45%).

For example, on a $100,000 insurance payout the attorney gets, for example, $35,000. This is not a bad payday. But if the contingency attorney loses the case, they get nothing. This means they have to be careful about which cases to take, which is good for the rest of us. As well, these attorneys have to wisely allocate their time and resources. If the $100,000 settlement doesn’t fully cover their clients’ damages, will the attorney look to the defendant’s other assets?

It depends.

If they are easy to reach (as in a sole proprietorship or an individually titled situation) perhaps they will. But if those assets are held in properly structured asset protection entities, perhaps they won’t.

Remember, these lawyers are still mostly on a contingency fee. They don’t get paid until they collect. Do they want to go after an LLC, get a charging order and wait for distributions to be paid? Probably not. It is not a good use of their time. There are too many other cases with new pots of insurance money to go after.

This discussion is not meant to denigrate attorneys. It is rather to explain why rational, economic animals (as most attorneys are) will probably not pursue claims against properly structured plans. They are on a contingency and it is not worth their time. Knowing that, we plan accordingly.

To read an example of how putting your asset into a well-formed entity can save you, read my book, Loopholes of Real Estate.