To Entity or Not to Entity

While the decision to establish an entity such as a corporation, trust or the most common for real estate, a limited liability company, in which to make real estate investments, may seem like a prudent decision to an investor. It is important for investors to understand the ramifications of such a move in the current market environment.  As with many decisions in life, awareness of potential unintended consequences up front can help minimize headaches in the future.

Certainly, the appeal of the anonymity and liability protection afforded by making real estate investments in entities are real and do not need to be reviewed here.  Many real estate investing gurus have profited from selling video tapes, compact discs, and seminars espousing these very benefits. Those advocates rarely take the perspective of a lender or other skeptics, and point out the potential downfalls of such a move.  They include:

  • ACCESS TO LOANS: The universe of lenders that have an appetite for Non-Owner Occupied Real Estate is small.  It becomes even smaller if the property is owned in an entity.  The exception is blanket commercial loans that typically are for larger dollar amounts and warrant the time of the bankers due to their size.
  • LOSS OF DEALS: Deals can be lost if, for example, a purchase contract is originally executed in the name of an entity but a lender refuses to make a loan secured by the property unless the contract is in the name of an individual.  These days, inflexible sellers such as banks, HUD or Fannie Mae/Freddie Mac typically refuse to amend contracts and would rather sell to the next bidder than go through the brain damage of modifying your deal.
  • COST OF LOANS:  The cheapest money in today’s market is Fannie Mae and Freddie Mac compliant loans.   If you can find a bank that will provide financing for non-owner occupied property held by an entity, it will cost significantly more.
  • COMPLEXITY:  The very liability-shielding attributes of investing via an entity may spook lenders if those entities lack long and well-established track records.  If lenders decide to lend directly to the entity, the individual owner(s) of the entity usually end up having to personally guarantee the loan anyway.  The days of non- or limited-recourse lending are a distant image in the rear view mirror.
  • ADDITIONAL COSTS: It is easy to undermine the underlying purpose of establishing the entities if people who use them are extremely vigilant, but it takes thought, time and money.  To have the desired liability-shielding effect, operating in an entity requires extra costs and hassles, such as formation of entity, distinct set of books and financial statements, tax returns, bank accounts, checks, and the like. 
  • LEGAL: The use of an entity may take away an individual’s ability to represent himself in small claims court or for real estate tax complaints.  For example, if an individual owns a four-unit in the name of his entity and seeks to evict a deadbeat tenant, a judge would not likely allow the landlord to appear in court without an attorney.  Why?  Because not doing so would be considered unauthorized practice of law in most states since as an individual (who is not an attorney) cannot represent a third party in court.  Even if the individual owns 100% of the entity which owns the building, the entity itself represents a discrete third party in the eyes of the court.

All hope is not lost, since certain goals can be achieved through alternative means.  For example, to the extent owning real estate in entities helps shield individuals from potential liability, such as the mailman slipping and falling, protection against this can be obtained through proper landlord policies and an umbrella insurance policy.

In short, be sure to think through all of the potential ramifications of whether to make your real estate investments in the name of an entity or as an individual.  Notwithstanding what the gurus say (and sell) in their tapes and seminars, always remember The Golden Rule.  And if the folks with the “gold” who are making you a loan to buy properties take steps to undermine the effect of your entity, then the use of it may turn out to be more hassle than it’s worth.

Navigating the “New” Real Estate Environment

As though the real estate rehabilitation investor did not have enough
challenges, finding properties, good contractors, capital, tenants/buyers, etc. prior to the real estate crash, now they face the new frontier of real estate investing.   There are opportunities and challenges that investors must recognize and evolve in order to grow their real estate rehab investment business and ultimately build wealth.

Best of Times…. Opportunities

  • Large Supply of Homes – Daily we are pelted with news about increased foreclosures.  (Foreclosure Market Report™ reported “a total of 2,698,967 foreclosure filings were reported on 1,887,777 U.S. properties in 2011”).   There are more options for investors and they should not be shy about making aggressive offers, focusing on neighborhoods that have a higher probability of future appreciation, or walking away from those that do not fit your profitable projects list.
  • Less Competition – During the “Real Estate” boom, many “Newbies” entered the market looking for quick and easy riches in real estate causing property prices to rise due to a large number of inexperienced investors speculating on rapidly increasing values.  Now with all of the negative news, the new entrants have dwindled.
  • Contractors – The slow down in the housing market, specifically new build, has resulted in a large number of qualified trades people looking for work.   This provides the rehab investor the ability to find good people at a reasonable price to complete the work.

 Worst of Times…. Challenges

  •  Exit Strategy –Tighter underwriting for purchasers has limited the number of potential end buyers of rehabbed properties.   Many rehab investors have turned to “Lease Options” or rental of completed projects.  However, this option requires the rehab investor to obtain the permanent financing.
  • Declining Prices –   Many markets are now in a declining real estate value market period, which a majority of us have not experienced.  Bottom line is that many of the “old” ratios, practices and models are now outdated.

 Evolution 

Rehab investors must rethink their models and strategies to adapt to the new real estate realities.  Several items to consider include, but are not limited to:

  •  Assume you will not be able to sell a property.  Will you rent, lease option, etc.?  Have permanent financing sources lined up due to the assumption that you will not be able to sell the property.  Non-Owner occupied financing solutions are more difficult to find in this environment.
  • Get permanent financing loans closed when the property is “Appraisal” ready.  This gives you the luxury of listing the property for a long period of time and/or using the rental or lease option strategy.
  • Do not list property on the MLS prior to getting permanent financing in place.   Listing the property for sale on the MLS may eliminate most, if not all, of your permanent financing sources.
  • Maintain your credits score.   The ability to obtain any type of financing or credit is getting tougher.  The requirements are getting higher.
  • Be prepared for full documentation loans.   There are very few non-owner occupied, stated programs available for borrowers, even if they have stellar credit scores.
  • Increase your liquidity.  Lenders are now incorporating higher requirements for cash and marketable securities as part of the underwriting criteria.
  • Think lower Loan to Values (LTVs).   Lenders are looking for lower LTVs for financing programs due to the volatility of the real estate market.  Conversely, investors should adjust their models to build in a higher profit margin to compensate for the volatility and the probability of a longer holding period.
  • Sales comparables.   Gives the most accurate value metrics within one-half mile and six months. If necessary, engage an appraiser prior to purchasing property.  You must be comfortable that the property will appraise for a purchaser or for you if a refinance is pursued.

Darwin said it best with this quote, “It is not the strongest of the species that survive, nor the most intelligent, but the one most adaptable to change.”

I am sure there are other items to consider in this new frontier.   Basically, all of us need to evolve in order to be successful in this new environment.   What would you add?

Real Estate Investing “Get Rich Quick” Schemes (Series of Seminars in Cleveland, Akron and Youngstown)

After completing thousands of rehab loans with our clients there are several lessons we have learned.

Real Estate investors do not “get rich quick.” Successful investors build wealth over time.

Investors do not need to spend large sums of money to learn about the real estate investment industry.   Networking, asking many questions, and learning from many realtors, contractors and lenders like ReCasa is free and will get you the education you need to successfully complete the first several projects.  The best way to learn is by doing!

Be wary of “Wholesale” real estate investment offers especially if you are the buyer of a property from a “Wholesaler.”   We have statistical evidence that show when a wholesaler is involved in a transaction over 86% of the time there is an issue for our clients.   Read this article to learn about the potential pitfalls of pursuing a “Wholesale Sales” strategy.

A flurry of alerts about traveling house-flipping seminars: Plain Dealing

ReCasa Financial Group’s Deal of the Quarter Winner!

Once in a Lifetime Buying Opportunity for Real Estate Investors!

We have been saying for some time now that the combination of low property prices, historically low interest rates, and high rental demand has created a once in a lifetime buying opportunity for real estate investors!

That window of opportunity may be starting to close!

Housing Passes a Milestone