Rental discussion
 

By the way -- the post about NOI and Cap Rate is not for those that know this information or understand it. It was - and I should have identified it as such - information for "INVESTING 102".

I personally think everyone that has the ability - should have investment(s) in commercial and/or rental properties. This is another way to diversify your investments... has great long term proven success etc.

Live every other form of investing - they are not without ups and downs, and their own perils. Renters move out leaving you holding the bag... neighborhoods change (fundamental change you must watch out for!)... they require investment for maintenance and even improvement. They are rarely buy it and forget it.

What people forget are some pretty important investment goals such as:


The income (NOI) is, or can be, offset by depreciation for taxable purposes.

You have "dividend" income - or at least an income stream - that should grow over time. Often times this is NEGATIVE in the first few years.

You can have long term appreciation of the asset on top of the cash flow (NOI) generated. This tends to accelerate with time.

If you compute the income created downstream - against your initial investment (down payment) - the return on investment (ROI) can be staggering.

Let's look at this in a very basic way.

You put 50K down on a 200K property. The rental rate is $1,300 a month. That rate just covers your overhead (payment - taxes - insurance). But 5 years later that rent is $1,500... and 10 years later it's $2,000. At 20 years the mortgage is paid off.... and you're not collecting $2,250 a month. Pocketing $1,750 after expenses. That's $21,000 a year in income off your initial $50K investment.

The above is obviously oversimplification - as there will be paint jobs - roofs - appliances - carpets - landscaping - down periods with no renter - or a period with a bad renter... but in the end.... Your $200K house is now worth $375K and it provides $21,000 a year in retirement income. BAM!

This is my personal plan(on top of 401k and ROTH). My question is, what is the best way to protect your rental(and other assets) from lawsuits, exc?

For "residential" type rentals (1-4 unit properties) I got a Landlord Policy. I pay a fair amount more for this from Farmers. It is not required - you can get a run of the mill homeowners/GL type policy. But this one covers a lot of problems you can get into with your tenants. And in my pro-tenant political environment investment area, it was an easy call for us.

My wife fights with insurance companies for a living, and she thinks Farmers is the most formidable opponent in our area at least.

I have always had an LLC for any investment property I've owned. It protects your personal assets from any lawsuit related to the property, if set up right AND you don't co-mingle personal funds with LLC funds. It must have it's own bank account and you can't ever buy anything personal from it. You can take cash out to "pay" yourself and contribute to it if you need to for big expenses and stuff and if it's a single member (meaning no partners) it doesn't need it's own tax return, it just goes on your personal return.

Good call. I kind of skipped over that part. :lol:

That should be the first thing you do IMO. I actually set mine up before I acquired the actual property.

You can own several properties under one LLC -- some do it that way, and it's better than nothing -- but having a separate LLC for each property is the cleanest and offers the most protection.

To be clear on the LL insurance policy -- it is to provide legal representation in the event of potentially expensive events such as unlawful eviction. You have to have Homeowners/GL policy on the property anyway - so paying a little more where 6 figures of legal fees could be provided by your carrier under a number of unfortunate circumstances is worth looking into IMO.

Are lenders OK with this conversion on a current mortgage, or does it have special requirements?

I would most certainly set up an LLC for investments like this.


By the way - you don't have to buy these properties on your own - there are many companies that do all the work - find the properties - set up the LLC's - do the management - and just send you a check. That's the way I have always done these types of investments. Personally - I don't want to manage an apartment building. I don't want a phone call that the sink is plugged... I just want the investment and the income.

Now - when you think about it - this is far easier than finding and identifying a "good" investment property - securing a mortgage - find tenants - all the legal ramifications etc.

Typically then - the management company sets everything up - offers a "prospectus" describing every detail of the investment - and their plans - and financials etc. Then if you want "in" - they offer "shares" at a set rate. You can choose to buy one share or whatever. The deals I've always done have been anywhere from 50K to 100K per share. They typically will return 6 or 7% and after a while (years) they're typically sold and have a capital return. Most if not all of the income received is offset by the depreciation on your taxes during the income / holding period.

Here's the downside:

You CAN NOT invest 401/IRA/ROTH funds in these. They're considered "passive" investments and as such have different taxable situations.

You have ZERO control of how they're run - when they might be sold - whether or not they're sold or 1031 exchanged etc. You're just along for the ride. They're very illiquid.

Because of the illiquidity - you typically must "qualify" as an accredited investor. Meaning - you must declare that you have "X" net worth - per share - outside the value of your house etc. This is done because they don't want investors that are going to be calling and wanting their money back 6 months or 3 years down the road.

Like any investment - things can go against you. Rental rates may face stiff competition from a new building in the neighborhood. Management might suck. The economy can actually be TOO GOOD and your renters move up or out (I once had this happen to one of mine).


Here's the upside:


You generally get a very nice cash dividend annually (typically paid every 6 months).

The income is "tax differed" in a sense - because of the offsetting depreciation you get in the tax forms.

The returns can exceed 100% over a 10 year period. I once had an investment that returned 117% in 4 years. That was a special - probably never to be duplicated - event.

A 50K investment (typical single share cost) that is far simpler than owning and managing a single family rental.

These are typically LARGE (100 or more units) Class A apartment complexes. Therefore the occupancy rate can fluctuate throughout the year (years) and not have a big effect on your income. If you invest in single family - and the renter doesn't pay - or moves out - or destroys the property... you have a LARGE swing in income!

This is great info for someone trying to get into that kind of investment property. In my case, I already live in my future rental(will buy property and build in future). Mainly wondering if I would need to change my loan to convert to LLC or if it is a simple title change? Thanks again for all the information.

On one of my properties I was unable to set up the LLC in time (my original name was rejected by the SOS for being too similar to an existing LLC) before taking possession and had to deed the property twice. My lender did not have an issue with it (not sure what I had to do - but it was not a headache). But I would check with your bank/lender on it for sure.

Every time I had to get an investment property loan the lenders wanted me to personally be liable for the loan in addition to the LLC. This doesn't affect the legal protection offered by having the LLC.

Also, we haven't talked about trusts here much but if you think you'll have compiled any significant amount of assets by the time you die you really should have one that fits your own personal situation. The trust will have just you as Trustee if you're single or you and your spouse (typically) if married but is it's own single entity and will be the sole member of the LLC