Typically landlords deal with pedestrian liabilities – slip and fall, fire, dog bites, electrocutions, or lead paint, but COVID-19 raises a new set of liability issues that landlord need to be prepared for.
Landlord Liability Issues
But before we jump into legal protection tools, let’s make sure that we have an understanding of what these legal entities do from a landlord-tenant liability perspective. I’m still amazed, even with all the information that’s out there on the internet and through educational seminars that people are still renting a property in their individual names which in my opinion is financial suicide.
They may say, “I’ve never really had a problem”, and I always add on the word “yet”. It’s never really a matter of if, it’s always a matter of when. Every state has different laws when it comes to landlord-tenant liability issues, but they’re almost universally very tenant-friendly. When you have a landlord-tenant issue, the things that tenants can sue landlords for are unbelievable – electrocutions, lead paint, mold, fires, dog bites, neighbors, insufficient lighting, insufficient security, etc.
Insurance may not be an option to turn to, especially if you don’t have the right type of coverage, so it’s important to find some way to limit liability or contain liability. This is where the legal entities come into play, and the legal entity of choice is an LLC, a limited liability company. A common structure for an LLC starts with a manager, which typically is the landlord. They’re the ones running the day to day operations, and they may also be the member or the owner. They may have a single property or several properties inside the LLC.
How Many Properties Should be in an LLC
The number of properties that go inside an LLC is always something to be concerned about because some properties have greater risk profiles than others. I always ask, is it a single-family home behind a gated community, duplex, apartment building, or a commercial building? Is it in a high or low socioeconomic demographic? All these factors create a risk profile for the property.
The more properties you place into one LLC, the more the risk profile increases because each property has a certain number of human beings and activities within it. Think of a traditional family living in a single-family home. This would include a husband and a wife, a couple of kids, and maybe a dog. That’s four or five people located on one entity and they may have a friend or two over as well. If you put a fourplex inside the same entity, you end up with 20+ people, all of which may be a source of liability. Sometimes it may be worth diversifying the entity by separating the properties into their own separate holding company. Especially under these current circumstances, it’s a good time to consider whether to diversify your holdings.
Why is diversification important? If a tenant sues the owner of Property #1 held under an LLC, the entire LLC gets sued and everything inside that LLC is at risk. If you also have Property #2 in that LLC, Property #2 is now adversely affected because of the activities on the land of Property #1. Potential risks, again, could be socioeconomics, the number of people there, or the amount of equity inside the properties. Various factors go into deciding how to limit the exposure within the entity.
An alternative is to use a multi-entity structuring strategy to segregate individual assets into individual entities. Let’s take the same scenario as above, but instead, we’ve diversified. We identified a problem property, and we also identified one of our preferred properties. Maybe this is the commercial building that’s worth $2 million or maybe this is the student housing that’s leveraged out and has no value in it. Now you’ve limited in space and scope the actual liability and as a result of that you are protected. Your other property is also protected because it’s not inside the same entity. The defendant here is LLC #1, not LLC #2. And consequently, you’re able to limit the liability and protect your overall investment. Besides what’s happening with COVID-19 these are best practices for landlords and real estate investment. You want to diversify the actual investments and diversify the risk.
Limiting Your Personal Liability
As the landlord you get personal protection. That’s the limited liability component of an LLC. You could lose your assets inside the LLC, but you’ll walk away without any personal liability.
LLCs also provide us another level of protection. With coronavirus affecting landlord cash flow, some landlords are now not worried so much about tenant activity, but more so about their personal creditors. If the property is in your name and not an LLC the bank is looking to your personal assets. If you have any pending liabilities that result from coronavirus, you want to make sure that your personal assets are protected.
An LLC set up in a proper jurisdiction can provide a liability shield as well. Keep in mind, not all states are created equally. Banks or other creditors will have a very difficult time penetrating LLCs to grab and foreclose on the assets. We always have entities registered where the entity is doing business, but we can choose jurisdiction in any state, so we look to the most favorable states for our clients to try to maximize their asset protection and their limited liability. In this case, Delaware or Nevada may be a good fit for various reasons.
Protecting Your Privacy
One of the other things that we deal with when it comes to rental properties is privacy. You want to try to go as incognito as much as legally possible. One of the most difficult things about owning real estate is that it is all public record. Anyone can type someone’s name in a public record search, search the property, then use Zillow to find out what the value is. Zillow may even list the chain of title and how much you refinanced or bought the property for. Your creditors or tenants can do some quick math and figure out how much equity you have in your property portfolio and use it as leverage against you.
One thing we try to do is get the client’s identity off public records by using a blind trust. Therefore, when someone is doing a public record search to find out who owns your property, your name doesn’t show up. We do often for celebrity clients in California and for landlords who don’t want tenants knocking their front door at 3 a.m. asking to have their toilet fixed.
The combination of a blind trust coupled with an LLC are tools that allow the property to go incognito and still give you very powerful asset protection. And this applies in the area of commercial properties and residential.