If you’re like most real estate investors, you probably own more than one property. Or, maybe you’ve gotten your start with your first investment and you’re ready to expand.
One of the most common questions from real estate investors is about how to structure multiple investment properties: Is it better to form separate LLCs (Limited Liability Company) for each property or to house them all under one LLC?
My answer is simple: Typically speaking, it’s best to create a separate LLC for each property. Each LLC should own only one property and not engage in any other business activity. This is the best way to contain your liability and maximize your protection.
To understand the reasoning, let’s get back to the basics and think about why a real estate investor forms an LLC in the first place. It’s all about minimizing personal liability.
Worst Case Scenario
You don’t want to lose your life savings because a worst-case scenario happens at your rental or investment property and someone decides to sue.
Hopefully, you don’t spend too many sleepless nights worrying about the “what ifs,” but things can happen with rental/investment properties… a water heater could explode or the balcony railing might break.
It could even be something as simple as a tenant slips on a patch of ice on the driveway and decides to sue.
Your Personal Assets Are At Risk
If you hold the property title in your name, you are the defendant in any lawsuit. And, if the judgment exceeds your insurance coverage, your life savings and personal assets can be at risk.
By contrast, if the property is structured in an LLC, the LLC is the defendant in the lawsuit, and you won’t be liable personally (unless your own personal actions caused the problem).
Contain the Liability
It’s easy to understand the importance of forming an LLC for a property, but why go through the trouble of creating separate LLCs for each place? The goal here is to contain the liability as much as possible.
For example, let’s say you purchased a few rental properties and put them under one LLC (named Three Properties, LLC). An unfortunate incident occurred at one of the properties, your tenant sued and was awarded a large settlement.
The LLC protects your personal assets from being used in the settlement. However, the judgment can be collected from any of the assets owned by Three Properties, LLC – and that includes the assets of all the other properties.
So, if you had $100,000 of equity in each of the three properties, you risk losing $300,000 from an incident that occurred on just one of the properties.
You can eliminate this risk by having a separate LLC for each property. In this case, the assets from Property B and Property C would be shielded from any judgment against Property A.
In other words, only $100,000 equity is at risk instead of $300,000. Think of it as diversifying your assets and containing the risk.
What’s the Downside?
Is there a downside to forming multiple LLCs? Not really. There’s a relatively small fee associated with forming an LLC, and the paperwork can be done in the amount of time it takes to finish your coffee.
Most states do require LLCs to file an annual report and pay a fee each year. This means you’ll need to file separate paperwork and fees for each property’s LLC. However, the time and money you’ll need to spend maintaining the LLCs are a fraction of the amount you’re investing in the property and the potential risk of not protecting your equity.
Consider the small effort to form and maintain separate LLCs an important form of insurance to minimize risk and protect your equity for years to come.