Creating LLCs and Protective Clauses for Investment Properties

The primary purpose of a limited liability company is to protect individuals from personal liability. Any property that could potentially expose you as the owner to a lawsuit or other liability over the course of your ownership, especially investment or rental property, should be held in the name of an LLC and not in your own name. Renting your property out to others can be a delicate and sometimes risky proposition. RRS partner Andy Gertz explains how creating LLCs can minimize fallout, should things go south. 

Don’t Wait to Protect Yourself

At our firm, we have many investor clients, and we nearly always recommend utilizing LLCs in the course of investment property acquisition. If possible, the title to said rental or investment property should be acquired directly in the name of the LLC and our team sets up unique LLCs for each property. In these types of cases, the LLC is not formed until after the property is under contract. 

You always want to make sure that the contract to purchase is fully assignable by the buyer so that it can be easily assigned prior to closing. If you’re financing the purchase yourself, some lenders may require that you take title to the property in your personal name for underwriting reasons. In that case, you should nonetheless move the property into the LLC right after closing. 

Tread Carefully Around the ‘Due-on-Sale’ Clause

However, as with all real estate transactions, this must be carefully handled within the law. Transferring a title after closing can create a potential hazard if you have financing and if the contract contains a ‘due-on-sale’ clause. This is a clause in the mortgage document or note that gives the lender the option to accelerate the note, or even potentially foreclose, if the secured property is conveyed without their consent. This clause usually does not mean that a transfer is an automatic breach or default, but it does give a lender the option to accelerate the note. 

In reality, lenders rarely take adverse action or call the note due when the loan is transferred to a borrower’s personal company for this purpose. When it comes to residential loans, this is especially true when the lender is already aware that the property will be an investment property and not an owner-occupied property. I’ve never encountered a situation where a lender accelerated a note for only this reason, but investors do need to be aware of this clause and its possible implications. What lenders tend to care about first and foremost is getting paid on time. So if you take steps to be assured of the lender’s consent beforehand regarding your LLC plans, it’s never a bad idea. 

The ’As-Is’ Clause & Assigning Debt

Another clause in the deed you may need to utilize is an ‘as-is’ clause. This clause addresses the physical condition of the property and is something we like to highlight in bold and all-caps within the deed. The clause’s chief purpose is to avoid having to make warranties as to the physical condition of the property. If the property is a rental and it’s rented out to a tenant, you may need to execute a separate assignment agreement or include assignment clauses in the deed to assign the lease or leases, the seller’s interest in insurance policies, tenant security deposit, and other related items. A bill of sale should also be used to convey ownership items of removable personal property. 

When it comes to the actual paperwork involved in creating LLCs, certain documents and clauses should be used over and above your standard warranty deed conveying the real property. Most investment properties have at least a first lien with outstanding debt or an existing mortgage and, if they do, it’s a good idea to include a clause in the deed that makes it clear that the LLC is taking the title subject to the debt and assuming the indebtedness. It’s also a good idea to have the LLC assigned the deed as the grantee, so it’s binding on the LLC and not yourself. Keep in mind this clause won’t change the loan terms or relieve an investor from their loan obligations, but it will be useful if a dispute arises down the road. 

Generally speaking, transferring property to an LLC is not usually complicated, but it’s important to do it right the first time so you don’t have title issues pop up down the road when you’re trying to sell the property. If you’re looking to rent or lease your property and have questions or concerns about personal liability and creating LLCs, Richards Rodriguez & Skeith’s Real Estate team may be able to help! Contact us today for more information.