When you hear that real estate investment can be risky, the first thing that comes to mind is probably the possibility that you’ll end up taking a loss on the investment property. Maybe the local market will decline, and the value of the property will decline with it. Maybe you’ll discover that more repairs are required than you’d factored in. But, these risks that involve nothing more than losing money on the investment are minor compared with the risk real estate investments can pose to other assets.
Real Estate Investment Risk Doesn’t Stop at the Curb
The mistake many investors make, which leads to an often-overlooked real estate investment risk, is holding the property in their own names. That means the investor is personally responsible for any liability that arises in connection with the property. Even those who recognize the risks associated with having investment property in their own names often make the mistake of putting all of their real estate investments into one LLC or trust. In that case, personal property may be protected, but investment properties may fall like dominos if there’s a serious problem involving one property.
Personal Liability for Real Estate Investment Property Issues
Imagine that a married couple, Joe and Sally, own their home and a vacation cottage. In addition to these two pieces of real estate, they’ve purchased two homes to renovate and sell, and a small apartment building to maintain as rental property. Since it’s just the two of them and there are only a handful of properties involved, Joe and Sally haven’t bothered to create an LLC, a trust, or other vehicle that would separate out ownership of their properties.
All is well until one day a tenant slips on the apartment building stairs and files a lawsuit. Maybe the insurance coverage isn’t sufficient, or maybe the insurance company finds a way to deny coverage. Either way, the tenant ends up with a large judgment that isn’t fully satisfied by insurance—and, that judgment is against Joe and Sally personally, since they own the property.
With very limited exceptions, that puts Joe’s and Sally’s property at risk to satisfy the judgment. In many states, the law protects a certain amount of value in a person’s home against judgment creditors, but New Jersey offers no homestead exemption. That means that all five properties are at risk: the family home, the family vacation cottage, the two investment homes, and the apartment building. And, of course, other property may be at risk, too. If Joe and Sally have significant cash assets, a boat, brokerage accounts, or other property of value, it may all be on the line to satisfy the judgment associated with the apartment building.
Protecting Personal Holdings from Real Estate Investment Risk
One of the most common ways to create a barrier between real estate investments and personal real estate holdings and other property is to place the investment properties in one or more LLCs. However, simply placing all investment property in a single LLC still leaves the investor at risk, for two reasons.
First, if the investor owns the LLC that owns the investment property, creditors may be able to reach beyond the LLC to the investor. One way to address this risk is to place the LLC or LLCs into a trust.
Protecting Other Investment Properties
The second risk associated with placing all real estate investment property into a single LLC is that it leaves all investment property at risk when liability arises in connection with a single piece of property. If, for example, Joe and Sally had placed the apartment building and two investment homes into an LLC, properly structured to protect their personal holdings, their home and vacation property could have been protected. However, the judgment associated with the apartment building would still have put the other two investment properties at risk. Obviously, as the number and value of investment properties increases, the risk associated with grouping them into one legal entity grows.
Talk to an Asset Protection Attorney
Real estate investment risk can be significantly reduced by strategic structuring of holdings, but many investors don’t understand the best way to protect their assets. Working with an asset protection attorney experienced in working with real estate investors is a smart step toward minimizing risk.