Lessons Everyone Can Learn From Successful Real Estate Investors

There is perhaps no better example of imitation being the sincerest form of flattery than looking at how the wealthy buy real estate. Whether they buy property for personal use or investment purposes, wealthy people and successful real estate investors have been taking title to their properties as trusts or limited liability corporations (LLCs) for years. Keep reading to find out why this benefits them and why it may benefit you, too.

Why Do The Wealthy Buy Properties As LLCs Or Trusts?

The short answer for why wealthy people and successful investors often take title to real estate as a trust or an LLC instead of in their own name is that they gain numerous benefits. This is why real estate investment trusts (REITs) are set up as trusts in the first place. It's also why most assets in REITs are all individual LLCs instead of one amalgamated portfolio with the REIT holding title to all the assets in the trust.

To understand the benefits that come with holding real property as a trust or an LLC, or which option is best for you, it's important to understand how each one works.

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How Do Trusts Work?

A trust is a company hired or formed to function as a fiduciary, which means it operates to protect the interest of a beneficiary or trustor.

The trust basically turns the property into a company run by a trustee, who is legally bound to manage the asset(s) in the trust to the best of their ability. You can put a property in a trust and name yourself or your loved one(s) as beneficiary. You may also be able to name individual charities or religious organizations as the beneficiaries of your trust.

In the case of both investment or personal real estate such as your primary residence, a trustee can handle everyday functions that a beneficiary may not be willing or able to do.

Examples of these functions include:

• Day to day property management
• Rent collection
• Accounting
• Staying current on property taxes

Benefits Of Trusts

Another important function of a trust is that you can use it to build a fence around the asset or assets you place in the trust. In many cases, neither a trust asset nor income derived from a trust can be taken from the beneficiary as part of a divorce or civil judgement.

By contrast, if you left a property directly to your loved one, they could lose the property down the road in a divorce settlement, or a plaintiff could demand the property as damages in a lawsuit. Additionally, because a trust continues to act in the beneficiary's interest in perpetuity, your beneficiary won't have to deal with the upkeep or accounting.

Trusts also offer beneficiaries an increased level of privacy. Property ownership records are public, meaning anyone with internet access can go to county databases and search for a property owner by name. When they do, any property owned by the search target in that county will pull up automatically. This may not be such a big concern for John Q. Citizen, but if you're rich or famous, the potential negative consequences of such easy access are obvious.    

How Do LLCs Work?

An LLC, an acronym for limited liability corporation, is a company that is formed by one person or a group of partners. Investors large and small have been taking title to investment properties as LLCs for years. LLCs are run by general partners, who are usually majority owners. They make day-to-day decisions about the asset and have a similar fiduciary responsibility to the LLC's partners as trustees do to beneficiaries.

The equity in an LLC can be structured in myriad ways. The breakdown of equity and shares in an individual LLC can be tailormade to suit any number of partners. Additionally, LLCs are run according to terms laid out in their operating agreements, which can include preferred shares that give some partners voting privileges or say in the management of the asset.

Benefits of LLCs

The flexibility in ownership terms and operating agreements is one of the primary reasons so much investment property is held as an LLC, but it is far from the only benefit.

Like trusts, LLCs can also function as a fence around an asset or group of assets. In an LLC, the LLC partner's legal exposure is limited to their equity or the value of the equity they have in the LLC.

Imagine for example, you own a 12-unit apartment building and one night, an old electrical outlet sparks and causes a fire. As the property owner, you could be responsible for the damages caused in that fire. If your tenants win damages because you were negligent in allowing a defective electrical outlet to exist in a rental unit, they can pursue you personally for assets if the total damage award exceeds your liability coverage limits.   

But if your rental property was owned by an LLC, the tenants would only be able to pursue damages equivalent to the maximum value of the LLC. For example, if you lose a $5 million judgment, have a $1 million policy and the building in the LLC was worth $2 million, the judgment bankrupts the LLC, but the tenants can't legally pursue you for the other $2 million.

This limited liability principle also applies to debts the LLC owes. If the investment fails or the asset is foreclosed on, creditors can't pursue you or any of your LLC partners personally for any of the LLC's unpaid debts. The benefits of this type of property ownership are easy to see, especially if you own other assets. The LLC status offers you powerful legal protections if worst comes to worst, which sometimes happens.

That's why almost every asset in a REIT is in its own LLC. The legal exposure from any one asset's problems is automatically firewalled from spreading to other assets in the trust. Lastly, LLC partners get a 20% tax break on pass-through income under provisions of the Tax Cuts and Jobs Act of 2016. Simply deeding your investment property, or taking title to it as an LLC, gets you a 20% pay raise.

How Come You've Never Heard Of This Before?

If you're sitting at home kicking yourself because you didn't take title to your family home or that fourplex you skimped and saved for years to buy, take heart. This is not a route typically taken by first-time home buyers or people who didn't have the benefit of experienced financial advisers to counsel them before buying their property.

If you financed the property, you would probably have had to jump through several hoops to get loan approval if you proposed to buy the property as a trust or an LLC. That's because the same strong legal protections that come with trusts and LLCs can make it difficult for banks to foreclose on assets in the event of default.

With that said, it is certainly not impossible to finance a property through an LLC. Every bank has its own underwriting requirements, and some of them will grant mortgages to LLCs that meet their criteria. At a minimum, the bank will require you to show that the LLC has revenue by providing profit and loss statements and tax returns. Some banks may also require that the LLC has been in operation for several years.

Review your mortgage carefully before changing the current owner of record from yourself to an LLC. Most mortgages have acceleration clauses that allow the bank to call the entire loan in immediately if the borrower attempts to record a title change during the finance period.The same property records that record owners, also record lienholders, meaning the bank would find out as soon as you tried to deed the property to the LLC.

You may have to wait until the mortgage is paid off or get written approval from your lender to convert title on your property from your ownership to a trust or LLC while it's being financed. The good news is if you're still paying it off or close to paying it off, you have some new options for how to take title on your asset and protect it to the best extent possible.

Which One Is Better For You?

Both trusts and LLCs offer investors strong benefits in terms of legal protection and privacy. But no two investors are alike, which means that whether a trust or LLC is a good option for you depends on your long-term goals for the property.

When it comes to LLCs, the operating agreement will control a lot of how the asset is handled. That means it's a good idea to have an experienced attorney review the documents before signing. Putting a property into a trust can also be complicated because of the numerous options that exist in terms of how you can set trusts up. This is an area where a skilled attorney or estate planner would be of benefit.

Don't read this article and jump online to deed your property to a trust or LLC in one fell swoop. The wealthy and the famous have been using trusts and LLCs to own property for decades. But they only did so after consulting with skilled financial professionals. Before you deed your property to a trust or LLC, it's a good idea for you to do the same.

You Can Also Leave It To The Professionals

It's not hard to see the potential benefits of setting up a trust or an LLC for one or all your real estate assets. But it's not a process you can undertake easily, and setting up the wrong trust or LLC may be worse than not having one.If this all seems like too much work for you, you can always become a real estate investor by buying shares of public REITs or exchange-traded funds (ETFs). Then you'll get all the benefits of this type of property ownership without the headaches because the professionals will handle the heavy lifting. In the meantime, keep the trust or LLC option in mind for your income property or estate planning. It could be just what the doctor ordered.

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