Author Topic: Real Estate LLC with Parents  (Read 12020 times)

GrayGhost

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Real Estate LLC with Parents
« on: September 04, 2013, 11:39:30 PM »
Hi all, sorry in advance for the long post.

I have been lurking on MMM forums for a while, in addition to following the blog over at Bigger Pockets and talking to friends and other associates who have been doing landlording for some time, and I think I'm almost ready to get the ball rolling on an LLC for doing rentals with my parents.

Background:

I'm still in college for another year, but scholarships and work mean that I support myself and have saved up a couple thousand bucks over the years after putting money into my IRA. Afterwards, I'll be in the military as an officer (and I have plans for getting 0 down VA loans on multi-family places--more on that other time, I guess) and I will have much more money to save and invest.

My father is a dentist, and my mom currently doesn't have a formal job since she's still a full-time mother. They have an SEP-IRA that has been maxed out for a while, and I have done the math--via the 4% rule, they're pretty much set for life as long as they make a few reasonable adjustments. They own their own house and they also have over a half million that used to be in a savings account earning about 1% a year, until about six months ago when I got them to put it into a few mutual funds (mostly indexes). Within another six months, my mom will get a real estate license and might well start to be a broker full or part time. In the future, my dad might start another dental practice or something like that. In other words, they're in superb financial condition and they live a relatively reasonable lifestyle, except for a large house and nice cars, but that might change in the foreseeable future.

The Plan:

As of now, we have agreed to start an LLC that's owned equally by each of us (50% me, 50% them). My dad's accountant is able to set this up for us, and will be able to do our taxes and stuff like that going into the future. My parents also might set up another LLC just for them, or for themselves and other investors, so that they can get really large apartment buildings, but that's outside of the scope of this post.

I have a little over $20,000 outside of retirement accounts, so I plan to put all of this into the LLC, while my parents will match that contribution to give each of us a 50% stake in the enterprise. I understand that it's tougher and more expensive to get mortgages as an LLC until you're established, but I am hopeful that since my parents have such excellent credit and financial histories, we might be able to get a decent deal. I'd love to hear your opinions and experiences with getting a good mortgage as an LLC.

As this is our first time landlording, we're going to do something very close to where my parents live, as in, within five or so miles. I've done a ton of research, and there are plenty of condos, townhomes, and single-families that meet or beat the 50% rule... for a thirty year FRM with rates of about 5%. I'm not sure how the math will work out at commercial mortgage rates for potentially shorter periods of time, but once we start to look at foreclosures and short sales, I'm confident that we'll be able to get a good deal. Ours is a great area with low crime, an excellent schooling system, reasonable costs of living, a good job market and more, so I don't foresee long periods of vacancy in the future. Friends of ours in the area who do some landlording have had pretty good experiences overall.

Since I won't be in the area and since my parents won't be doing renovations on their own, we will have to hire contractors, but we know a couple of reasonable guys in the area, so the profit margins should be more or less okay. I really have to do math for particular cases, I suppose, but I can only do that once we start to look at specific properties and we have mortgage pre-approval, so we know how much of a financial burden the mortgage will be.

Our goal with this LLC and our joint investing is a relatively hands-off approach that will produce passive income. My parents will both have full-time obligations in the future, and I won't be in the area, so this isn't really subject to change. I understand that we might miss out on the best deals and greatest opportunities, but even a few hundred dollars of cash in the bank a month is great, plus extra money from appreciation and tax benefits. We don't intend to hire a property manager (until we have multiple properties, if and when we get to that point) and I am confident that I will be able to get a system up and running for collecting rent, advertising, and doing background checks very soon.


Whew, thanks for reading all of that! Anyway, I welcome any feedback, especially from those of you who have used LLCs to own property in the past and those of you who own properties with your parents or other family members. Thanks in advance!
« Last Edit: September 04, 2013, 11:45:01 PM by GrayGhost »

willn

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Re: Real Estate LLC with Parents
« Reply #1 on: September 05, 2013, 08:48:59 AM »
Since I won't be in the area and since my parents won't be doing renovations on their own, we will have to hire contractors, but we know a couple of reasonable guys in the area, so the profit margins should be more or less okay


Quote
Our goal with this LLC and our joint investing is a relatively hands-off approach that will produce passive income. My parents will both have full-time obligations in the future, and I won't be in the area, so this isn't really subject to change.

These two things don't quite match up too well.  Renovations can require close attention to detail, and so can property management.  You can hire property managers of course, but they vary wildly in diligence and can quickly eat up profits if they screw up.

None of what you say sounds horrible, and I don't necessarily disapprove of your plan, but why are you so motivated for real estate investing?  Since you won't be nearby, and your parents are busy, the risk factor goes up, financially, and relationally.  How strong is your relationship with your parents?  Can they afford to take a bath or come out even? If that happens, will it damage your relationship? Do you have siblings? Will they be affected?  How will your parents deal with the properties if multiple things go wrong at once, say, a natural disaster followed by 4 months of vacancy, along with a drop off in dentist business.

One thing that stands out to me about your plan is the overhead of managing--construction, property, finances. Sounds like you're hiring people to do all of these, and when you deal in real estate and construction, count on everything taking 2x as long and costing 2x as much.  If it does, do you still win?  One good way to win with real estate is to buy bargains and keep overhead very, very low by doing things yourself.

All these types of plans sound great when everything works.   What you need to look at is does if still go well even if things don't work the way you plan....

Good luck and let us know how it goes!

GrayGhost

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Re: Real Estate LLC with Parents
« Reply #2 on: September 05, 2013, 11:04:26 AM »
When I said that my parents won't be doing renovations on their own, what I mean is that they won't personally be painting, changing out carpets, et cetera, but will instead hire contractors to do it. We don't intent to use property managers unless we get several properties, so there will be a lot of attention paid to the detail of any renovations that have to be done after several years of letting out a place, or if we buy on in a fixer-upper condition.

Quote
None of what you say sounds horrible, and I don't necessarily disapprove of your plan, but why are you so motivated for real estate investing?  Since you won't be nearby, and your parents are busy, the risk factor goes up, financially, and relationally.  How strong is your relationship with your parents?  Can they afford to take a bath or come out even? If that happens, will it damage your relationship? Do you have siblings? Will they be affected?  How will your parents deal with the properties if multiple things go wrong at once, say, a natural disaster followed by 4 months of vacancy, along with a drop off in dentist business.

Our relationship is fine, and the reason I want to do real estate is to build up a small passive income portfolio. They want to do it for the same reasons. My parents can afford to lose out financially, and even if the worst were to happen, I think our relationship would be fine. I have a sister who will be going to college in a few years, but there will be scholarships and such, and my parents will still have a lot of money, so I'm not too worried about messing up her life.

I think my parents are more than prepared for a worst case scenario, since about half of my dad's practice's profits get banked, he pays himself some of what remains, and he and my mom spend about 50% of that. Our area is growing rapidly, so I don't think there'll be a drop off in business or long-term vacancy.

Quote
One thing that stands out to me about your plan is the overhead of managing--construction, property, finances. Sounds like you're hiring people to do all of these, and when you deal in real estate and construction, count on everything taking 2x as long and costing 2x as much.  If it does, do you still win?  One good way to win with real estate is to buy bargains and keep overhead very, very low by doing things yourself.

We won't be hiring a property manager, and although there is a one-time fee to set up the LLC, I don't think the fees for getting our taxes done by the accountant will be very high at all, since he and my dad have a relationship going back years, he does taxes for my dad's practices, and he's done my taxes for the past few years without asking for anything extra.

So, it's true that we are outsourcing finances, but the costs of this will be low. Construction will be outsourced, but general property management will not.

I've done the numbers on a couple of properties a few weeks ago for dramatically high interest rates and vacancy rates (5-6% and 10%) and there's still plenty of money after taxes to go towards reinvesting, renovation, and other things, so even though our margins aren't as good as they would be if we insourced everything, it's not really an option to do that. My only real requirement is something that's cashflow positive, not necessarily an amazingly awesome deal.

Thanks for the advice!

willn

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ok
« Reply #3 on: September 05, 2013, 11:46:10 AM »
Ok, like I said, it isn't a horrible plan.  I do suggest you resolve to keep your debt ratio's very very low compared to your debt.  Like 50% low.  Lots of real estate investors make it fine for 10 years and keep piling on debt.  Then, when another S&L crisis hits, or mortgage interest spikes, or war happens, or stock market bubble bursts, and their portfolio value drops in half, they are screwed and the bank calls the loans.

So the idea is to be patient, well capitalized with equity, and let this thing gain steam over a decade or more.  Buy more properties only when you can keep your debt low.

Lots of people disagree with me by the way, and see leverage as a magic pill to get rich quick, I prefer the slower method.  So.

Our area is growing rapidly, so I don't think there'll be a drop off in business or long-term vacancy.

Note that this veers into "aspirational forecasting".  Instead of hoping it continues, assume it won't, and invest accordingly.  Like I said, you win in the long run, only if the deal works even when things go bad.

Since you're in college, maybe you're in your early twenties? I suggest going out and finding a 55 year old real estate investor who made it through the last 3 major crises and is still wealthy. Ask him why he survived the early 80's, the early 2000's, and 2007-8 for example.  If he crashed and burned in those years, ask him how it felt and what he'd do different.




GrayGhost

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Re: ok
« Reply #4 on: September 05, 2013, 03:23:16 PM »
Ok, like I said, it isn't a horrible plan.  I do suggest you resolve to keep your debt ratio's very very low compared to your debt.  Like 50% low.  Lots of real estate investors make it fine for 10 years and keep piling on debt.  Then, when another S&L crisis hits, or mortgage interest spikes, or war happens, or stock market bubble bursts, and their portfolio value drops in half, they are screwed and the bank calls the loans.

So the idea is to be patient, well capitalized with equity, and let this thing gain steam over a decade or more.  Buy more properties only when you can keep your debt low.

Lots of people disagree with me by the way, and see leverage as a magic pill to get rich quick, I prefer the slower method.  So.

I tend to agree that it's best to get rich slow rather than quickly, but what's wrong with a 5:1 or 3:2 levered investment in real estate? If I wait until I have the cash to buy a place outright, or even buy 50% of a home outright, it'll take time, and it's an incentive to do bad math, because once you own a place outright, it's far easier to get (force) positive cashflow. Our first investment will give us an extremely high debt ratio, there's no avoiding that unless I dump in thousands and thousands of dollars that can be used for other things.

I'm not going to spend money on investments the moment that I'm able to, but I really disagree with the Mustachian idea that one ought to buy investment properties outright.

I'm not sure that banks can call loans as long as you make regular payments. That doesn't seem right to me, unless you have a shady contract. I've never heard of a bank calling in a loan when the lendee is following contractual terms. Can you give me an example of a bank calling in a loan that's being paid back in a timely manner?

Note that this veers into "aspirational forecasting".  Instead of hoping it continues, assume it won't, and invest accordingly.  Like I said, you win in the long run, only if the deal works even when things go bad.

I have every intention of sticking to the 50% rule. In fact, I have done the math with 0% down, 5% interest rate, 10% vacancy, and other worst case scenario parameters, and there are still opportunities in my area. I have every intention of being conservative with this kind of thing, especially since we're just barely getting our feet wet. Houses are still well-priced in my area, so once we get into looking at short sales and foreclosures, I am confident we can find good deals.

Since you're in college, maybe you're in your early twenties? I suggest going out and finding a 55 year old real estate investor who made it through the last 3 major crises and is still wealthy. Ask him why he survived the early 80's, the early 2000's, and 2007-8 for example.  If he crashed and burned in those years, ask him how it felt and what he'd do different.

I am in my twenties, and my parents have family friends that have been doing real estate since the late eighties--mostly in our area, but also in others, and now they have multiple properties as well as a large apartment complex that they own with another couple. My parents have talked to them a lot in the past few months, and it's getting time for me to sit down with them and ask a bunch of questions as well. We also have several other friends who do real estate on the small scale (two to five or so places) and have been taking their input for some time as well.

Thanks for all the advice.
« Last Edit: September 05, 2013, 03:29:12 PM by GrayGhost »

willn

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Re: Real Estate LLC with Parents
« Reply #5 on: September 05, 2013, 06:08:26 PM »
Re: calling loans:

Rare. Not as rare with commercial or hard money loans. Read the fine print, each loan contract is different. Sometimes there are clauses where if the collateral is no longer valuable enough to secure the property they want to call it. In recent times banks have such a backlog of foreclosed properties they aren't aggressive with these tactics. But read the fine print. In five or ten years the environment may be different.

CatamaranSailor

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Re: Real Estate LLC with Parents
« Reply #6 on: October 02, 2013, 10:10:49 AM »
IMHO...doing business with family is always a recipe for disaster. If things turn south, you could very well damage the relationship forever. I know they are your parents and things sound all rosy in the beginning...but if there is one thing that doesn't mix it's money and family.

There are always good deals to be found and you are still young. If I were in that situation, I would thank my parents profusely for even thinking about getting into business with me...and I would then bow out gracefully.

Save up some money, buy a little fixer. Live in it and fix it up yourself.

You'll learn invaluable skills, you'll keep the family relationship intact and you'll be able to look them in the eye and say "Yep...did this myself. No help!"

No one breathing down your neck, no one asking you for status updates, no sleepless nights worrying about losing your or your parents money).

Have I known people who've made family businesses work? Yes! Absolutely! But I also know a heck of a lot more who got into some type of business deal and no are not on speaking terms.

Just food for thought!

Good luck!!

KingCoin

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Re: Real Estate LLC with Parents
« Reply #7 on: October 02, 2013, 06:16:15 PM »
Why not just invest it in the S&P500? It should outperform real estate over the long haul (you're plenty young) with the added upside of not having to worry about deadbeat renters or fielding calls at 1am about clogged toilets. Not to mention that stocks are a far more liquid vehicle that you can easily liquidate to, for instance, buy your own place or deal with other unforeseen expenses as you transition into real-life.

You seem like a thoughtful guy who's getting up to speed quickly on the real estate game, but plowing your entire net worth into a partnership LLC and trying to manage a property remotely seems unnecessarily complicated, especially at this stage in your life.  I like the idea of planting seeds early and potentially leveraging off your parents credit and assets, but I think the downsides outnumber the upsides vs traditional assets. You're probably better off waiting, building up a bigger stache, and then pouncing when you find a screaming deal. Just one guy's opinion.

TrulyStashin

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Re: Real Estate LLC with Parents
« Reply #8 on: October 04, 2013, 09:15:27 AM »
Why not just invest it in the S&P500? It should outperform real estate over the long haul (you're plenty young) with the added upside of not having to worry about deadbeat renters or fielding calls at 1am about clogged toilets. Not to mention that stocks are a far more liquid vehicle that you can easily liquidate to, for instance, buy your own place or deal with other unforeseen expenses as you transition into real-life.

You seem like a thoughtful guy who's getting up to speed quickly on the real estate game, but plowing your entire net worth into a partnership LLC and trying to manage a property remotely seems unnecessarily complicated, especially at this stage in your life.  I like the idea of planting seeds early and potentially leveraging off your parents credit and assets, but I think the downsides outnumber the upsides vs traditional assets. You're probably better off waiting, building up a bigger stache, and then pouncing when you find a screaming deal. Just one guy's opinion.

+1

But if you really want to do this............

Please please please get a good lawyer involved with the creation of the LLC.   

Here's why.... every state has default rules in place for how the contractual relationship among LLC members is governed but those default rules may or may not work for your situation.   That's why every LLC with more than one member should have an "operating agreement" which contractually binds the members to one another.  In the OA, you and your parents can set out how to allocate profits, losses, responsibilities, whether one member can bind the whole LLC (by contract to a third party) without consulting the other members, how one member can leave the LLC if s/he so desires, and so forth.  You can (and should) also add "duties of loyalty" in the OA.   Essentially, the OA creates the rules by which you'll interact with one another and having rules and guard rails set forth that are negotiated and agreed to right now WHEN EVERYONE IS OPTIMISTIC is essential because when you disagree about something later, you have the rules to guide you and reduce/ prevent conflict.

And there WILL be conflict.

Finally, the 50/50 set up you're considering treats your parents as if they are one unit and they are not.  Coverture no longer exists in U.S. law -- your mother and father are distinct individuals.  Therefore your LLC has 3 members, not two.  You each have a 33.33% share.

Get a good business lawyer to advise you. The money you spend up front now is a wise investment to prevent problems later.

Or just put your money in an index fund with reinvested dividends and spend your energy building your military career.

MrMoneyPinch

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Re: Real Estate LLC with Parents
« Reply #9 on: October 04, 2013, 01:43:55 PM »
Why not just invest it in the S&P500? It should outperform real estate over the long haul (you're plenty young
Um. I will sound dismissive, but I can't let this slip.

If you are operating a business that is giving back less than the public stock index, you probably are in the wrong business.

Stock returns are made after paying for the business AND it's management.   If you are managing, you should at least make the management ratio.   Anyway, what is the point of doing work if you can make the same or more by doing nothing?

 If what you meant only included capital gains, then I agree, but operating a land lording business for capital gains only is pure speculation, not business or investing.

KingCoin

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Re: Real Estate LLC with Parents
« Reply #10 on: October 04, 2013, 02:52:43 PM »
Um. I will sound dismissive, but I can't let this slip.

If you are operating a business that is giving back less than the public stock index, you probably are in the wrong business.

Stock returns are made after paying for the business AND it's management.   If you are managing, you should at least make the management ratio.   Anyway, what is the point of doing work if you can make the same or more by doing nothing?

 If what you meant only included capital gains, then I agree, but operating a land lording business for capital gains only is pure speculation, not business or investing.

It's of course true that, in theory, managing a property yourself should yield more profit than hiring a property management company. But you're working for those marginal returns, so it's not a free lunch. Secondly, since the buyer has no experience managing property, has no economies of scale, and lives in a remote location, I have to expect the value add is going to be low, and perhaps even negative vs a traditional property manager.

Do you have evidence that self managed property outperforms equity over time? Simply arguing that corporate management gets paid, therefore it should do worse, doesn't really hold water if the assets live in different places on the risk/return frontier. To be clear, I'm not arguing that one asset class is categorically better, but rather that equity is a hell of a lot easier, cleaner, and less likely to lead to strife, all without sacrificing much, if any, expected return.

To me, it seems like the biggest sources of conflict are likely to be:
1) How to divvy up management duties. It's human nature to believe that you're shouldering the lion's share of the load (everyone thinks they're doing 70%) so this is a natural point of contention. It's easy for resentment to build if you feel like the other party is shirking.
2) How to exit amicably and fairly if you want out. This can be especially sticky if things aren't going swimmingly with the property.

Both items point to it being much easier to go it alone when you have the resources to do so. At the very least, hiring a property manager might be reasonable idea.


« Last Edit: October 06, 2013, 02:19:36 PM by KingCoin »

knownastron

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Re: Real Estate LLC with Parents
« Reply #11 on: October 09, 2013, 09:34:44 PM »
I'm actually in basically the same situation. College student with some spare cash hoping to leverage my parent's perfect credit and dormant cash.

I've talked with my parents about going into real estate together, without becoming an LLC and working at a more primitive level. With them putting up much more money than I would, but I would be 100% responsible for the management.

I'll be watching this thread closely!

TrulyStashin

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Re: Real Estate LLC with Parents
« Reply #12 on: October 11, 2013, 07:57:52 AM »
I'm actually in basically the same situation. College student with some spare cash hoping to leverage my parent's perfect credit and dormant cash.

I've talked with my parents about going into real estate together, without becoming an LLC and working at a more primitive level. With them putting up much more money than I would, but I would be 100% responsible for the management.

I'll be watching this thread closely!

When I was in law school, we learned the law by reading opinions handed down in lawsuits ("caselaw") that all had their roots in this kind of idea. Happy, excited people starting out on a business venture together but without the proper legal protections, only to wind up in court five years later for a variety of reasons.   

Just reading this post sent a chill down my spine.   Do not do this without a LLC and an operating agreement drafted by a good  lawyer (not LegalZoom or some other software; a real lawyer who will ask questions you never considered in order to ensure you're protected).  The legal implications of operating as "general partners", which is what you're proposing, are horrific.

But then, I told my brother the same thing, and he ignored me and signed the lease for his restaurant's space in his own name instead of setting up the LLC.  Three years later he was bankrupt.


KingCoin

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Re: Real Estate LLC with Parents
« Reply #13 on: October 11, 2013, 08:24:20 AM »
I'm actually in basically the same situation. College student with some spare cash hoping to leverage my parent's perfect credit and dormant cash.

I've talked with my parents about going into real estate together, without becoming an LLC and working at a more primitive level. With them putting up much more money than I would, but I would be 100% responsible for the management.

I'll be watching this thread closely!

A much cleaner arrangement? Your parents buy the property and hire you as property manager for 10% of the rental revenue. The potential complications of joint ownership aren't worth the marginal return you're going to earn on your $5-20k stake. This would allow you to learn the property management business, make a little dough at it, but also allow you to walk away if circumstances change and being involved in this property is no longer a priority for you (things can still get complicated if you do a lousy job and your parents need to fire you, but it's far better than a joint ownership entanglement). It would be a simple enough matter to hire another property manager and everyone can go on their merry way. If things go great, and you're a little more flush, you can consider starting an LLC and making a joint purchase of another property, this time with some experience under your belt and a track record of working with your parents on a real estate venture.

MKinVA

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Re: Real Estate LLC with Parents
« Reply #14 on: October 11, 2013, 03:25:59 PM »
I just have to say that anyone who thinks being a landlord is creating passive income has never been a landlord! There are always emergencies that cost more than you plan and occur at the worst time. It only takes one bad tenant to blow your entire year's income stream.

MrMoneyPinch

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Re: Real Estate LLC with Parents
« Reply #15 on: October 11, 2013, 04:37:13 PM »
I just have to say that anyone who thinks being a landlord is creating passive income has never been a landlord! There are always emergencies that cost more than you plan and occur at the worst time. It only takes one bad tenant to blow your entire year's income stream.
That is exactly what I was trying to say in my last post.

Operating any business takes time and presents a certain amount of *risk*.  That risk is factored into the price of publicly traded companies;  that is why each and every stock has a different long-term Price/earnings ratio.  A bottle-rocket junior-mining stock costs little for the earnings, but those earnings are less certain and there is a greater chance of failure (or disproportionate success) than a blue-chip stock, like General Electric, which has neither good nor bad surprises in store for the investor.  That is called the "risk premium" by the pros.

When you operate your own business, that *risk* is your own to evaluate and price.  You can invest in a piece of land which returns nothing and run the risk it's price rises;  a professional investor would demand a better return in such an operation than if he/she were investing in CD's for example.   

The landlording business has clearly identified inherent risks AND is work.  I am not interested in taking a risk and working hard if there is not a good return to be expected.  The risk is amplified by the fact that you use leverage to "buy into" that business;  depending on the size and the leverage, you could have bigger swings than you can paper over with your salary income.

Of course, if you start with good positive net income and manage the risks and the business well, landlording is a rewarding business!  I have success in it, MMM has success in it, a lot of good and average people make good money in it.  BUT  I know people who lost more than they put in at the start, and had to cut their losses by doing a fire sale.  I bet the biggest mistake they made is not measuring the risk right and paying too much for their properties.

On a side note: when you buy a rental property, you are buying into a certain clientele.  The only way your clientele will change is by act of God, or if you have enough money to fund your own gentrification project ($$$$$$$$!)  So look closely at the tenants, or neighbors if you are buying a single-unit, and decide if that is the style of business you are prepared to operate.

New Balance

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Re: Real Estate LLC with Parents
« Reply #16 on: November 14, 2013, 08:01:38 AM »
Since no one else as mentioned it;  I don't think it is possible to buy a multi-family home with a VA Loan.

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Re: Real Estate LLC with Parents
« Reply #17 on: November 14, 2013, 08:11:17 AM »
Since no one else as mentioned it;  I don't think it is possible to buy a multi-family home with a VA Loan.

Depends on what multifamily means to you.  1-4 units is considered the same for mortgage purposes, only 5 units or more is different.

So a fourplex, for example, falls in that weird area to be called a "multifamily" by most people, but considered the same as an SFR by the bank.
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GrayGhost

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Re: Real Estate LLC with Parents
« Reply #18 on: November 26, 2013, 11:08:01 AM »
Quick update... the legal structure has been created and we're in the process of opening up bank accounts and getting loan pre-approval. We're also scouting out a six unit place that meets the 50% rule given a 0 down, 7% interest rate, 30 year mortgage. I'm pretty hopeful about this one, since it's already got 100% occupancy, individually metered power/water and is in a nearby, decent part of town. Last year's cap rate was over 10%.
« Last Edit: November 26, 2013, 11:10:44 AM by GrayGhost »

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Re: Real Estate LLC with Parents
« Reply #19 on: November 26, 2013, 12:19:35 PM »
Quick update... the legal structure has been created and we're in the process of opening up bank accounts and getting loan pre-approval. We're also scouting out a six unit place that meets the 50% rule given a 0 down, 7% interest rate, 30 year mortgage. I'm pretty hopeful about this one, since it's already got 100% occupancy, individually metered power/water and is in a nearby, decent part of town. Last year's cap rate was over 10%.
I will be eager to hear what mortgage terms you are offered as an LLC. Unfavorable mortgage options have been one of my biggest reasons I haven't purchased through an LLC.

FWIW, yes it's true, as some have pointed out, that historical average appreciation of real estate has been less than the rate of return of the total stock market. That argument applies if your real estate investment return is based on property value appreciation, but doesn't really apply to the OP as he is looking at rental income as his primary investment return. Whether or not this beats the stock market depends almost entirely on his local market conditions, and from what he writes, they sound very favorable for landlords. If ROI from the rental beats the market, and appreciation equals inflation over the long term, then he's doing fine relative to the market, tax considerations aside.

Daleth

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Re: Real Estate LLC with Parents
« Reply #20 on: November 26, 2013, 01:17:37 PM »
Quick update... the legal structure has been created and we're in the process of opening up bank accounts and getting loan pre-approval. We're also scouting out a six unit place that meets the 50% rule given a 0 down, 7% interest rate, 30 year mortgage. I'm pretty hopeful about this one, since it's already got 100% occupancy, individually metered power/water and is in a nearby, decent part of town. Last year's cap rate was over 10%.

Did your bank say 0 down was possible? I've never heard that for an investment property. You can't even do 0 down for a single-family that you're moving into these days.

arebelspy

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Re: Real Estate LLC with Parents
« Reply #21 on: November 26, 2013, 02:02:20 PM »
Quick update... the legal structure has been created and we're in the process of opening up bank accounts and getting loan pre-approval. We're also scouting out a six unit place that meets the 50% rule given a 0 down, 7% interest rate, 30 year mortgage. I'm pretty hopeful about this one, since it's already got 100% occupancy, individually metered power/water and is in a nearby, decent part of town. Last year's cap rate was over 10%.

Did your bank say 0 down was possible? I've never heard that for an investment property. You can't even do 0 down for a single-family that you're moving into these days.

Doesn't matter, you run the numbers with nothing down to make sure it cash flows, and that the amount you're putting down isn't "forcing" cash flow.

Then you run the numbers with whatever you're putting down to determine other metrics (cash on cash, cap rate, etc.)

FWIW, I know many people who have bought properties with 0 down, but not with conventional financing, it takes more creative financing to do that.
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GrayGhost

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Re: Real Estate LLC with Parents
« Reply #22 on: November 26, 2013, 08:15:46 PM »
As arebelspy has said, I've run the numbers for a 0 down loan just to make sure that we're not going to force cashflow.

We had a chance to talk to a commercial lender representative today, but he offered us a 10 year loan at 5%, and the numbers don't work out for that... it barely flows cash in that case and doesn't come close to meeting the 50% rule. I've done some research, and it looks like it might be possible, if difficult, for us to get this place through an LLC with a long-term FRM.

Any tips on how to proceed? Since it's a 6 unit property, we -must- use a commercial loan no matter if we buy it through an LLC or if my parents buy it personally. Where can I find commercial/multifamily loans with long amortization periods, with relatively low minimums? The place we're looking at is on sale for less than $500k.

Hamster

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Re: Real Estate LLC with Parents
« Reply #23 on: November 27, 2013, 03:05:44 AM »
As arebelspy has said, I've run the numbers for a 0 down loan just to make sure that we're not going to force cashflow.

We had a chance to talk to a commercial lender representative today, but he offered us a 10 year loan at 5%, and the numbers don't work out for that... it barely flows cash in that case and doesn't come close to meeting the 50% rule. I've done some research, and it looks like it might be possible, if difficult, for us to get this place through an LLC with a long-term FRM.

Any tips on how to proceed? Since it's a 6 unit property, we -must- use a commercial loan no matter if we buy it through an LLC or if my parents buy it personally. Where can I find commercial/multifamily loans with long amortization periods, with relatively low minimums? The place we're looking at is on sale for less than $500k.
I don't think that the loan you are looking for can be had anywhere. Last I looked at commercial loans a few years ago, lenders typically offered a 5 year loan which is amortized over 30 years, with 30% down. At the end of the 5 years, you make a balloon payment of the balance or refinance.

 I can't imagine anyone would issue a 30 year fixed rate commercial loan, since it is too risky and when interest rates go up (they will go up in the next 30 years) they will be stuck with that crappy return. The only reason residential mortgages like that exist is because of government policies which insure them and make them viable. Would you loan money at 4.5% fixed for 30 years without a guarantee?

GrayGhost

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Re: Real Estate LLC with Parents
« Reply #24 on: November 27, 2013, 08:29:09 AM »
Yeah, you're probably right about that... in any case, I crunched the numbers a bunch of times and it looks like it'll work out if we bump up the rent by ~10% (should be possible given current conditions) and lock in a 15 year mortgage at 6, or a 20 year mortgage all the way at 7.2 percent. We're going to try and see if this is possible...

arebelspy

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Re: Real Estate LLC with Parents
« Reply #25 on: November 27, 2013, 11:16:04 AM »
I crunched the numbers a bunch of times and it looks like it'll work out if we bump up the rent by ~10%

This is called "eraser math" and it's not good to base your investments on...
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GrayGhost

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Re: Real Estate LLC with Parents
« Reply #26 on: November 27, 2013, 03:52:01 PM »
Just visited the area and reviewed pictures of the interior... it won't be possible to bump the rent up, not without a lot of renovation anyway. We're going to talk to a couple of lenders and see if they can give us longer amorization periods in exchange for higher interest rates, and if that works out and we can get a pretty low offer accepted, we can do it.

Our agent sent us another, even more promising listing though. This one is a quad, and last year's cap rate was over 12%. The sticking point right now seems to be securing a good mortgage... I really want to stick to the 50% rule, but if it doesn't work out for our LLC, my parents will probably buy it personally.

arebelspy

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Re: Real Estate LLC with Parents
« Reply #27 on: November 27, 2013, 06:10:39 PM »
We're going to talk to a couple of lenders and see if they can give us longer amorization periods in exchange for higher interest rates, and if that works out and we can get a pretty low offer accepted, we can do it.

Not sure I agree with that, but I can see the merits based on one's prediction of future interest rates.

Our agent sent us another, even more promising listing though. This one is a quad, and last year's cap rate was over 12%. The sticking point right now seems to be securing a good mortgage... I really want to stick to the 50% rule, but if it doesn't work out for our LLC, my parents will probably buy it personally.

Definitely agree with waiting for the right deal.  Let your parents do what they want, but don't rush to buy anything if it doesn't meet a narrow criteria you define.
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Hamster

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Re: Real Estate LLC with Parents
« Reply #28 on: November 27, 2013, 06:20:05 PM »
Just visited the area and reviewed pictures of the interior... it won't be possible to bump the rent up, not without a lot of renovation anyway. We're going to talk to a couple of lenders and see if they can give us longer amorization periods in exchange for higher interest rates, and if that works out and we can get a pretty low offer accepted, we can do it.

Our agent sent us another, even more promising listing though. This one is a quad, and last year's cap rate was over 12%. The sticking point right now seems to be securing a good mortgage... I really want to stick to the 50% rule, but if it doesn't work out for our LLC, my parents will probably buy it personally.
With a quad, they should be able to get much more favorable terms buying outside the LLC.

GrayGhost

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Re: Real Estate LLC with Parents
« Reply #29 on: November 29, 2013, 11:21:14 AM »
We're going to get personal pre-approval for my parents (well, my father, technically) today so that no matter what happens as far as LLC mortgages go, they can start to get a couple properties. The quad I mentioned is a great opportunity, and there's also another quad, and a couple of condos that look pretty great. If the LLC is a no go, my parents are ready to pull the trigger on a couple of properties personally, contingent on getting a green light from our friends, real estate agent, and inspectors.

arebelspy

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Re: Real Estate LLC with Parents
« Reply #30 on: November 29, 2013, 01:43:21 PM »
We're going to get personal pre-approval for my parents (well, my father, technically) today so that no matter what happens as far as LLC mortgages go, they can start to get a couple properties. The quad I mentioned is a great opportunity, and there's also another quad, and a couple of condos that look pretty great. If the LLC is a no go, my parents are ready to pull the trigger on a couple of properties personally, contingent on getting a green light from our friends, real estate agent, and inspectors.

(Emphasis mine.)

If there are that many opportunities and they have, I'm assuming, a limited amount of cash (say, enough to buy 5 or less), you should probably tighten your bing criteria so you get a screaming deal instead of just a good one - I.e. Likely none of the ones listed above.  Better to wait a few months and make your money when you buy then just buy one of the many ones currently available that's a decent deal in comparison to other areas, but not in comparison to each other and what you could get with patience and determination.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
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GrayGhost

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Re: Real Estate LLC with Parents
« Reply #31 on: November 29, 2013, 10:06:22 PM »
Our budget is quite high, so we could go with "okay" deals instead of smoking hot ones, especially with leveraging. I agree with you, though--I apply the 50% rule very, very conservatively, with 0 down and interest rates that are two points or more over what we were offered today. There are still two quads that meet and beat that figure, and a couple of the condos are right around that level as well.

We're going to prioritize going after the sweetest deals, of course, but since our budget is so high and we're so familiar with the area, I don't see anything wrong with going after a deal that's not quite as amazing as some of the ones we're jumping on, but very promising nonetheless.

I'll keep your advice in mind, though--it's important to remain conservative and skeptical. My parents have already rejected a couple of deals that our friends said look good, because they don't match our criteria.
« Last Edit: November 29, 2013, 10:37:51 PM by GrayGhost »

Hamster

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Re: Real Estate LLC with Parents
« Reply #32 on: November 30, 2013, 02:19:14 PM »
There are still two quads that meet and beat that figure, and a couple of the condos are right around that level as well.
My personal bias is that as an investor, be very wary of condos as rentals. You have too little control. It is typical for condo associations to limit the number of units that can be rented, and you can be stuck with a unit that can't be leased and is eating up your money. And, the condo association's priorities may differ from yours, so you get stuck paying in money to the association that you don't get a good return on. 

GrayGhost

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Re: Real Estate LLC with Parents
« Reply #33 on: December 03, 2013, 08:28:28 PM »
Thanks for the heads up, we'll look into any condos that seem good to the last detail.

GrayGhost

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Re: Real Estate LLC with Parents
« Reply #34 on: December 05, 2013, 04:14:53 PM »
I mustache you guys a quick question...

Is one supposed to apply the 50% rule for 10 year commercial loans? Because I haven't found any deals that come close to doing that. There are many that meet and easily beat the 50% rule for 30 year FRMs, but 10 year loans, even at 20% down, are a different matter.

The reason I ask is that my dad's accountant is highly concerned about shielding my dad's considerable cash and business assets. He's also looking several decades into the future, when my parents might want to start to give their stuff to my sister and I. Since he's got decades of experience with lots of upper-middle and comfortably upper-class clients, I can't just ignore his advice, and he recommends using our business setup just as I strongly as I recommend to my parents that it won't be necessary.

It's not like the 10 year commercial loan will result in negative cashflow, but they're just a couple hundred bucks from meeting the 50% rule. Am I being ultraconservative by worrying about this, is my dad's accountant being ultraconservative by worrying about lawsuits and estate issues, or is the truth somewhere in the middle?

In any case, we're just about ready to make offers (contingent on A-OK inspections) for one, maybe two places, so thanks to all of your guys and of course MMM himself for all of your help--you really do change lives for the better.

arebelspy

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Re: Real Estate LLC with Parents
« Reply #35 on: December 05, 2013, 05:14:34 PM »
It depends on the property type.  I certainly wouldn't expect 50% expenses on a NNN lease.

It'll be specific to the situation.

But the loan type won't change the expenses.  So yes, being on a 10-year loan may make you cash flow negative.  That may be acceptable due to the rate of equity buildup with the quick payoff schedule.
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Re: Real Estate LLC with Parents
« Reply #36 on: December 09, 2013, 10:58:25 PM »
First buy will be a 4-plex owned personally by my parents. Next will be a 6 unit place owned through our business setup. We're going to see both tomorrow with our inspector and make an offer on the former, contingent on sound, annotated records of expenses. We'll probably make an offer on the second one as well within a couple of days. Looks like we're finally starting to rock and roll here.

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Re: Real Estate LLC with Parents
« Reply #37 on: December 10, 2013, 02:30:46 PM »
First buy will be a 4-plex owned personally by my parents. Next will be a 6 unit place owned through our business setup. We're going to see both tomorrow with our inspector and make an offer on the former, contingent on sound, annotated records of expenses. We'll probably make an offer on the second one as well within a couple of days. Looks like we're finally starting to rock and roll here.

Congrats!  Thanks for keeping us updated!

GrayGhost

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Re: Real Estate LLC with Parents
« Reply #38 on: December 15, 2013, 01:39:19 PM »
Offers were made and accepted. We got significant amounts off of the asking prices, which were already quite good deals, so I'm really proud of the prices we got. Expected closing dates are in mid to late January, so we've got a couple of weeks to get the cash together for downpayments, fund the proper bank accounts, get tenant agreements drawn up, etc. Looks like the commercial loan will be a 20-25% down, 20 year ARM, currently set at about 5-5.2%.

I was actually thinking about moving the free-and-clear date up for at least the 6-unit place by making extra mortgage payments. It does consume cash and decrease leverage, but a guaranteed return rate of 5% is pretty good. What do you Mustachians think? I glanced at the numbers and it looks like an extra couple hundred a month can literally cut our payoff time in half, and leave a few hundred extra in profits. Seems like it might be a wise course of action, after a sizeable buffer of cash is accumulated for repairs and stuff.

EDIT: I just read this blog post: http://www.mrmoneymustache.com/2012/02/24/pay-down-the-mortgage-or-invest-more-a-winwin-question/
and the linked forum post too. Is there anything more to be said on the topic? It doesn't look like the specific idea of making extra mortgage payments was covered... I guess there's a lot to consider about it!
« Last Edit: December 15, 2013, 02:04:54 PM by GrayGhost »

arebelspy

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Re: Real Estate LLC with Parents
« Reply #39 on: December 15, 2013, 02:39:50 PM »
Congrats!

Regarding paying it off or investing, there's tons of threads related to discussing that.  Use the search feature and you'll have hours of reading. :)

I personally would be plowing that cash flow into buying more units, if you're still in the accumulation phase.

If you're close to FIRE and looking to reduce risk, then I'd start looking at paying down/off some mortgages, but I wouldn't be doing that now, personally.

Or extra wrinkle that would make many people vote pay it down is that it's an ARM, not fixed.

Like I said, you can probably find 5+ threads with dozens hundreds of posts talking about this exact topic.

But back on topic, congrats on the offer acceptances!
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Hamster

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Re: Real Estate LLC with Parents
« Reply #40 on: December 15, 2013, 04:22:32 PM »
Congratulations!

Hope everything works well for you.

As for my take on the pay it off vs. let it ride, it really is a question of whether you want to leverage that money and use it elsewhere. By leveraging it, you take on more risk, but potentially earn a lot more. If your long term plan is to buy more property and you expect to make (well) over 5% return, then go for it. If you only expect to make 6%, then the risk premium is definitely not worth it.

That calculus may change when interest rates inevitably increase.

GrayGhost

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Re: Real Estate LLC with Parents
« Reply #41 on: December 29, 2013, 10:54:08 PM »
Inspections are done and paperwork is processing. Looks like we're going to move forward on both, though there is of course some work that we'll have to get done first. The roof on one place is really bad, so we're either going to get a nice deduction for it, or we're going to get the seller to fix it first. (Probably going to go for a deduction, since he's got every motive to get a shady contractor to do an "okay" job--and he's definitely done stuff like this in the past).

Hoping to close in a couple weeks... until then, we're hard at work getting bank accounts together, accounts for tenants' deposits, et cetera, et cetera.

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Re: Real Estate LLC with Parents
« Reply #42 on: January 01, 2014, 09:20:26 PM »
Congrats! Really interesting thread to read. It sounds like you're being really careful in your selection of the properties. For selfish reasons, I want you to keep us updated as the adventure continues. 

GrayGhost

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Re: Real Estate LLC with Parents
« Reply #43 on: January 04, 2014, 10:03:34 PM »
Working on getting the prices down due to an issue that could cost a few thousand bucks to deal with, and has been put off by the seller for years. Finances are almost ready to rock and roll, so we hope that'll give us the leverage to talk the price down.

GrayGhost

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Re: Real Estate LLC with Parents
« Reply #44 on: January 14, 2014, 07:42:35 PM »
We're closing in on closing. Looks like we're going to get a 7% cap rate on bad years, which is fine by me. A few repairs will be performed as ownership changes hands, so I hope we've got a smooth few months ahead of us.

GrayGhost

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Re: Real Estate LLC with Parents
« Reply #45 on: February 09, 2014, 10:40:37 AM »
We've got most of our rent checks for the first house. One more is still in the mail, and since we closed in very early February (after rent was due), just before a whole lot of bad weather in our area, we're didn't charge any late fees as we're still finalizing leases and some other issues. Technically we will be cash flow negative for February, since we had to pay insurance for the year, but we are now full-fledged landlords and I would like to thank MMM forums and all of you who have helped us in this process. We're looking to close on the second property sometime next week or the week after that, pending some pre-sale repairs.

arebelspy

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Re: Real Estate LLC with Parents
« Reply #46 on: February 09, 2014, 11:14:06 AM »
Congrats!  Years from now you'll think back to all the things you could have done better, but won't have regretted just getting started.

You'll learn a lot as you go.  Keep us updated. :)
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.