Real estate holding companies or real estate LLC’s are designed to reduce personal exposure of an investor (property) to anticipated risks and liabilities. The company not only helps in simplifying taxes and bookkeeping but also isolating income from a property or specific properties. This is why most investors are advised to start with their own real estate holding companies.
Owning a property comes with its risks coupled with a possibility of loss and liability that impact the personal net worth. For investors looking to own a real estate for doing business, forming a real estate holding company can minimize such risks and impacts.
It consists of the ups and downs connected to the economy, inflation, market trends, and interest rate fluctuations.
The risk is proportional to the type of assets owned. Apartments are considered to be low-risk investments, but office buildings come with high-risk investments.
Related to a specific type of property, higher the risk more is the gain. Construction is an example that adds risk to a project as it limits the capacity to collect rent during that period. Entitlement and environmental risks are the other major idiosyncratic risks that can impact returns from real estate investment.
Not related to the actual structure of the building; it is the investment’s financial structure and rights offered to an individual participant. For instance, the structural advantage is higher in the case of a senior secured loan in comparison to subordinated debt or mezzanine. This is because the former has to be paid first.
Areas like Evansville are easy to invest compared to places like Houston. On the contrary, Houston will be able to attract a larger number of buyers, and it will be possible to sell off a property much quicker than Evansville.
Stability and length of the income stream of any property offer more value. A property leased to a multi-national company for 2-3 decades will command a comparatively higher price
With the increased demand for space, the lease rates in older properties tend to grow up. However, it will not sustain for a considerable period if those lease rates are not justified at par with new construction and increased supply.
Risk increases with the debt involved in a particular investment. Leverage acts as a force multiplier that can move the project quicker besides increasing returns if things go well. On the contrary, if the loans are under stress, especially when the returns on assets aren’t enough to cover the interest payments, an investor loses quickly and in large amounts.
Limited Liability or LLCs are the preferred business structures for most real estate holding companies. An LLC offers protection to the business entity and allows them to claim on the personal tax returns. To form an LLC, individuals need to file a COF or Certificate of Formation alternatively known as Articles of Organization. The certificate requires you to mention the state you wish to operate in. The entire process requires paperwork and attracts a fee that ranges from $50 to $200.
In most states, an LLC needs to be renewed each year by paying a nominal fee. Also, the company has to register for tax ID with the IRS. In case the company has to be made with additional members, it is important to draft an operating agreement that details about the management of the company.
The sole purpose of making a Real Estate Holding Company is to own real estate. The holding company is formed to execute a contract for sale and the deed in its name. In case one seeks financing, they need to pledge the mortgage under the name of the real estate holding company.
As mentioned, the holding company offers protection to the personal assets against the liability of owning real estate as an investment. On the other hand, it also provides tax benefits for the properties and keeps the property’s finance separated from the personal finances.
It is quite simple to start a real estate holding company. The first step is to set up an LLC. This requires choosing and registering a business name. You also need to mention the state this LLC would be operating in. You have to make sure that the name of the business is unique, and there is no such name that has already been registered. The business name should end in Limited Liability Company, LLC, or a variation that signifies the type of entity it is.
Each state has its own LLC office which is associated with the Secretary of State’s Office. To check if you have selected a unique name you may call them. You may also ask your lawyer to check online and verify if that particular name has already been registered.
Next, you need to apply for EIN or employer identification number with the IRS. The moment you have the business name and EIN, you have to file the paperwork to incorporate the LLC. In most cases, you will also have to file the articles of incorporation at the respective offices in the state.
In the next step, you should be creating an operating agreement for the LLC. This agreement has to spell out the rights and responsibilities of each member. It also contains information about the voting structure, the interest percentage of each member, and how profits and losses will be managed.
Finally, before you begin operations, it will be important for you to create a business checking account in the name of your LLC. This way, you will be able to separate the funds for purchasing the property and your funds. The moment you have separated the funds, you are all set to search for and purchase a property.
The above steps are relatively simple, but it will be a good idea to consult an attorney to ensure everything is carried out smoothly.
When the interests of real estate are placed in a property-holding company, it provides added protection to your assets and primary business assets. An example of why such protection is beneficial is illustrated below.
For instance let’s take the case of a real estate LLC that owns a restaurant. In case a customer by accident gets injured due to any property issues like a broken step, the customer is likely to sue the property owner. However, as the property belongs to a real estate holding company, the owner’s personal and business assets will be protected from the lawsuit.
Other advantages include:
Generally, fit for both long term, and short term investors, a real estate holding company apart from above advantages, is an inexpensive organization to manage. The costs and commitment are nominal against the benefits. This type of company is perfect for Fix and Flippers, Long-term investors, commercial investors, real estate investors, first-time investors, and landlords.
On the flip side, it is not advised if you are merely purchasing a home as your primary residence. In this case, an LLC will be costly and require high maintenance. Thus ensure you keep the primary residence in your name.