Avoiding Common Landlord Liabilities

Whether you are a new landlord, an accidental landlord waiting for the market to recover before selling a house, or an expert in the business,  it is important to take a few minutes to consider some of the common risks that come with owning a rental property, and adjust your strategies to meet these demands.

Tenant Injuries

When a tenant is injured in a rental property – from a fall, an intruder, a dog — the first instinct is to blame the landlord. Avoid these common premise liability claims by inspecting the property regularly, and mitigating dangers around the property.

In some cases, that is as simple as warning the tenants about a known hazard, as in the case of a Houston landlord ordered to pay a $20 million judgment for failing to warn a female tenant that a sexual assault had occurred nearby just days earlier.

Environmental Hazards

Federal and state laws hold a landlord accountable for disclosing certain conditions on the property like lead paint in older homes, or the presence of mold.  More recent ordinances require landlords to disclose if drugs were manufactured at the property.  Local laws may require disclosure of recent bed bug infestations, and others require a statement regarding the presence of second-hand smoke.

Research the requirements in your area, download the necessary disclosure forms, and distribute the information to your tenants as required by law.

Tenant Crime

It is imperative to check the criminal history on every applicant before they move in, and routinely throughout a long-term tenancy.  This is a must not only for multifamily rentals, but for single-family homes as well.  If a landlord rents to a dangerous criminal, a neighboring resident may have a claim against the landlord for negligence.

A number of cities recently have enacted penalties against landlords if tenants are repetitively in trouble with the police.

Fire Mitigation

Following local building codes is one of the best way to minimize injuries from fire.  Others precautions include property inspections, and instituting a non-smoking policy throughout the property.

Discrimination

Virtually every landlord falls under federal, state or local laws prohibiting discrimination when it comes to housing.

Common cases prosecuted today involve race, families, and persons with disabilities requesting companion animals.  Landlords often land in hot water for falsely claiming that a vacancy has been filled to discourage a particular applicant.

It is important for all landlords to understand what behavior is prohibited, and avoid stating preferences which violate the law.

Carry Insurance

Despite the growing costs of property insurance, landlords should not risk being uninsured.  Even if they have enjoyed years of trouble free tenants, the costs of defending even one lawsuit can be significant.

Shield Your Assets

In many cases, a landlord can shield personal assets not related to the rental property in the event of a lawsuit.  Many choose the LLC route, and experts suggest forming a separate corporate entity for each property owned.  For more, seeForming a Real Estate LLC.  It is important to note that forming the entity before purchasing property may be significantly easier than transferring property, especially if it is subject to a mortgage.

http://www.american-apartment-owners-association.org/blog/2012/08/20/avoiding-common-landlord-liabilities/

Risks of Buying Real Estate in Emerging Markets Out of State

Real estate investors, hungry for break-even or positive cash flow rental properties, purchased income property out of state the mid 2000′s. California investors bought houses in Florida, Texas, and Oklahoma. Florida investors purchased houses in Louisiana. Texas investors purchased in Las Vegas. Some these investors made millions of dollars because of the appreciation in those hot markets.

On the other hand, many beginning investors lost their hard-earned investment capital or only made a meager profit because they failed to do their homework on the out of state area’s real estate market and customs. If you’re thinking about buying investment properties in a different state than you’re accustomed to, beware of these five surprises.

Pitfalls of Investing in “Emerging Markets Out of State

Surprise #1 – “This house will only rent for $750 per month, not $1200!”
This was one of the top mistakes made by investors. Large real estate investing groups, selling out of state properties to local investors, inflated the rental income. Because so many houses were purchased in a limited area by investors, a rental glut lowered expected income. This created hardships for investors who suddenly had to pay out hundreds of dollars a month instead of reaping promised profits.

Surprise #2 – “You can’t sell this house, now!”
Some investors who couldn’t rent the out of state property decided to sell because the values did rise significantly while the house was built or during the purchase time. However, many investors were stunned when they were told they couldn’t sell the property within the first year after purchase. Restrictions prohibiting real estate investors from quick-turning their properties is a trend that is growing increasingly popular with some developers.

Surprise #3 – “You Can’t Lease This Property!”
New home developers and many Homeowners’ Associations (HOA)s prohibit property owners from leasing their properties. Some of these restrictions got passed, without the investor being notified, during the property purchase phase. You must read the fine print to see if any clauses prevent the rental of the property. Home builders, to keep the value of the neighborhood up, added restrictions requiring the purchaser to occupy the home as a primary or secondary residence.

Surprise #4 – “These (extra) costs are the norm in this state!”
Besides extra closing costs like pricey surveys, common in Florida but rare in California, other surprise costs included higher transfer fees and taxes. Property taxes in Florida cost much more for investors in Florida than in California. On the other side of the country, out of state investors were shocked by California’s state tax held in escrow: 3.8% of the property’s SALE’S price, no matter the actual profit made. In other words, an investor who made a quick profit of $20,000 on a fast flip could have more than the profit held until the next year’s income tax filing.

Surprise #5 – “Houses don’t appreciate 30% per year here!”
Perhaps you’ve attended or been invited to a high-power investment seminar that promotes out of state real estate investing. Some of these ‘investor clubs’ really are promoters who receive kick-backs in real estate commissions, property management fees, mortgage loan fees, and even fire insurance premiums. They tell stories of huge appreciation gains, which are probably true. However, not all areas enjoy significant appreciation-year after year.

Emerging Markets Investing Due Diligence
Don’t make the costly mistake of not fully researching the complete market customs and restrictions in the area where you’re thinking about investing. If you can’t afford to go to check out the area in person, choose another area that you can visit.

Beginner’s Guide To Short Sale Investing

When a bank loans money by giving a mortgage to a homeowner, the bank expects to be paid back in full when the homeowner sells or refinances the property. A typical bank mortgage is a loan at a loan to value (LTV) ratio of 80%. The standard conventional loan requires a 20% down payment and an 80% mortgage.

As long as the property does not decline in value, the bank has the house as collateral and can be assured of getting their money back by selling the house via foreclosure auction in the event that the homeowner does not pay.

Short Sales Investing For Beginners

However, occasionally prices decline so rapidly that the equity in the home is diminished to the point that there is no equity left in the property. In extreme cases, the homeowner is said to be “upside down” meaning that they owe the bank more money than what the house is worth.

Upside down situations usually result from either a sharp decline in prices, high LTV loans or a combination of both. Currently the foreclosure crisis that we are in is a direct result of poor lending standards and sharply deteriorating property values.

When a homeowner is “upside down” and cannot afford to stay in their home then the best option is for them to try and sell the home. However, if prices have dropped dramatically and they cannot sell the house for anything close to the loan value then when they do find a buyer, the purchase price will be lower than the amount that is owed to the bank. In this situation they will have to receive prior approval from the bank to accept an amount less than the full amount owed on the mortgage. This is called a “short sale”.

In this situation, the bank will have to decide if they want to accept the “short sale” offer which is an amount less than the full value of the mortgage balance. The bank has to carefully weight many factors including the condition of the house, the time it will take to foreclose on the property and the legal costs and holding costs of lost mortgage payments. Typically banks will easily accept a 5% to 10% discount off the face value of a mortgage when faced with a homeowner in foreclosure. However, the irony is that the bank will not be willing to negotiate with a homeowner that is current on their payments.

In order to proceed with a short sale, the bank has to feel that the homeowner is going to allow the bank to foreclose on the property. Usually a homeowner needs to be at least 90 days late in order for the mortgage bank to file a foreclosure notice called a “lis pendens”. Once the property is “in foreclosure” the bank will be more willing to entertain offers that are less than the full value of the mortgage balance.

The bank has to carefully analyze what they believe the house is worth, and what they think it would sell for at a foreclosure auction or as a bank owned property. Then they need to consider the time it would take to get the house back and how many months of lost interest payments that would amount to. They also have to consider the legal costs of the foreclosure as well as the currents condition of the property and if any repairs are needed.

Sometimes the bank will consider selling a property for as little as 50% of the face value of the mortgage. Usually this occurs when there is substantial damage and rehab required to bring the property to a marketable condition. A more typical short sale is probably at around 70% of the previous balance although each property is different and there is no set guideline. I have seen banks decline high offers and I have seen banks accept very low offers. Each case depends on the property in question, the sales comps, the condition of the property and many other factors. The ability to have a working relationship with the loss mitigation representative is also a key factor in the negotiations.

Navigating A Short Sale Deal

Negotiating a short sale is a time consuming and cumbersome procedure. It can typically take a few months of back and forth negotiations between the buyer, the owner and the banks loss mitigation department.

An astute buyer will have supporting documentation such as the following:
1.Extensive documentation and pictures of all damages to the property (the more the better). If there is mold or severe damages to the property then the bank will be much less willing to take the property back than if the property is in perfect condition.
2.Proof of low sales comps supporting a lower value for the property along with solid BPO’s (broker price opinions) as to the value of the house
3.Proof of how long it will take to remove the occupant of the house and foreclose on the property.
4.Proof that the seller is prepared to file bankruptcy (which will delay significantly the foreclosure process). Many sellers facing foreclosure are behind on all of their bills and so bankruptcy is an option for them to consider.
5.A solid case for why the buyer is not prepared to offer more. For example, previous REO sales at the same price, or previous low purchases by the same buyer. A solid cash buyer that buys many properties will be taken much more seriously by the bank than a buyer putting together their first short sale package.

After all of this information is gathered, it needs to be put together in a short sale package and then submitted to the bank. The loss mitigation department then reviews this package and takes it to their superiors for review. The process is extremely time consuming and cumbersome and there is no guarantee that loss mitigation will even be interested in negotiating at all. You can get anywhere from a great response to no response at all. It really depends on how desperate the bank is to make a deal and how professional the buyer appears to be.

Any buyer will have to be a cash buyer so a proof of funds is an absolute necessity in order for the bank to take the buyer seriously. You need to show that you have the ability to close quickly for cash and you need to be willing to waive inspections and have no contingencies to your contract. You also need to be able to show the bank that the previous owner is not deriving any benefit.

In an ideal situation you should seek a “non deficiency judgment” meaning that the bank will not go after the previous owner for the difference between the amount owed on the mortgage and the purchase price. The previous owner will be required to report the difference as income since the bank will definitely issue a 1099 since they will be deducting the loss for income tax purposes and their loss will be your gain which by definition means income. Filing bankruptcy will not absolve the previous owner from any taxes that are due in the following year as a result of this 1099 so the purchaser should make sure that the seller is aware of this fact.

Putting together a short sale package can be a cumbersome and time consuming task. There is no guarantee that the bank will accept, review or even communicate with you once you have submitted a short sale offer. It can be quite disheartening to spend so much time on a short sale only to get a tepid response from the bank. For this reason, in the current foreclosure crisis the easiest way to buy discounted properties is to buy them directly from the bank once they are bank owned REO properties.

Forming a Real Estate LLC to Buy Investment Property

In order to protect personal assets and save thousands of dollars, many people are transferring the ownership of real estate and other assets to an LLC. A Limited Liability Company cannot be held responsible for personal debt and lawsuits. For this reason, creating an LLC is one of the most popular asset protection methods used today.

A limited liability company, or LLC, is similar to a partnership but has the legal protections of personal & real estate investing assets that a corporation offers without the burdensome formalities, paperwork and fees. The exact rules for forming an LLC vary by state.

The good news is, you can protect yourself and sleep easy at night, knowing you have an iron-clad legal fortress around you – you’ll also save thousands each year on tax deductions because of it. First, let me go over a couple of aspects you’ll need to know about protecting your investing property assets.

LLC’s & Real Estate Assets

All personal and investment real estate, including primary and vacation homes, can be included as assets in an LLC. This allows all residences and real estate to be protected from seizure. Also, an LLC can be created with a single member, a single owner, and still be a valid asset shelter. If a real estate loan is required, the LLC may be eligible for special loan terms.

You don’t have to hire a lawyer to set up an LLC, since state requirements are usually self explanatory. But it’s a great idea to have one read over paperwork and your operating agreement to make sure your interests are protected along with your business partners.

Privacy, Control, and Inheritance
In addition, the ownership of any transferred asset is difficult to track and locate. Moving your assets to an LLC does not mean that you will lose control of your assets. In fact, you retain complete control of every asset, especially if you have a single-member LLC. To reduce inheritance tax and problems, simply add your family member(s) as owners of the LLC. This allows the assets to flow directly through to your heirs without paying exorbitant inheritance taxes.

Pitfalls of LLC’s
If a lawsuit is filed against the LLC, the property or other assets can be seized under any judgment. If the LLC has more than one member, or owner, any lawsuit brought against any owner can affect the entire LLC. A lien could be placed against the LLC, and cash distributions must still be disbursed equally. Finally, personal expenses cannot be paid by the LLC directly or the LLC loses its limited liability status. The court could argue that paying personal expenses makes the LLC invalid and that the member illegally transferred assets to the LLC as a shelter.

Taxation
Similar to sole proprietorships and partnerships, LLCs are taxed by a pass-through tax system. Unlike a corporation, which encounters double taxation and must file tax returns separate from an individual’s income tax, the LLC is only taxed once.

The pass-through tax system allows an LLC’s income taxes to be included on the personal income taxes of its members. Listing your assets as LLC assets also allows you to take added tax deductions that are not available if you do not have a business.

Forming an LLC

To create an LLC, you file “articles of organization” (in some states called a “certificate of organization” or “certificate of formation”) with the LLC division of your state government. You can usually go online or in person to your local secretary of state’s office to file the paperwork. Filing fees range from about $100 to $1,000, generally.

Many states supply a blank one-page form for the articles of organization, on which you need only specify a few basic details about your LLC, such as its name and address, and contact information for a person involved with the LLC (usually called a “registered agent”) who will receive legal papers on its behalf. Some states also require you to list the names and addresses of the LLC members.

In addition to filing articles of organization, you must create a written LLC operating agreement. You don’t have to file your operating agreement with the state, but that doesn’t mean you can get by without one. The operating agreement is a crucial document because it sets out the LLC members’ rights and responsibilities, their percentage interests in the business, and their share of the profits.