Real estate is as lucrative as it is risky. If you’re thinking about getting into real estate investing, protecting your assets should be your first goal before you ever start acquiring properties.
Asset protection should take the form of establishing an LLC and creating a holding company. Holding companies are excellent ways to limit your liabilities and protect each of your assets while you grow your investments and your business.
Real Estate Risks
The biggest risk when investing in real estate is the potential for your business losses affecting your personal finances. If you lose money on a property, you want to make sure you’ve protected yourself from personal loss. To do this, you’ll need to create a clear separation between your personal finances and the money you use for your real estate investments.
If you own multiple businesses, you’ll also want to make sure that your real estate investments are separated from your other business ventures. Keeping these funds clearly separate and defined, protects you from losing all assets in the case of a lawsuit or other financial setbacks. This is especially true if you own the building where your separate business is located.
Other real estate risks include:
- Real Estate Market Risks - your real estate holdings are only worth what the market dictates. If the market dips, the value of your properties take a hit.
- Construction Risks - your properties will likely need repairs or construction projects at some point. You might lose money on rent or materials costs depending on the extent of the repairs needed.
- Liquidity Risks - at some point, you’re going to want to sell your properties for one reason or another. Depending on the market and the area your property is located, you might have a difficult time finding a buyer.
- Credit Risk - if you plan to own rental properties, you’ll be dependent on the financial means of your tenants. When a renter falls on tough times, you run the risk of losing money and incurring potential legal fees.
Though the risks in real estate can be endless, these alone are enough to make creating legal and financial protections of your assets a must.
What’s an LLC
To legally define your real estate investments from your personal funds and other business ventures, you’ll need to create a separate business entity known as an LLC. An LLC, or a limited liability corporation, is the most common business structure and the easiest to manage.
Your LLC will serve as the company name that collects income from any source associated with your real estate properties. As such, the name of your LLC should be separate from your other business ventures or otherwise uniquely defined.
When you apply for your LLC and choose your company name, you’ll also receive an EIN (employer identification number) that the IRS will use to track income and taxes. The next step is filing the necessary paperwork with your state office. If you have a business partner, this will be your chance to describe the roles, interests, and profit and loss management for each individual involved in your company.
What’s a Holding Company
Once you’ve secured your LLC, you’ve completed the first step in creating a real estate holding company. The LLC dictates the way in which your company will be structured.
A holding company quite literally holds the income, assets, and liabilities that you incur when you buy, sell, or manage properties. As a company, it will have a separate checking account that keeps operating funds and profits separate from your personal accounts.
When you purchase your first properties, collect rent, or handle any disputes, the holding company will be the entity performing those actions. The profits you make at the end of the year, however, will be yours.
Holding Company Benefits
Holding companies allow you to collect profits while legally protecting you from personal losses. Once your holding company is all set up, you can start acquiring properties with confidence. Whether you’re planning to flip properties, create housing rentals, or offer spaces to businesses, your ventures will be completed under the protection of the LLC and the holding company.
If you need to apply for financing or a loan, you’ll do so using the holding company, which means the bank or lending organization will examine the funds of the holding company instead of your personal funds. This also protects your personal credit from liabilities associated with applying for loans or potentially losing properties.
Once you have your property, your holding company will serve as the business entity that assumes liability in any and all legal matters. For example, if you own a business in addition to your holding company, any legal action taken against that business will be prohibited from impacting your real estate holding company in any way.
If you’re looking to invest in real estate, protecting your assets is key. Creating an LLC and holding company allows you to safely collect profits while protecting yourself from liabilities that could prevent you from growing your business opportunities.