The Pros and Cons of Purchasing Multifamily Real Estate with an LLC

Investing in multifamily real estate can be a lucrative venture, providing rental income, potential long-term appreciation, and tax benefits. When considering investing in multifamily, one important decision is whether to purchase the property through a Limited Liability Company (LLC). At JP Acquisitions we purchase our properties using an LLC and it’s standard in the multifamily industry to do so. That being said, it’s not always clear why real estate firms and individual investors purchase properties using an LLC. In this blog post, we will explore the pros and cons of purchasing multifamily real estate with an LLC from the perspective of an individual and private equity firms.

Pros:

1. Limited Liability Protection: When you purchase multifamily real estate with an LLC, the liability of the LLC is typically limited to the assets owned by the company. This means that if any legal issues or liabilities arise from the property, your personal assets are generally protected. For example, if there is a lawsuit related to the property, your personal savings, investments, or other assets outside of the LLC are less likely to be at risk. The same protection applies when syndicating a property. The liability of the LLC is generally limited to the assets held within the company, shielding individual investors from personal liability related to the real estate investment.

2. Asset Protection/Segregation and Risk Management: By using an LLC, you can create a legal separation between your personal assets and the assets held within the LLC. This separation helps protect your personal assets from potential risks associated with the multifamily property. If you face any legal or financial troubles in your personal life, the property held within the LLC is generally shielded from those risks. This separation provides an added layer of protection for your investment. If we expand our thinking, we can see how this applies to private equity firms such as JP Acquisitions. Real estate investments made through an LLC allow private equity firms to segregate assets and manage risks more effectively. By using separate LLCs for each real estate investment, the firm can compartmentalize the risks associated with each property. This way, if one investment faces financial or legal challenges, it is less likely to impact the overall portfolio or other investments within the firm.

3. Tax Flexibility: An LLC offers flexibility in terms of taxation. By default, an LLC is considered a pass-through entity for tax purposes. This means that the profits and losses of the LLC “pass through” to the individual members, who report them on their personal tax returns. In other words, an LLC does not file its own corporate income taxes. Instead, after the LLC pays its bills and debts, the members collect its remaining revenue and pay taxes on that income. This structure allows you to avoid double taxation that can occur with other types of business entities, such as C-Corporations. Additionally, you have the option to elect for different tax treatments, such as being taxed as an S-Corporation, depending on your specific circumstances and goals. This flexibility can help optimize your tax situation and potentially save you money.

4. Easy Transfer of Ownership: When you purchase multifamily real estate with an LLC, transferring ownership interests in the property becomes simpler. Instead of transferring the property itself, you can transfer ownership interests in the LLC. This can make the transaction process more efficient and potentially reduce costs associated with legal and administrative procedures.

5. Operational Control and Decision-Making: Using an LLC allows private equity firms to have greater operational control and decision-making authority over the real estate investment. The firm can establish the governance structure and operating agreements within the LLC, enabling them to make strategic decisions and execute business plans according to their investment objectives. The operating agreement (see definition at the end of this post) outlines who the managing member is. The managing member can be an individual but usually is another LLC which possesses the power and right to enter into agreements and operate the property as they see fit. This control is important for private equity firms seeking to actively manage and add value to their real estate assets.

6. Alignment with Investors: Private equity firms often have limited partners (LPs) who provide capital for their investments. By structuring real estate investments through an LLC, private equity firms can offer LPs membership interests in the LLC. This structure provides a clear and organized way to allocate ownership, profits, and distributions among the investors, ensuring alignment of interests and transparency in the investment structure. Typically, and this gets a bit into the weeds, a private equity firm will hire an SEC attorney to create a private placement memorandum (PPM). The PPM is a legal document that provides the details about a private security and in our case the “private security” is multifamily real estate. PPMs are commonly used in private equity and to syndicate property. The purpose of a PPM is to disclose key information about the investment, including the terms, risks, and potential returns, allowing investors to make informed decisions.

Cons:

1. Initial and Ongoing Costs: Establishing and maintaining an LLC involves certain costs. You will need to pay filing fees to form the LLC, and depending on the jurisdiction, there may be ongoing requirements such as filing annual reports or paying franchise taxes. Additionally, you may need to hire legal and accounting professionals to ensure the LLC is set up correctly and to handle ongoing compliance. These costs should be considered when evaluating the financial feasibility of using an LLC. At JP Acquisitions, our accountant files our taxes for the managing LLC (i.e., the “managing member” I mentioned earlier) and the property LLC. The cost associated with filing the property LLC are accounted for in our underwriting and is a flat fee.

2. Financing Challenges: Financing a multifamily property through an LLC can be more challenging compared to purchasing as an individual. Lenders may require personal guarantees or higher down payments when dealing with an LLC. Depending on the creditworthiness of the buyer, history of operating multifamily properties, cash flow of the property, and other factors, a lender may choose to provide a non-recourse loan (i.e., a loan without a personal guarantee). A bank may need to have a borrower provide a guarantee because they perceive a higher level of risk when lending to an entity rather than an individual. These requirements can limit your financing options and potentially increase your upfront costs.

3. Additional Administrative Responsibilities: Operating an LLC involves certain administrative responsibilities. You will need to maintain proper accounting records, file tax returns for the LLC, and comply with state and local regulations. While these responsibilities can be managed through professional assistance, they still require time and effort on your part or the involvement of hired professionals. It’s important to note that the costs can vary significantly depending on the jurisdiction and the specific circumstances of the LLC.

4. Restrictions on Personal Use: It’s important to remember that when you purchase multifamily real estate through an LLC, the property is considered an asset of the business entity. This means that personal use of the property may be subject to restrictions. For example, if you plan to live in one of the units, you may need to follow specific guidelines to ensure compliance with zoning or rental laws. These restrictions can limit your flexibility and control over the property. While private equity and syndication firms don’t typically have one of the owners living in a unit, the restriction of personal use is necessary to note.

Conclusion

Having listed the pros and cons of using an LLC to purchase multifamily real estate, you now understand why syndicators use LLCs to purchase properties. While there are cons to using an LLC, they are far outweighed by the pros, and the cons are typically seen as standard business practice. Something essential to note is that you should consult with legal and financial professionals who specialize in real estate and business law to fully understand the specific implications and considerations for your situation. They can provide personalized advice based on your goals, location, and local regulations.

If you have any questions regarding the terms and concepts in this post or previous ones, don’t hesitate to reach out to either me (tedi.nati@jpacq.com) or someone on our team so we can help explain what is causing the confusion. If you’re interested in investing with us at JP Acquisitions, you can contact us via email (contact@jpacq.com), LinkedIn, Instagram, or our investor portal to set up a meeting.

As always, I hope you enjoyed reading this post as much as I have writing it. Best of luck!