I want to make it very clear that I am not a lawyer and I am not giving legal advice, these are simply tactics I use to avoid liability and I encourage everyone to speak to their attorney about any legal questions.
I believe buying rental properties can be one of the safest investments you can make, because you can buy them below market value. However, there are some risks involved and you should take steps to protect rental properties. Whenever you own a business you raise the risk of being sued for monetary reasons or physical injury. With rental properties the biggest risk is someone getting hurt at your property. It could be a freak accident or neglect by the owner, landlord or tenant that causes someone to get hurt.
My returns are high enough on my rental properties that I am willing to take on these risks, but I also do quite a few things to protect myself and my assets. To see how I find properties, obtain mortgages and detailed numbers on my rentals check out my complete guide to investing in long term rentals.
If you are managing your own properties or someone else’s properties your liability increases greatly. I have seen a property manager get sued after a tenant was hurt while being evicted. The tenant fell in a window well and claimed the landlord broke the tenants TV and left the broken glass in the window well. The tenant claimed to have been permanently injured by the TV and sued the landlord.
Long story short, the case went to court and a jury had to decide the outcome. After two years and over $40K in legal fees the court ruled in favor of the landlord. This landlord learned a valuable lesson, make sure you have proper insurance! If the landlord would have had liability insurance to cover issues like this the insurance would have paid the legal fees. If you are a property manager make sure you talk to your insurance agent about liability insurance. In many states you must be a licensed Real Estate agent to be a property manager. All Real Estate agents must have E and O insurance, but E and O may not cover issues like this one.
If you are managing your own properties there are many state and local ordinances you need to know. Please take the time to research exactly what forms and documents you need. In my state we have to have the tenants sign a lead based paint form and give them a lead based paint flyer on every house built prior to 1978. The state can fine you $10,000 per occurrence so make sure you pay attention to all laws in your area.
Many investors protect their assets by creating one or multiple corporations for their rental properties. I create a separate LLC for each property I own. I let my wife name them silly animal names and she gets to take part in the fun of the business as well. So far we have Llama Lane, Penguin Place, Porcupine Point and a few others. For every property I open a checking account and all money going in and out for that property goes through that checking account. I create or have my assistant create all my LLC’s to save some money. I asked a lawyer to create my first LLC and he wanted to charge me $750! I decided at that point it would be well worth it to learn how to do it myself. It is actually a very simple process that takes less than 30 minutes and there are online companies that will help you do it as well like Legalzoom.
Always check with your bank who finances your properties before you transfer a property to a LLC. Some banks have due on sale clauses, which mean they call your loan due in full immediately if you sell the property. Transferring a property from an individual to a LLC, even if the LLC is owned by that individual can trigger the due on sale clause. It also may be difficult to to refinance a property if you transfer your rental property into an LLC.
Home Owners insurance
Many things can happen to a rental property to cause damage. Pipes can freeze and break, a tree can fall on the house, a sewer can back up or a natural disaster can destroy a home. I always carry plenty of insurance on all of my rental properties. I talk extensively with my insurance agent to insure my properties are covered properly. Many insurance policies do not cover many events such as floods, sewer back up or acts of terrorism. Not every property will need every coverage available, but you need to weigh the chances of an event occurring versus how much your insurance will cost. Here is a recent story on how I had to use a lot of insurance on my rental properties.
The easiest way to protect rental properties is to hire a property manager and make sure they are properly insured. Make sure you use a knowledgeable insurance agent who knows rental policies. Hire an attorney to make sure all your assets are legally protected and hire an accountant to insure you are filing all your taxes correct.
This can all be very expensive, but it doesn’t hurt to consult with all of these professionals when first starting out in the business to make sure you understand the risks and how to protect rental properties.