The Real Estate LLC Mistake That Could Cost You Thousands (Rookie Reply)

Ashley:If you are sitting there right now trying to decide whether to buy your first house hack before your income changes or whether the rate window you qualify today is worth jumping on even if the deal does not fully cash flow. We are answering that exact question today.

Tony:And if you’ve ever Googled, do I need an LLC before I buy a rental property and ended up even more confused than when you started? We’re coming through all of that noise and giving you a straight answer.

Ashley:This is The Real Estate Rookie Podcast. I’m Ashley Kehr.

Tony:And I’m Tony J. Robinson. With that, let’s get into our first question for today. So this question comes from the BiggerPockets Forums and it says, “I’m 23 years old and I’m currently planning to househack my first property in the St. Charles, Missouri area with my fiance. I’m primarily looking for a multifamily property duplex ideally since my fiance isn’t comfortable with renting out individual rooms in a single family home. We’re getting married in a couple of months, but I’m hoping to buy before then because Missouri’s first place program offers below market interest rates for first time buyers who make under 96,000 in household income. I currently earn about 92K, so once we’re married, our combined income will push us over that limit and we’ll lose eligibility. The first place non- DPA option offers rates around 5.25%, which is a full percent lower than what I likely get on a standard conventional loan after we’re married.The issue is that the St. Charles market is extremely competitive and I’m struggling to find any duplexible cashflow even modestly once I factor in long-term expenses like management, maintenance, and vacancy. Right now, we’re in a great situation renting a house with a friend and only paying about $800 per month total for our share. Financially, there’s no urgency to move, but I feel pressure to lock in this rate window before we lose eligibility after the wedding. My question is, number one, does it make sense to buy now just to capture the 5.25% rate even if the first property doesn’t cash flow well? Two, how do you personally weigh below market financing versus waiting for a truly cash flowing deal? And three, in a market like St. Charles, where duplexes are rare and competitive, would you consider breaking even or slightly negative cashflow acceptable for your first house hack if it’s a strong long-term location?All right, lots to kind of unpack here, but we’ll kind of break it down for each question. But I think the first thing, and he didn’t quite clarify this, but the question says, or in the question he says that he’s having a hard time finding a deal that’ll cashflow. I’m struggling to find any duplex that will cashflow even modestly once I factor in long-term expenses. And then he also goes on to say that they’re spending right now $800 per month for living. So I think the way that I look at this mathematically is not necessarily how much cashflow will this house hack produce, but how much will your living expenses change? So if going into this duplex or this house tax situation, even if it’s not positive cashflow, if you’re able to take your living expenses from $800 a month to $200 per month, that’s still a net gain of $600 every single month that you didn’t have before, not to mention you’re getting the appreciation and the loan pay down on this property as well.So I think I would just maybe clarify what do you mean when you say that the deals aren’t cashflowing? Because honestly, in a lot of house hacking situations, you’re not typically living quote unquote for free. You’re just significantly subsidizing the cost of your living.

Ashley:Yeah. That was the first thing I was going to point out too as to were you expecting to live there for free and to get cashflow where that can definitely happen, but is a lot harder to get. And I think you broke it down perfectly as to how to actually compare it apples to apples to what you’re paying now with rent and how you’re able to maybe reduce your expenses, but also the other benefits that come along, the mortgage paydown, the appreciation that comes with that too. The next thing that he had asked that we want to look at is how do you personally waive a low market financing versus waiting for a truly cashflow deal? I think we kind of answered that as to this possibly could be a truly beneficial deal for you. If you were looking at just a standard investment, I would probably not take the deal knowing that I could get this discounted financing rate just to be able to buy something and I would wait to cashflow because it’s not my primary residence.It’s not expenses I’m already paying in my household. I would want the deal to at least break even or be able to cashflow to cover itself. I wouldn’t want to come out of my own pocket for my first investment to be able to cover it just because I want to lock in a 5.25% interest rate. But this situation for house hacking is very different that I think you could make it work for you and not cashflow because you’re going to be your primary residence. The next question here is, so that area is really competitive for duplexes. And again, he talks about the cashflow and how do you find a property that has a strong location but may have negative cashflow on it. I think he’s thinking of the appreciation play as to whether it’s okay to take negative cashflow because it’s going to be appreciating in that location, you’re going to get that benefit from it.But I think as your house hack, it also has some personal preference to it as to where you want to live and what type of property you like. I do think that you probably will have an advantage making offers on duplexes because you will most likely be able to offer more than an investor because this will be your primary residence and you’ll already be getting a lower interest rate on financing. Yes, an investor could come in with cash, whatever, but they’re going to most likely want that property to cashflow. So I could see your offer being more, you could be able to offer more because you’re accounting for your own living expenses with the property. The only hiccup I could see is if you’re using a VA loan or FHA loan, the seller not wanting to deal with the inspections that come along with that.

Tony:I think the only last thing that I’d add is maybe be a little bit more creative around what house hacking looks like. If your fiance has already said, “Hey, we don’t want to share rooms in the house we’re living in, that’s fine, but maybe there are other options aside from a duplex. Can you find a single family home that maybe has an ADU in the back?” And either you guys can live in the main house or you can live in the ADU and rent out the main house. I don’t know if there’s maybe finished basements in that part of Missouri where again, either you’re living upstairs or they’re living downstairs, but I think there are maybe other ways aside from just, it’s got to be a duplex that you can still execute on this idea of house hacking.

Ashley:Yeah. Oh, sometimes you’ll see houses listed as an in- law suite that actually have a whole separate unit that you could rent that out and it’s usually separate. The utilities probably aren’t separate and you would just have to factor that into the rent that you’re paying their utilities. But I’ve seen that so many times where it’s listed as an in- law suite, but it’s actually a full-blown apartment. Also above garages, that’s pretty standard if somebody does have an instead of ADUs where you just have an additional dwelling unit on your property, they’re usually more on top of garages that I would say in my area too. Okay, we’re going to take a short break, but when we come back, we’re going to talk about one of the most Googled questions in all of real estate investing. Do you actually need an LLC before you buy your first rental?We’ll be right back. Okay, welcome back. So we got question two today. This one is from the BiggerPockets Forums. I am new to real estate investing and I would like to buy and hold rentals. I am wondering if it is best to set up an LLC, get a business account and business credit cards before actually buying a property. I want to keep my personal finances and rental property finances as separate as possible so I’m thinking yes. I currently only own one rental property in Florida. It only became a rental because I moved to California to work, so I decided to keep it. I manage it myself and don’t have an LLC set up. Really, all I have set up for the property is a separate checking account and a landlord-specific home insurance policy. My questions are, should I set up an LLC just for one property and what are the pros and cons?If so, do I set up the LLC in California where I live now or in Florida where the property is? And if I do set up an LLC is transferring a property from your personal name to the LLC pretty straightforward, even with an active mortgage. Hi, these are great questions and yes, very common questions. So the first one, the first question that she asks is, should you set up an LLC before you actually purchase your property and I’m going to say no. What about you, Tony?

Tony:Yeah, I would agree with that for sure.

Ashley:What happens if you don’t get a property under contract? You make offers, you make offers a year goes by or something changes in your life and now you have this LLC. I know in California the fees are pretty expensive to have an LLC. You have to maintain it, you have to file a tax return for it. So what does that cost to pay someone to file it? So I would say no, I would wait until you have the property under contract at least if you want to do an LLC. When you go under contract, you can put on your contract is that, I can’t remember exactly how it’s phrased, but it’s like you could put it as your name, Ashley Care and/or assigns to. And then later on during the process of being under contract, you can go ahead and fill in your LLC. I’ve done that a ton of times where I use my development company LLC and then I’ll be like, okay, where do I actually want this?Am I doing this with one of my partners or not or whatever? And then I’ll go and change it into whatever LLC it’s going into before we actually close on the property.

Tony:Yeah, I agree with that notionash. And I understand why, but I think a lot of people, they put the cart before the horse and they start asking a lot of questions about asset protection and corporate structure and all these things and they candidly don’t have a lot to protect in that moment. Now, unless just in your personal life, you’ve already amassed a lot of personal wealth. Well, then yeah, definitely be more diligent upfront. I shouldn’t even say more diligent, be more, I guess, cautious upfront about protecting that. But I think a lot of rookie investors maybe put the cart before the horse. Now, one thing I do want to clarify though is that having an LLC, it doesn’t mean that you can’t … The risk of liability goes away. There’s still, even with an LLC, there’s ways to pierce the corporate veil is what they call it.So even if you set it up, you still have to make sure that you’re running it the right way and you don’t doing all the right things and the right attorney can help you with that. But there are lots of real estate investors who, much like this story, where they have a personal residence, they move out, they turn it into a rental and it just kind of stays in their personal name. So there are other ways to protect yourself aside from just having the LLC as well. And I think that’s a piece that maybe a lot of rookie investors don’t recognize that there’s other forms of liability protection aside from just having your LLC. Now, obviously the LLC is, I think, a good option and I think I’ll just describe those differences really quickly.You can have liability protection through your insurance, you can have entity protection, like who’s actually on the deed of the property or how’s the property deeded, who’s on title.You can have an umbrella policy, just additional liability protection for anything that happens to you. So those are all different forms of protection. LLCs and the right legal structure are probably the most, I won’t say airtight, but probably the most concrete in trying to protect yourself. But even those, if they’re not structured the right way, you can still kind of break through. Insurance is probably the lowest level because a lot of insurance providers, their goal is to reduce the amount of money they spend on paying out claims, so it’s not always the easiest. But if someone sues you, the insurance is what kind of kicks in to say, “Hey, here’s what happens.” I think the goal for the LLCs and the right legal structure is that it prevents a lawsuit from happening. If someone goes through all of these things and they see like, “Man, even if we sue this place, because of how it’s set up, we’re not going to get a whole heck of a lot.” It hopefully just prevents any lawsuit from happening in the first place.So they serve slightly different purposes. But all that to say, does a rookie need to go out and invest $30,000 in legal fees to set up this crazy corporate entity structure where you’ve got an offshore trust and the trust is allocating or delegating responsibilities to this entity? Probably not, but you can probably start a little bit simpler and still have enough protection to give you peace of mind to sleep at night.

Ashley:Another kind of difference that you should think about too is financing on your property. So how are you going to purchase your investment property? Because if you have the LLC set up and you’re buying the property in an LLC, it is much harder to get conventional residential financing on the property. And if you do, like I did it before through a small local bank on the residential side and it was 2% higher than what the interest rate would’ve been if it would’ve been in my personal name. So you also have different financing options when the property is in your personal name compared to an LLC. So also it was addressed that she currently has one property in Florida that’s in her personal name and what would be the process to actually transfer it into an LLC while having the mortgage? So first I would look at your mortgage documents and what does it actually say about a loan being assumed or transferring ownership, a change in ownership?And there can be a clause in there that says that the balance of the loan is due upon sale, so the due on sale clause. And if that’s in there, then technically the bank could call the loan due upon the change of ownership. So there’s some language in mortgage documents that allows for the change of ownership as long as it is the same membership percentage. I don’t know exactly how it’s phrased, but so if you’re 100% owner of an LLC and you change it from your personal name, 100% you owns it to an LLC where you’re 100% owner will not trigger the due on sale clause. I have read of a ton of people doing it even though they have a due on sale clause and don’t have that written language and nothing ever happening, they continue to make their payments. I’ve also heard of it the other way, not as common as I’ve heard of people getting away with it, I guess, but I’ve also heard of people doing it and the bank does call the due on sale clause.So read your mortgage documents what it says and then if it does trigger your due on sale clause, make sure you have some kind of strategy plan in place to actually pay that. But I would read your mortgage documents and what you can do is you could do a quick claim deed and deed it just into your name quickly without having to do all the title work and everything because it’s just being transferred from you to you, which an attorney would do, and it’s not a long process at all to have that happen. Okay. We have one more question after the break and this one is for anyone planning to use a 203K loan to buy a fixer upper. There are some rules you absolutely need to know before you close and we’ll be right back. All

Tony:Right guys, welcome back. Our last question today is a great one for anyone thinking about using a 203K loan to buy a duplex in house hacket because this loan does have some specific rules that can maybe trip you up if you’re not prepared. So this question also comes from the BiggerPockets forms and it says, “I’m planning to purchase my very first property next year.” It’s a duplex and plan to house hack it using a 203K loan. I’m doing tons of research and getting my finances in DTI, debt to income ratio in line. I have a few questions I’m hoping to get answered. First, when should I start speaking to an agent? I currently have an apartment lease that is up at the end of August 2026. This recording is as of April. I’d like to avoid going month to month on this lease. I’m trying to understand when to start the process with an agent, a lender, and a contractor.Second, with a 203K loan, renovations must be completed within six months. I plan to use a limited 203K. This won’t be an issue for the side I’ll be living in, but how would I renovate the tenant occupied side within those same six months if their leases goes for another 10 months? Logistically, what would you do in this instance? Any guidance on how to plan this out would be greatly appreciated, have you ever used a 203K loan before?

Ashley:No, I haven’t. I don’t think you have great yet.

Tony:No, I haven’t either, but basically guys, think of the 203K loan as like a renovation loan. So it’s a government backed loan kind of like FHA, but it also gives you the money to make certain renovations to your property as well. Now again, Ash and I haven’t used it so we can’t speak from a firsthand experience about how difficult it is to actually go through that renovation process. But like many government type products, there’s usually a lot of hoops you have to jump through. So just first for table six, I think that’s an important piece to know. Now from a timing perspective, you’ve got what? Roughly four months when your lease ends to hopefully be able to move out into somewhere. So really you need to be under contract in about three months because that’ll give you that last 30 days to be going through your escrow and moving out of your apartment.So the first person I would go talk to now is a lender and I would just get a really clear sense on, hey, what am I pre-approved for? What kind of budget am I working with? And that’ll, I think, give you better context on what types of properties you should start looking for. And then even though you’re still kind of three months out from actually wanting to close in that property, I would still start searching today like four months like, yeah, let’s hit the ground rent. Let’s go start hunting today. Worst case is that you find something that is an incredible deal and then you move into it or you try and negotiate maybe a slightly longer escrow period or you tell your apartment like, “Hey, I’m only leaving a month or two early. Can I get a break and not break my lease?” But I wouldn’t worry too much about the timing on the lease.I will start hunting for that deal today because chances are it’s going to take you some time regardless to find a duplex that not only meets your criteria as an investor, but also meets whatever criteria you need from the 203K loan side as well.

Ashley:And also too, if you do find a great deal, maybe that leaves extra money on the table for you to maybe pay for your lease an extra month or two while you’re living in your duplex. So if there is some overlap, you have gotten a great deal and you’re not putting as much money into the property and instead you can pay for your lease extra. But I would definitely start sooner rather than later of first of all, building your team, making those connections and then start putting offers into properties when you have the funds and you have the pre-approval and you’re ready to go is don’t wait for your lease to end. There was another question in here as to how do I renovate the tenant occupied side within those same six months? So one thing you could do is when you purchase the property is you could put it into the contract that the purchase is contingent on that unit being vacant and going ahead and having it vacant and renintivating both at the same time.The second thing that you could do is they stay in that unit and you go to them and say, “Hey, I’m renovating this other side and when it is done, I would like to offer it to you to move into and you’ll get this brand new unit, maybe you’re increasing their rent a little bit.” Hopefully they would accept that offer, move into that and then you go ahead and start renovation on the other side of it too. So basically you’re giving them first dibs at this brand new unit that they can move into and then you can go ahead. And that’s a nice strategy because it offsets you having two vacancies at once and not even having to find a tenant for the first finished unit and then you can move into the second one when it’s

Tony:Finished. And maybe the easiest aproach of all is just to find one that’s vacant right on both sides. And if you can move into a unit where it’s vacant, then that makes the whole kind of musical chairs of renovation a little bit easier. One thing to note though on the 203K loan is that, and again, double check this guys, but I believe that you must use a licensed contractor for all the work. So you got to make sure, again, like we talk about building out your team, that’s the other person I’d probably start reaching out to now as well just to make sure that like, hey, not only can you find someone, but do they have the room and their schedule to actually start when you need them to start? Because if you’ve got this six month clock on when the renovations can be completed, if the contractor you like is booked out for three months, well, now you’ve got 90 days left to finish all those renovations.So I think just making sure that you’re having those conversations sooner rather than later to make sure the timing works out will be important as well.

Ashley:And with your bank that you’re going through, especially if this is a small local bank to get this 203K loan is ask them for a list of vendors or contractors that they’ve already worked with on 203K loans because I did a new construction loan and the bank had to approve my contractor, but he was already on their list of an approved and vetted contractor. So if you can start interviewing and working off of contractors that are already vetted by your bank and approved by them and also ask your loan officer for a recommendation because the contractor left and didn’t finish the job, that loan officer is going to know because he probably withheld their last draw. So they’re the ones most of the time issuing the draws and making sure that the work is done, hearing back from the inspectors that are inspecting before each draw.So you can always ask them for a recommendation too. Well, thank you guys so much for listening to this episode of Real Estate Ricky. I’m Ashley. He’s Tony. And we’ll see you guys on the next episode. I