How to Take Possession of the Property
This is Part 9 of a series on how to get started in real estate. Each article is a bite-sized tutorial gleaned from 30 years of investing experience. The goal is to remove as much doubt and fear as possible, so you’ll begin, or continue, the process of creating enough passive income to change your life.
You’ve followed all the steps. You located a good property in a good location. You did a preliminary analysis and determined it would be a good asset to own. You did your initial due diligence and unemotionally negotiated a fair price based on your inspections. You presented your findings and your new price to the seller and your counteroffer was accepted! Your inspection period has ended, and you are satisfied with the price and the property condition.
Now you’re about to own investment real estate!
What’s next?
Preparing to Close
At this point, the due diligence period has ended, and negotiations are over. Barring unexpected changes, you’re locked in.
If you’re buying a single-family home, you now prepare to close.
If you’re buying a multifamily property, the contract might stipulate that your earnest money becomes “hard” or non-refundable after the due diligence period ends. Once your earnest money is hard, if you back out of the deal, the seller gets to keep it.
This is reasonable in a competitive seller’s market because you’ve had ample time to inspect, run the numbers, renegotiate, and make your decision. Otherwise, the seller will want to put the property back on the market.
The haggling is now over. As the buyer, you’re obligated to be prepared to close. The seller is also obligated to perform his or her duties to facilitate a smooth closing.
A firm date will be chosen, and you must be ready for that day.
Closing
There is a lot to keep track of when getting ready to close a transaction. It helps to have a system.
In the single-family world, your agent will guide you through the process. If you don’t have a broker, the title company will help, or you can hire a closing attorney.
For multifamily, your broker will be a tremendous help. However, it helps to have your own list of items to be checked off before closing day. As you close more deals, you’ll add to this list until closing is just another day at the office!
Closing checklist:
It is important to keep tabs on what is required to close the transaction successfully. Below is a checklist of some important items and tasks:
- Communicate with your lender to make sure they have everything they need from you, and to assure you understand payment terms, etc.
- Confirm your equity. (Make sure you have the cash to close.)
- Communicate with insurance brokers to assure coverage starts the day you take possession.
- Confirm title company has what they need, and title is clear.
- Confirm proper standing and bank accounts for the purchasing entity.
- Send soft cost invoices to title to be placed in closing docs.
- If you have professional management, meet prior to closing to confirm these tasks:
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- Review business plan with you
- Create operating bank accounts for the property
- Switch utilities and trash services
- Obtain copies of all leases
- Obtain a current rent roll
- Obtain all keys to property
- Communicate with existing or new tenant(s) regarding new ownership, rent payments, etc.
- Line up vendors for repairs and maintenance
- If you don’t have management, you do the above tasks.
- Confirm contracted repairs are completed
- Final walk through
This is not a complete list, but it’s reasonably comprehensive. Your list will grow.
Forms of Ownership
Who should take possession of your property on closing day?
That seems like a dumb question, but the answer could save you taxes and protect you from personal financial liability.
If someone asked who owned your house, would that surprise you? Who else would own it but you? (Of course, the old joke is that the bank and the tax man own it, and you’re just living there!)
But seriously, most people own their home in their name. That’s normal in most states.
When it comes to investment real estate, you have the same choice, but there are other options to consider
Individual Ownership
As discussed above, this is how most folks title their personal residence. In the state of Texas, that’s the way to go, because in the case of bankruptcy, the court can’t take your house from you. That’s not the case in some other states, so other forms of ownership must be employed.
You can also own investment real estate in your own name. It’s simple and easy, but it can expose your nest egg to risk.
For example, if you own a rental house and your tenant is severely injured or dies due to negligence on your part as the landlord, they can attack your personal assets. This introduces unnecessary risk.
From a liability standpoint, it is typically not recommended to own investment property in your name.
General Partnership
A general partnership is like individual ownership, but with more people. In this arrangement, the asset is owned by each of the individuals in the partnership.
This can cause liability problems.
First, if anything goes wrong at the property, each of the partners is liable for damages. Taken one step further, each partner is typically responsible for 100% of the damages. So, if you have assets that can be seized, and your partner does not, your assets will be taken to satisfy any judgements. There is no “limited liability.”
Furthermore, in a general partnership, if your partner does something wrong or illegal regarding the property, you are 100% responsible for those actions also.
So, while simple to set up, general partnerships are not recommended.
Entity Ownership
Another option is to own your property through a limited liability entity.
This comes in the form of an LLC, Limited Partnership, or trust, to name the most common. We will treat all the entities the same for this discussion.
An ownership entity functions as a separate “soul” from you. You control it, but it has a separate tax identification number and has a life of its own. It’s not connected to your personal bank account.
Why is that useful?
Let’s assume your tenant gets injured on your property and you are found to be at fault. If you own the real estate in your personal name, their lawyer can go after damages and legally can include all your personal assets. This puts at risk everything you’ve worked for up to this point in time.
If the real estate is owned by a limited liability entity, the opposing attorney can only attack the assets within that entity. He cannot touch your personal assets, or those of other entities. In addition, and in contrast to a General Partnership, only the amount of your initial contribution is subject to loss.
This is Asset Protection 101, but it can save you a lot of heartache. There are some administrative steps and there are increased costs. However, the risks often far outweigh the cost of putting your personal assets at risk.
Another good reason to use an entity is that you can, and should, treat your real estate as a business. Businesses have revenues and expenses, and one offsets the other. Any cost outlay designed to improve, repair, finance, or market the property is a deductible expense.
This is important because you’ll only pay tax on the difference between revenue and expense. The less tax you pay, the more money you keep in your pocket.
I would encourage you to consider using a limited liability entity to own your real estate. As a practical matter, you can buy a property in your own name and later transfer the interest to an entity. It’s cleaner to buy it through the entity, but sometimes that can be difficult. Check with your attorney.
Summary:
If you’ve gotten this far, you know how to find, evaluate, and purchase a real estate investment that will make you money.
It’s your responsibility to fully evaluate the property once you’re under contract, and still in the due diligence phase. It is during this time that you can confirm every detail regarding the physical, financial, and operational status of the property. Once that period ends, you are obligated to close.
It helps to have a list of items to check off before closing.
Ownership through a limited liability entity will shield your personal assets and give you the opportunity to decrease your tax liability. There is some work and expense to set up an entity on the front end, but it’s worth the protection, tax savings, and peace of mind going forward.
Congratulations on your new acquisition!
To your success!
Tom
