Create An LLC
Maintain An LLC

I mentioned that I would write a follow up to my post on Friday discussing the number of LLCs a real estate investor or landlords might want to form in an effort to protect the properties in his or her portfolio.  The follow up was to discuss another very commonly asked question by real estate investors.  The question generally goes like this:

So now that the property is in an LLC, I am protected from legal causes of action that arise because of the property. But one problem remains — even though I transfered the property to the LLC, the “note” or loan that I signed to purchase the property is still in my name. That means if I default on the loan, the lender goes after my credit, and can take me to court personally to seek a deficiency judgment. What do I do to get the loan on this investment property out of my name and into the name of the LLC that holds it, and how do I purchase property in the future directly using my LLC so I do not get involved personally?

This basically gives us two questions.

1. How do I get an existing note (loan) taken out of my name and put in the name of the LLC that holds the property after the transfer, and
2. How do I purchase real estate in the future in a way that the note is made in the name of my LLC and not my own personal name.

To understand the answer to these two questions, we have to understand the law that lenders are looking at if they consider extending credit to an LLC instead of a person.  The Arizona LLC Act is probably closest to the Uniform LLC Act (ULLCA) in its treatment of creditors of the LLC.

29-651. Liability to third parties

Except as provided in this chapter, a member, manager, employee, officer or agent of a limited liability company is not liable, solely by reason of being a member, manager, employee, officer or agent, for the debts, obligations and liabilities of the limited liability company whether arising in contract or tort, under a judgment, decree or order of a court or otherwise.

As we see from this statute, a lender who makes a loan to an LLC cannot go after the member’s personally to repay the note if the loan is defaulted upon.  Sure they will have a mortgage on the property that will allow them to take the property if the debt is not paid, but they want more.

A Reputation Gives A Lender Some Leverage To Twist

Lenders want something more than the ability to reclaim the asset the loan was made over.  Especially in today’s market.  Foreclosing on a property is expensive.  Fixing the abandoned property after the foreclosure is also expensive.  With the way assets have devalued in the last two years, there are no guarantees that the asset will even come close to repaying the debt if sold, or that the asset will sell at all.

For a real estate investor, marketing the property is the full time job.  For the bank or lender, the property sits on its books and does not get marketed.  For this reason, a lender or bank does not want the property back at all.  The bank wants to have an arm to twist that is attached to something that will feel the pain.  This is why individuals’ credit scores are so important.  The bank views an applicant with a low credit score as extremely risky because hammering this person’s credit will not twist his arm at all.  A borrower with a good credit is generally concerned with keeping credit worthiness and the bank knows it can cause some real pain to ensure repayment.

When a bank considers making a loan to an LLC, the bank is concerned with the same issue — who is going to feel pain when we need to twist an arm to ensure payment.  An investment LLC is can be effectively viewed as a diaper.  The LLC is fungible and a new LLC may be formed easily.  The LLC has value only until “crap happens” and then they are easily thrown away.  By filing a dissolution with the state, and a final tax return with the IRS, the members of the LLC can say - “take the assets, have the LLC, according to law we have not been grossly negligent, but just doing business, so you cannot touch us.”   This is the reason most lenders and banks will never dream of extending credit to an LLC, especially a new one.

So How Do I Get Credit For This LLC

Now that I have fully explored why most LLCs never get credit extended to them, lets talk about those that do.  Knowing that a bank will not lend to an LLC because it wants an arm to twist helps us see the banks real motive.  They do not care whether they lend to a person or a business.  In fact, who do you think your local bank would rather lend to, you? or Apple (with their $50Bill stockpile of cash)?  Probably Apple right?  Well, that is because there are enough arms that could be twisted to cause some real pain if Apple just decided not to repay a loan.  Here are some ideas that generally make a bank want to lend to a company.

1. Credit Worthiness: Just like a person, a business that has built up its credit has an arm to twist.  It takes a long time to build credit worthiness for a business.  A business that has credit worthiness is a real asset in itself.  The lender is pretty sure members will not lightly cut the LLC loose.  The next two ideas are ways to get banks to lend to the LLC, but also help to build credit worthiness.
2. Joint Venturing: If it is real estate you want to get your paws on, or rehabing you need money for, do what the big guys do and joint venture with banks and lenders.  Big companies often put down as much as 30% so the lender is only taking a 70% chance.  The contracts are often written in a way and the deeds often executed such that the banks do not have to go through the normal foreclosure process to take the property.  For many investors who are just starting, a lender may not joint venture with the LLC or extend credit to the LLC on a property for which the LLC puts less than 60%.  This seems like a waste of time because you could probably get the current owner to carry-back 40% of the purchase price on an owner financed loan, but the point is to build credit worthiness so the exercise has merit.
3. Posting Assets: The bank likes to see that the LLC already has other assets and is not worth cutting off.  The banks or lenders especially like to see that the LLC will put a deed to a current asset in escrow so in the event of a default on the loan, the lender is assured an easy to sell asset that more than compensates for the loan that was defaulted upon.

These are just some of the ways to build credit worthiness and get a bank lending to the LLC rather than to you personally.

Tags: business loans, financing, investment llc, LLC Credit Worthiness