20) Liabilities and Asset Protection

Let’s talk about protecting your assets.

There are certain professions that are targets for lawsuits including doctors, attorneys, accountants, and real estate investors. Owners of real estate, especially those that own large numbers of properties or high value properties, are especially at risk of being sued.

Sadly, it’s inevitable, but there are ways to avoid suits and/or to reduce losses when such a thing arises. Let’s look at an example to illustrate this.

Let’s assume an individual investor has purchased and held one property as a rental. Things are going well, the property is cash flowing, so the investor decides to pick up another. Things are getting even better, so the investor picks up another… then another… then a multi-unit property… then another…

The investor has financed each deal, however they’re cash flow positive, so he is feeling good!

The investor is flush with assets and cash flow. A few years down the road, he pays off one property, then uses the cash flow to pay off the next, then the next, and eventually all of the properties. The investor’s financial position is extremely strong and cash flow has never been better.

The tenants at one of the multi-unit buildings have been complaining about the condition of the stairs, which all tenants use to get to their front doors. The investor checks it out, and they definitely need repair, but he just bought a new boat, so it’ll need to wait until next month.

As all of the tenants came home from work at about 5:30 in the evening, they chatted on the landing of the stairs when suddenly the stairs collapsed.

Sadly a few of the tenants were injured. One very seriously. The two escaped with a broken ankle, cuts, and bruises; however, the one broke their neck and was in the ICU. The property owner visited, brought flowers, had friendly conversations with the family of the tenant. He bought the largest bouquet of flowers available at the shop, so he was feeling pretty good. He even bought dinner for the two that only had cuts and bruises. All was well.

Six months later, and four months after the seriously injured tenant was released from the hospital with long-term injuries, the investor was served with a seven-figure lawsuit which included compensation for hospital bills, attorney bills, income lost during the hospital stay, and income lost due to inability to work in their field in the future thanks to the injury.

The investor was sued personally because he owned the property in his own name along with every other investment property, his personal house, his cars and toys, and his fancy, new boat.

The judge awarded the plaintiffs, and all of his assets were seized to satisfy the judgement against him. Everybody loses in a situation like that sadly.

Obviously, this example is pretty dramatic and unlikely; however, getting sued and having all assets at risk is not unlikely. Sadly, just like sharks in the ocean, when attorneys have a case, and the defendant has assets, then there’s blood in the water, and they want it all.

But there are ways to protect yourself as a real estate investor and reduce losses in a situation like the example above.

We refer to this generally speaking as “asset protection,” and it primarily means separating assets from each other and from the owner, or the person controlling the investment, so that if a single asset becomes liable then it is liable on its own separate from all other assets.

Let’s take that same example from before to show how the investor may have set things up differently and how things may have been different. Disclaimer: this video is not intended to give you legal advice or to tell you to copy this exact model, but it meant to provide an example to teach a principle. Please consult with an attorney regarding your individual case.

Let’s assume that the investor set up a limited liability company (LLC) to begin investing, which he owned. He then purchased his first rental property through that LLC. As the manager of the LLC, he also controlled the assets owned by the LLC. Things go well so he decides to pick up another rental property. He sets up another LLC and purchases the next property under that LLC, and so on.

Each property is owned by a separate LLC and stands alone and independent from the other assets and companies.

Let’s assume that the same scenario occurred where the staircase collapsed, and the tenants were injured. Typically, in a situation like this, the company that owned the property would be liable only. The lawsuit could not bridge the gap between entities and could not bridge the gap to the owners of the LLC. The multi-unit building and anything owned by that LLC might be at risk, but typically, that’s where the liability ends.

There is nuance, of course. For example, if the owner was using the bank account associated with that LLC for personal expenses, then they may be able to break the corporate barrier to the owner.

Make sure to check with your attorney as you begin investing to get advice on your structure and how to protect yourself. It may not seem important in the beginning, but it is, and the importance grows as your business grows.

Also, take care of your properties and tenants. 