HOPE FOR THE BEST, PLAN FOR THE WORST
There are many things you should do not only protect your investments, but also your personal assets. From general maintenance to legal entities, make sure you are doing all you can to protect your investment and yourself. I am not an expert in law, and laws vary state to state. This article is not legal advice, but simply to make you think about legal protections. Talk to a local real estate lawyer for full legal advice.
An easy form of protecting your assets is to establish a limited liability company (LLC) that owns your investment properties. A limited liability company is exactly what is says it is; a company that limits liability. By holding your rental properties in an LLC, you create a barrier between your personal and business assets. If a creditor or judgement comes against you personally, they cannot take the assets in the LLC. If something happens at your property and you are sued, they can only get judgement against the assets in the LLC so your personal assets remain safe.
Keeping separate checking accounts is a must too. If your rental income just goes directly into your personal account it will make it very hard to distinguish what cash is yours and what is the LLC’s. Create a clean and distinct line between your personal and your business. However, even with an LLC if it can be shown that you were neglectful and knowledgeable of dangerous issues and did nothing about it, it is possible that you can still be found at fault. You still have to maintain the property and cannot be negligent.
Carry a personal umbrella insurance policy. These are pretty inexpensive annually but can provide a lot of additional coverage in a worst-case scenario that often covers legal defense as well.
On the smaller scale to protect yourself and your investments, make sure you have a sufficient cash reserve to cover major repairs and upkeep on the property. Major expenses can and will happen and you need to be prepared. Things such as HVAC replacement and roof repair or replacement. Maybe when a tenant vacates you may have to replace all the flooring and repaint everything as well as pay the mortgage and expenses while vacant. Perhaps a tenant stops paying and you have to go through the eviction process. You will have to cover the mortgage and all expenses while that process is under way and then spend money on repairs once they are evicted to get it ready for the next tenant.
There is no magic formula for how much of a cash buffer you need, but more is always better! Think of everything that could happen and make sure you are prepared for it. The amount you need will be very dependent on the state of your property and the age of the systems. If it is a newer property and the major systems like the HVAC and roof are relatively new, a smaller cash reserve is ok. If those items are older a larger cash buffer will be required.
As you purchase more properties your cash reserve needs will go up. With multiple properties, there will probably be a year that several big ticket items happen in a short window. I had one of those years and wish that I would have had a much larger cash buffer at that time. It was not fun to try to find enough cash to cover everything that had to be done. Thankfully I had a line of credit already established.
LINES OF CREDIT FOR ADDITIONAL SAFETY NET
Establishing a line of credit can be a life preserver, and most only cost around $100 per year to have open. That’s a pretty cheap insurance policy! Plus they usually have very reasonable interest rates too. It is easy to borrow money when you don’t need it so ask a bank for one when you have no immediate use for it and they will probably happily give you one. Then you will have it readily available just in case you ever do need it.
My LOC was a life-saver. I had a small window of time when major unexpected expense after unexpected expense kept happening. It seemed that anything that could possibly go wrong did. And just when I thought nothing else could go wrong, another major system broke down. Thankfully I had that LOC available because I did not have the cash reserves needed.
If you wait until you are in need of the money it becomes much more difficult to obtain the loan. Banks become leery of giving you a line of credit then, so do yourself a favor and get one established beforehand. Having the safety net of a line of credit is an excellent addition to the cash reserves. Whatever combo you use, just make sure that you have yourself covered.
TAKING CARE OF YOUR INVESTMENT
Make sure you stay on top of routine maintenance too. Taking care of the little issues can prevent them from becoming a big issue. Replacing old caulking around a tub could be all it takes to keep from having to rip everything out years earlier than if you had done a little maintenance. Having your HVAC serviced could prevent having to do a major repair or replacement. Hiring a competent property manager that screens tenants well and stays on top of routine maintenance and inspections also makes a big difference too. If you are managing yourself make sure you have a good screening process for prospective renters.
Do everything you can from the small stuff to the large legal concerns to make sure you are not putting your investment or your personal assets and family at risk. This article is not to scare you, but just to point out things that should be considered. Thankfully, I have never needed the legal protection of the LLC. I have never needed the personal umbrella insurance policy. I hope I never do, but if a situation ever arises that I do need either of those protections, they will be worth their weight in gold.