In recent years, more and more real estate investors are opting for a limited liability company (LLC). Forming an LLC is ideal primarily because it comes with the benefit of the same limited liability available to a corporation’s stockholders while providing the flexibility to describe the parties’ relationship by contract, without having to worry about a mandatory statutory scheme. Additionally, for tax purposes, it can count as a partnership or pass-through entity. This helps in avoiding taxation at the entity level and the profits and losses of the company are passed through to the members.
Business owners who wish to create an LLC should be familiar with the Limited Liability Company Act since any action done must be pursuant to any relevant statute. The guidelines that must be followed before being able to form an LLC may vary from state to state. As such, it is best to consult with a reliable real estate syndication lawyer who can give legal advice and respond to your legal questions.
What this article will focus on are provisions that must be included in LLC operating agreements for real estate investments. It covers the following:
- Purpose of the Company
- Restrictions on Authority Concerning Major Decisions
Purpose of the Company
Forming a limited liability company is possible for any lawful purpose, with a very narrow or broad definition. Most of the time, however, LLCs in the real estate industry have narrow definitions. This is because LLC members often have a specific purpose, which is to purchase and own certain real estate property. Additionally, with such a definition, the company is protected from actions taken by the manager or managing member (on behalf of the LLC) that are not covered by the stated purpose. This is because the company will not be liable for any action that is not authorized by the LLC agreement.
Limiting the purpose clause to creating and maintaining the venture as a single-purpose entity (SPE) is beneficial for the following reasons:
- Financing requirements. SPE provisions are often part of the LLC agreement or relevant amendments. This is because a borrower will likely be required by lenders to meet certain SPE requirements.
- Liability and bankruptcy protection. An SPE will generally not be able to incur unrelated liabilities since its sole purpose is to own and operate a specific real property or a determined group of real properties. This prevents creditors of other businesses or properties from attacking SPE for unrelated debts. This is, as long as operational formalities are taken into account.
Restrictions on Authority Concerning Major Decisions
In an LLC, unanimous approval is usually required for major decisions. Alternatively, to prevent a deadlock from being forced by a few minority owners (which can lead to loss of value in the real estate project), a supermajority percentage threshold may be specified for major decisions. However, such should be expressly articulated in the real estate LLC operating agreement.
Before one can form a limited liability company, it is crucial to be familiar with all the licenses and permits required by state law for this business structure. Experienced Calabasas real estate lawyers can help you learn how to start setting up a rental property LLC.
The management structure and allocation of control among the members is also a crucial part of operating agreements when investing in real estate. When LLC is used as the venture entity for real estate, there is a certain flexibility in terms of management and control. Such would depend on the venture’s structure, the members’ experience in real estate, and all parties’ negotiating leverage.
Normally, an experienced managing member will handle the daily management of the limited liability company. However, specified major decisions will require the approval of a certain percentage interest of the venture members. Alternatively, if there is no member with adequate real estate experience, if there are too many members, or if the members agree to engage a professional manager, a non-member may be appointed to manage the operation of real estate (although this is quite uncommon).
If it is agreed that a real estate operator or developer will act as the managing member, the real estate venture will usually separately contract an experienced property or asset manager, in exchange for a nominal interest in the company or a fixed fee.
Operating agreements are key in protecting your investment. Call us at Moschetti Law Group and consult with our real estate syndication experts which can assist you with the legal forms and paperwork necessary for a proper LLC formation.
Tilden Moschetti, Esq., is a highly sought-after syndication attorney with nearly two decades of experience. His clientele ranges from real estate developers and startups to established businesses and private equity funds. Tilden’s expertise in syndication law comes not only from his knowledge of syndication and securities law but from real, hands-on experience as an active syndicator himself in every real estate product type and nearly all markets in the US. His knowledge and experience set him apart and established him as the Reg D legal services leader.