Real Estate Liability Protection – “The Protection Pyramid”

I wanted to share some thoughts about liability protection in real estate. It’s a frequent topic if you’re interested in investing in real estate and is often centered about how best to hold property – in an LLC, corporation, etc. This is certainly a point to consider but there are many other ways to go about addressing liability and working to reduce your risk. Following is a summary of the biggest areas I’d consider.

I’ve tried to build this pyramid model with the base being the broadest type of liability protection and getting more specific going up. Not every piece of the pyramid will make sense for every property or situation – the intent is to have a comprehensive set of options to consider.

• Legal
  • Entity Form – Holding a property in an LLC, S Corporation, or other entity form can be considered to separate assets from other assets or investment assets from personal ones. Creating an entity will likely include annual fees and filings with the state. There are different tax and legal elements to consider when selecting a form.
  • Revocable Trust or Will – As part of estate planning a revocable trust can be considered in addition to holding property in an entity or directly.
• Insurance
  • Property Insurance – Property insurance is typically required if property is purchased with debt and is likely a good idea in case of accidents.
  • Umbrella Insurance – Umbrella insurance goes “on top of” property insurance to provide additional liability for incidents not covered by property insurance or exceeding the insurance coverages.
  • Specialty Insurance – Earthquake, flood, or other insurance policies that may make sense depending on the property location.
• Operations
  • Property Management – Hiring a professional property manager may be a good idea to make management less time intensive and to have a professional on your team. Additionally, this may reduce your liability related to tenant relations and selection.
  • Diligence
    • Due diligence (before purchase) – Inspections of the property before purchasing can identify potential issues in advance to address or avoid. A general inspection as well as specific inspections for foundation, roof, termites, radon, and other areas can be considered.
    • Ongoing diligence – Annual inspections of the property with an eye to potential water damage (roof, plumbing), safety equipment (smoke detectors, CO detectors, fire extinguishers) can identify current or future concerns to address and avoid ongoing damage.
    • Tenant screening – Considering criminal background, credit history, and other criteria when screening tenants can reduce liability.
• Equity
  • Equity Stripping – To reduce the amount of value that is potentially at risk in a property you can “strip out” the equity in the property by refinancing the property and taking cash out or through other means.

I hope this set of liability considerations is helpful to you and best wishes in your real estate investing!

Note: The content of this post is for informational and discussion purposes and is not financial or tax advice. Consult with an advisor before relying on this or any information.