Need help starting a Real Estate Corporation
December 22, 2005 11:00 AM   Subscribe

RealEstateFilter: Some friends and I are looking to create a real estate corporation to maximize our buying power while lowering our individual risk.

Real estate in Northern California is a highly volatile market with double digit appreciation values on top of already very, very high property valuations. My group of friends is considering pooling our resources to buy the largest plot of land or house or whatever that we can.

Web searches seem to turn up scams more than information. Does anyone have a good resource for information about the steps needed to create a real estate corporation?

I'd also like to hear some insights from anyone who's been involved in one, things to be careful, things to make sure are written into a contract and things along those lines. I'd also like to hear about the best properties to consider for this project.

We're not looking to do the six week buy, fixup and flip stuff that's on tv. We're looking more for long term growth and stability.
posted by fenriq to Work & Money (6 answers total) 2 users marked this as a favorite
Best answer: things to be careful, things to make sure are written into a contract ... best properties to consider for this project.

Five things to think about: leverage, cash flow, liquidity, tax consequences, and cashing out.

* Leverage: do you intend for the corporation to borrow any money, so you can buy more/larger/whatever, or just to invest your own money? (Advantage of borrowing: if prices continue to rise, you increase your profits sharply. Disadvantage: if real estate prices drop, you increase your losses sharply. Also, if you borrow, you have to consider cash flow.)

* Cash flow: if you borrow (see above), you'll have a mortgage (or equivalent to pay). If you have significant borrowing (say, 80% of the value of the properties), you're unlikely to have sufficient revenue from the properties to pay (a) the mortgage, (b) operating costs (repairs, etc.), and (c) property and other taxes. At the extreme, if you only invest in undeveloped land, you're almost certainly not going to have cash flow, even if you don't borrow, to cover property taxes. If it looks like you're going to have a negative cash flow, you need a plan for people to continue to add cash to the company, until a decision is made to sell some or all of the properties.

* Liquidity: if an investor wants to leave the group, will the company be able to sell a (small) property to pay off the investor, or will it have to find another investor first, or are investors locked into the company until it cashes out (see below)? And if an investor can cash out, what is the process for determining the net realizable value of the portfolio of properties held by the company? (Related question: can an investor sell his/her state to another investor without approval of the group as a whole?)

* Tax consequences: land can't be depreciated; buildings can. Depreciation typically results in "paper" losses ("paper" because there is no actual cash loss), which can be used to offset capital gains on individual returns. But this is useful ONLY if people actually have capital gains (or possibly under other circumstances - research and possibly a tax accountant is of assistance here, to find out what is allowed and not allowed). So, the decision as to whether to invest heavily in undeveloped land, or in properties where the buildings are the majority of the value (or inbetween), needs to be considered in light of tax consequences - would losses due to depreciation be worthwhile to have, or worthless?

* Cashing out: if the corporation does have large profits (or even if it doesn't), what sort of agreement (majority of ownership? supermajority?) is needed to liquidate the corporation and distribute the proceeds?
posted by WestCoaster at 12:09 PM on December 22, 2005

Will the shareholders live in the property themselves, or will they rent it out to non-shareholder tenants or merchants?

You are looking at a fundamentally different mortgage / tax / accounting / legal structure depending upon what your answer to that question is.

However, in each case, there are pretty straightforward structures for your lawyer and accountant to put you in. Nothing very exotic in either case.
posted by MattD at 12:32 PM on December 22, 2005

Will the shareholders live in the property themselves

I suspect that the IRS has some very serious concerns with someone who lives in a house owned by a corporation that is owned by that person. Essentially, corporations get to claim depreciation, which reduces the taxes owed while not incurring cash outlays; regular homeowners cannot claim depreciation except for any part of their home that is used EXCLUSIVELY for their occupation/business.

I doubt having a group of investors owning their own homes (and more) would change the view of the IRS; this is a rather fundamental concept.

At minimum, the corporation would not be allowed to treat that owner-occupied property as if it were occupied by an unrelated third party.

And even if IRS-related problems can be dealt with, the partnership might well have a lot of internal disputes over how much "rent" such a person should pay. If the property appreciates in value, for example, should the occupant pay more "rent"?
posted by WestCoaster at 3:14 PM on December 22, 2005

The corporation's not going to be able to get a loan. Limited liability means that when the corporation goes tits-up, creditors can't come after the assets of the principals.

Corporations with zero assets and no cash flow could then get a loan, go tits up, and no one be accountable for the money.

No bank would loan to this corporation.

So that's worth considering.
posted by ikkyu2 at 7:56 PM on December 22, 2005

The corporation's not going to be able to get a loan.

Of course it is (which isn't to say I recommend borrowing), assuming that "pooling our resources" means "contributing some money". A bank making a loan is looking for collateral and a margin of safety. If the group had (say) $400,000 to invest, it could easily borrow an additional $400,000 from a bank, assuming that the bank got a first mortgage on the $800,000 of property that the group's corporation purchased. The bank certainly wouldn't worry that the property's value would drop by 50%. (And it certainly would want its own independent appraisal to validate the proposed purchase price.)

By contrast, a bank would be unlikely to loan money if the investors were putting up no money at all, or a very small percentage of the total to be invested, with the rest to be borrowed.
posted by WestCoaster at 10:11 PM on December 22, 2005

Response by poster: Excellent information everyone. Thank you. Especially you, WestCoaster!

I've got some new ammo with which to do research.
posted by fenriq at 10:24 AM on December 23, 2005

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