house with wraparound porch in the woods

Understanding Liabilities on Rentals

Updated January 1, 1 . AmFam Team

By creating separate LLCs for each of your rental properties, you could be doing yourself a big favor. Learn all about the benefits of creating individual limited liability companies for each piece of commercial real estate.

If you’re a landlord, you understand the importance of making sure your rental property is safe and habitable for your tenant. By investing a small amount of time and energy into creating business entities for each of your rental properties, your big investments can be better protected.  

Get Financing and Make the Real Estate Purchase through the LLC

It can be easy to forget that your first purchase of rental property is a business venture. It’s really important that you treat it as such from the start. One of the best ways to handle the purchase of new rental property is to seek legal advice in advance and purchase the property through the LLC.

Reduce Liabilities and Professionally Manage Your Rental Property

One fundamental way to protect your business is to prevent small issues from turning into big problems. Here are some suggestions on how to manage your rental property professionally.

Focus on maintenance. By keeping your rental property in good repair and maintaining on-site equipment on a regular schedule, you’re off to a great start.

Be on-site frequently. Maintain the property regularly and be sure to remove any hazards from common areas. Manage stray trash around the mailboxes and be sure walkways are well-maintained.

Hire a property management company. With a lawyer’s sign-off on your operational agreement, you can outsource much of maintenance. Be aware that you may still be held liable for your property management group’s missteps. To prevent that, have your real estate attorney review your agreement and make sure that they consent to be held liable for damages resulting from their negligence.

Build Liability Protection into Your Lease Agreement

You may not be able to avoid all liabilities but you can fortify your lease agreement so that it offers some liability protections. Here are a few ways to bolster the liability protection in your lease:

Define conduct, rules and regulations. By defining expected behaviors and required actions that the tenant’s take in certain circumstances, you can protect your rental business. For instance, if you provide a pool for tenant use, prohibiting alcohol consumption in that area may be advisable. If a tenant should injure themselves while drinking there, your business would be protected from being held completely liable.

Define emergency issue notification protocols. Another way to prevent financial loss is to define protocols for tenants to follow during emergencies. Requiring them to immediately evacuate the rental when the fire alarm sounds, is one example. Landlords and property managers suffer financially when tenants suffer injuries because actions are not clearly laid out in the lease agreement.

Stay professional with problem tenants. If your tenant is up late, making noise and bothering other tenants, the remedy to that problem should be included in your lease. Define consequences for common nuisance behaviors in the terms of the agreement, and you may be able to take legal actions more quickly.

Why Your LLC Needs a Good Commercial Umbrella Liability Policy

By supplementing your existing business insurance, you can further protect the assets of your LLC. American Family’s Commercial Liability Umbrella Coverage gives you peace of mind when you need it. It’s a package of insurance protection that’s custom-built for the needs of business owners that require additional coverage above and beyond underlying policy limits.

As you’re planning your next real estate opportunity, remember to check in with our American Family Insurance agents (Opens in a new tab). They’re trained to craft coverage that protects you best — so you can focus on growing that business.

This article is for informational purposes only and is available through different sources. This information does not, and is not intended to, constitute legal advice. You should contact your attorney for legal advice specific to your situation.

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    Understand the formula

    If the total purchase price of the property is $200,000, rent should be no less than $2,000 per month or one percent of the total cost. Likewise, a $600,000 purchase price for a multi-unit rental property should meet or exceed $6,000 per month in total monthly rent earnings.

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    When factoring in the purchase price, remember to include closing costs, property taxes and insurance. One way to better estimate these costs is to use an online closing costs calculator which can approximate appraisal fees, home inspection fees, application fees, prepaid interest among a host of other out-of-pocket expenses that can up your purchase price, sometimes by thousands.

    Factor in repair costs now

    Because real estate investing as a landlord requires the space to be “habitable” upon tenant occupancy, you may need to make certain repairs or upgrades before renting the property. As a result, you’ll want to add the total cost of these repairs into the purchase price.

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    Neighborhood classifications help buyers understand the potential return on investment in a given area. If you’re new to being a landlord, you’ve got to pay close attention to what the neighborhood’s telling you.

    One good way to check out an area — specifically if it’s an investment that requires some traveling — is to use Google map’s street view. Is trash left out on the front lawn? Do neighbors maintain their property? What can the cars parked on the street tell you about the demographic? Here are details on the four distinct neighborhood classes real estate agents use to classify a region:

    Class A neighborhoods

    High income neighborhoods, combined with a home that is move-in ready will usually get an A class rating. Because homes are expensive in these neighborhoods, and their higher than average tax burden, real estate investors usually won’t buy a home there because the one percent rule fails the test. Tenants in these areas tend to be very reliable, high-quality renters.

    Class B neighborhoods

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    What is a cap rate?

    A cap rate determines a profit ratio that a property can generate. It’s best used as a quick way to compare investment opportunities to determine which one is the better value. Start by dividing the total of one year’s rent by the current market value of the home which should include costs and upgrades required to get the space habitable — you can’t rent the place if it’s not livable, right? The resulting percentage is your cap rate. The higher the rate, the better your annual profit margin.

    How to Calculate the Cap Rate for an Investment Property

    Although the cap rate’s a useful tool to quickly analyze the relative value of comparable real estate opportunities, it’s used as a rough guide to qualify properties for consideration, given the state of today’s current market climate. First, estimate your property’s overall purchase price:

    Figure the acquisition value

    Simply put, this is the total purchase price. It should include all upgrade costs, closing costs, taxes, business insurance, fees, points, etc. Let’s assume a property you’re considering has a total purchase value of $200,000.

    Calculate one year’s rent

    If you’re collecting $2,000 per month, you’ll have twelve payments at the end of the year, or $24,000. This figure is your gross annual income.

    Account for half a month’s vacancy

    Because turnover typically requires some painting and repairs, it’s fair to consider that half a percent (two weeks’ worth of rent) of your total annual income will be deducted to cover the mortgage payments. Assume that your new tenant will cover the remaining pro-rated rent for the other half of that month. Once the vacancy amount is deducted, the result is your gross operating income.

    • Gross annual rental income: $24,000
    • Less the cost of vacancy: -$1,000
    • Gross operating income: $23,000

    Factor in operational costs

    These costs will include money required to keep the property habitable, like paying for trash collection, making repairs, fees from property management, and landlord insurance. Let’s put that cost under fifty percent of the gross operating income, or $9,300. Some years it will be more, some less.

    • Gross operating income: $23,000
    • Less operating costs: $9,300
    • Net operating income (NOI): $13,700

    Divide the NOI by the total value of the property:

        $13,700 
    ---------------------  =  0.0685 or 6.85 % - That's your cap rate.
       $200,000 

    The capitalization rate for this investment is 6.85 percent annually. If another property under consideration returns a higher cap rate like 8.23 percent for instance, you may want to explore opportunity with the higher annual yield in order to maximize your profit potential.

    What is considered a good cap rate?

    Generally, a cap rate between 8% and 12% is considered good. However, an optimal cap rate is really going to depend on several factors including location, risk and current rental income. For example, in high-demand like big cities, a cap rate of 4% may be considered good.

    Reach Out to Your Agent Today

    With so many different ways to look at profitability when determining where to invest in rental property, it’s important you do your homework before you decide to buy. And while you’re making that big decision, remember to contact your American Family Insurance agent and discuss your upcoming purchase. When it comes time to close the deal, you’ll have peace of mind that your property’s insured carefully.

    This article is for informational purposes only and includes information widely available through different sources.

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