A couple of days ago I blogged about moving assets out of your name and into the name of your minty-fresh new business structure. It was late at night, I’d been travelling all day through some very interesting weather in the Sierras, and so I took the easy road – I just talked about assets like equipment, computer gear, etc.
Today, I’m tackling a harder question: moving real estate from your personal name into your business’s name without triggering mortgage disaster. And I’ll tell you right now, it’s not always going to work – but I do have several suggestions, one of which will hopefully be right for you.
There are two parts to this process: transferring the property, and transferring the liability for the debt. Transferring the property is easy. There’s nothing that links the property transfer with the debt transfer. Contact just about any title agent in the country and they’ll be more than happy to write up the transfer document and file it for you with the county recorder’s office to officially record the ownership transfer. It’s not illegal – it’s a purely contractual issue. You won’t go to jail! But you have violated the terms of the contract, and that leads to the “due on sale” problem.
Due On Sale
The way that most mortgages are written today a lender has the right to call the balance of the mortgage due any time a transfer of title to real estate is recorded without their consent. This presents a problem for investors who want to get property out of their name and into their business structures, because limited liability companies (LLCs) and limited partnerships (LPs) are both considered to be separate and distinct from you in the eyes of the law. You aren’t responsible for the debts of your LLC/LP and vice-versa. If you transferred your property into an entity and then stopped paying the mortgage, the lender could have a hard time getting it back, and without the collateral to backstop the debt, you become a lousy risk as far as your lender is concerned.
But at the same time, your lender isn’t really interested in becoming a landlord, especially right now with foreclosures and REOs coming out their ears! I’ll never forget a discussion I had with Diane Kennedy and Morgan Smith a few years back, during one of Diane’s seminars. We were talking about this issue and asking Morgan for his input, as the head of a major mortgage lender. His response went more or less along the lines of “as long as I get paid, I don’t care. I’ve got more important things to do that play landlord.”
Solution 1: Ask the Right Person
So the first possible solution is to contact your lender and ask them about moving the property title. But be smart when you make the call. Don’t ask the person who answers the phone – he or she isn’t going to know. Ask for the legal department, and preferably an attorney within that department. Explain your intention, and that you are looking for a solution that keeps your assets safe and keeps the lender protected. Be prepared to offer up a continued personal guarantee over the loan, although the more equity you have in the property, the more room you have to negotiate on this point. If you don’t have a lot of equity, and your business structure is brand new, with no track record or other collateral, then you probably won’t get away with anything other than a personal guarantee.
Something else Morgan mentioned really struck me. He said that in all of his years in this industry he’d yet to see a financial institution say no. He stressed, though, that the key was making sure you talked to the right people.
If you’ve tried this method and been turned down, you aren’t powerless. There are plenty of lenders out there – you may need to talk to another institution about moving your loan. Heck, why not contact Morgan’s company and see what they can do for you? Email Aaron Van Trojen, at firstname.lastname@example.org.
Solution 2: Seek Forgiveness, not Permission
Some people take the bull by the horns and just contact their local title agents to draw up and file the transfer papers. They figure that as long as the monthly mortgage payments are made, the bank isn’t going to look any deeper. When a title transfer is made, it’s usually not publicized anywhere. So unless your bank checks up on all of its mortgaged properties, there’s no way the transfer will be brought to its attention. And even if it did, what’s to stop you from refinancing through another lender and paying off your original mortgage company? Or transferring the property back into your name?
I know a lot of real estate investors who’ve gone this route over the years. I haven’t heard of anyone getting into irreparable trouble – but that doesn’t mean it hasn’t happened or it won’t happen. This particular solution definitely falls into the “information not advice” category.
Solution 3: Unrecorded Deed
Many people prepare a transfer deed, have it signed by themselves and their new LLC, and file the deed away in a safe place. The idea here is that the title has transferred, even if it hasn’t been recorded. Just because it hasn’t been recorded doesn’t mean a legal transfer hasn’t taken place. The recording process is a public confirmation of the ownership transfer.
While I like this solution if you’re transferring from yourself to your business structure, I wouldn’t want to see it used with an unrelated third party. That’s because I’ve seen legislation in some states that limits the rights of property owners where a transfer isn’t recorded. It’s terribly risky for the person coming in, too. How would they prove they were the legal owners without being able to produce the signed transfer document? What if the owners still on title did a separate deed that was recorded, transferring the property to someone else (I’ve seen that one happen!).
Solution 4: Transfer into a Trust
Some time ago the government decided that revocable living trusts were good things, and we should be encouraged to use them. Part of the encouragement process was a new law, called the The Garn-St. Germain Depository Institutions Act of 1982. This law provides an exception to the lender’s ability to enforce the due-on-sale clause if you transfer the property into a revocable living trust, where you remain a beneficiary. If you transfer title into a trust, and then later transfer ownership of the trust itself from yourself to your LLC or LP, again, you’re still within the boundaries of the law. The transfer of the trust ownership from yourself to your LLC/LP isn’t recorded anywhere, making it “between you and your corporate records.”
However, this law doesn’t apply to all types of real estate – it’s only good for residential properties containing 4 units or less. It also doesn’t apply to situations where there is also a transfer of occupancy rights – which is more or less exactly what you are doing if you sell your LLC/LP to a third party some time down the road. From an outside perspective, nothing changes. The property is titled in the name of the trust. The trust is in turn owned by the LLC/LP, and whomever owns that is not part of any public record. But the beneficial owner of the trust certainly has changed, and that puts you outside of the provisions of the Garn-St. Germain Act. And there’s the question of what happens to any personal guarantees to answer here, too.
Of all the solutions, I still like #1 the best. It’s certainly where I’d start, if I were looking to make the transfer.
Diane’s also going to be weighing in on this question with an online workshop. Look for something from her in the next couple of weeks. The online workshops are free to First Class Lounge members, and if you’re not a member you can still sign up for a 30-day free trial, then get immediate access to the workshop.