Musings About Asset Protection for California Real Estate Investors

I visited with a client of mine yesterday.  He’s about one year into “asset protection mode.”  He has several problem properties teetering on the edge, where the personal guarantees could bankrupt him.   Creditors are circling, but have not yet pounced.  It’s a Kabuki dance, will they or won’t they.  This client wants to be sure if they do pounce, they can’t wipe him out, like they did in the 90’s.

Since I am not an attorney, I can only assume the following that he told me is correct, but I cannot be sure.  This is what I learned.

1.   Get your money out of California bank accounts!  A creditor can walk into a judge the day you default and get a pre-judgment lien on your bank accounts.  Day 1.  A California judge cannot give a creditor such a lien on an account in Wyoming.

2.  Hold your properties in an LLC, preferably an LLC with members not involved in the day-to-day workings of your real estate enterprise. It is much harder for a creditor to get a hold on your assets in an LLC (vs. a corporation or no entity at all).

3.  Be out-of-town on the day of default (so you can’t be served).

4.  Begin squirreling away money into bank accounts that won’t honor a California judgment.  Many foreign jurisdictions, including plenty of ones where it is safe to keep your money,  will not do so.  I knew better than to ask where he was putting his.

5. Pay your federal taxes, file your returns, report your foreign bank accounts and keep on VERY good terms with the IRS.  Chances are, with all the real estate losses floating around, the IRS is not very high on any real estate investor’s creditor list.  The IRS has a worldwide power to collect, unlike the State of CA, and most people are unwilling to stomach the measures necessary to defy that power.

On that cheery note, if you have potential net worth-ending creditor problems and you have not done any bona fide asset protection, you are  a year behind the smart ones who learned their lessons in the 90’s.

Need a Real Estate CPA?

Man, times are tough and keep getting worse in the real estate CPA business.  I’ve been in the real estate CPA business a long time, and this makes the early 80s, the late 80s and the early 90s look like a walk in the park. 

I saw the real estate bubble like a car speeding towards the cliff.  Some real estate developers and investors were smart, they saw the cliff coming, slowed down early and stopped in time.  Some saw the cliff coming too late, slammed on the brakes, but still skidded over the edge and went into the abyss.  And then there were the ones emulating the ending of the film “Thelma and Louise” reaching the cliff “peddle to the metal,” launching themselves into the deepest depths of the debtor’s abyss, exploding in a huge fireball of unpaid creditors. 

Commercial development remains at an absolute standstill.  When commercial landlords can’t keep their spaces rented, who on earth would want to create more spaces?  And it’s not just the empty spaces that are causing the problem.  Strong tenants know the landlords are weak.  Tenants with renewals coming up are demanding concessions.  The strongest tenants are demanding mid-lease concessions, testing the will of landlords that desperately need them to stay.  And it’s not just the strong tenants demanding concessions.  Tenants who are weak themselves have come to landlords begging for concessions so they can stay out of default.  I’ve seen many a landlord make such concessions only to have the tenant fail anyway. 

All this activity has made the banks stark raving paranoid.  They are going after debtors who haven’t missed a payment for violating loan-to-value covenants, demanding loan re-margins or other down payments.  Negotiations in favor of the landlord who is current on the mortgage are nonexistent.  They are literally forcing the landlord to default, just to get their attention.  Lawsuits are coming.  Creditors can get an injunction on a defaulting creditor (even just ones out of covenant) and attach their bank accounts.  Mark my words, this is coming very soon unless the economy recovers PDQ.  For landlords owning multiple properties, with multiple banks as creditors, a lawsuit by one lender likely means a rush to the courthouse by the remaining lenders.  Going back to the car and the cliff analogy, the car may have stopped in time, but now the cliff is eroding, and it’s getting really close for many commercial property owners.  2010 could get VERY ugly.

On a modestly brighter side, on the residential side homebuilding is showing some signs of life, for those players who still survive, albeit on life support.  New home inventory is almost non-existent and there is just enough demand for homebuilders to carefully try to build one or two homes and try to sell them.  Nobody I have talked to expect to expose themselves to more than a few homes under construction at once until a consistent demand can be assured. 

Residential landlords are experiencing an extremely soft  rental market, and many rentals have loan to value ratios that are under water.  I have had many clients come to me and say that they have serious negative cash flow issues and cannot get a workout done with the bank.  That’s when I tell them they HAVE to stop making payments to get the bank’s attention.  If you are experiencing  negative cash flow and facing foreclosure, the worst thing you can do right now is to hesitate.  Either make the committment to carry the property for X years (if they can hold out that long) and wait for property values to come back or GET OUT NOW.  If you can’t hold out, if you wait six months and then default, that’s six more months of negative cash flow for no reason!  That money is wasted.  Use that money to pay down other debts you will continue to carry.   

And by the way, times are tough for this real estate CPA, when my clients are hurting, my business suffers too.  I saw the cliff coming and I put in some measures that kept me away from the edge.   Fortunately these measures did not forced me into auditing school districts and battling Turbo Tax and H&R Block for simple 1040 business.   I am surviving by helping my clients survive, and I’m taking on new clients who want that kind of expertise. 

Does your accountant or CPA know this kind of stuff?  Would having a CPA who is current on the local market forces, and has information on what his other clients are doing that could help you?  Does your CPA have a Masters in Tax and more than 25 years in real estate tax background?  Times are tough.  Get some help fighting back.