How Lien Risks are Heightened with Real Estate Investment Properties
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Real estate is often seen as a more stable investment compared to stocks because this asset class historically offers lower risks, yields a better return on investment, and provides unique opportunities for portfolio diversification and wealth building. Still, investing in real estate isn’t always easy or risk-free.
Unlike stocks, buying real estate can be a lengthy and involved transaction. The learning curve is steep. There is no straightforward one-size-fits-all pathway to real estate investing, and one misstep could turn a promising asset into a money pit.
Here, we’ll discuss how lien risks can increase for real estate investors.
Investors approach real estate differently from the average homebuyer. Laws regarding liens may also impact investors disproportionately because they are more likely to hold multiple real estate assets. State and local laws around how a lien is filed, whether it attaches to the property, and if a tenant or landlord is obligated to pay can also vary. Here are a few things about liens new investors should consider.
A lien is a claim attached to an asset (like personal property or real property) demonstrating another party is owed money. Liens can be voluntary, like a mortgage, or involuntary, like a tax lien. A lien may also be specific and apply to only one particular asset, or general, meaning that it attaches to all assets owned by the person with the debt obligation.
An involuntary general lien may be filed against a landlord by various parties for a variety of reasons. For example, a couple, Frank and Susan, decide to invest in several rental properties as means of early retirement. After several years, their portfolio consists of four rental properties occupied by stable long-term tenants. One day, their tenant named Terry falls on a broken step and breaks his leg. Although he’s been a perfect tenant for years, Terry’s been out of work for several weeks and filed a personal injury lawsuit against the landlords. During the proceedings, the court determined that the landlords’ negligence in fixing the stairs contributed to the injury and lost wages. A judgment lien is filed against all the couple’s properties, including the ones that Terry has never set foot in.
Many real estate investors form a Limited Liability Company (“LLC”) to mitigate the impact of such liens. However, an LLC and all property owned by it can also be subjected to general liens. Holding each property within a single-asset LLC (meaning a different LLC owns each property) is a strategy many investors use to minimize the risk of general liens attaching to more than one property. Lien laws vary by state and you should consult an attorney to learn more about how this strategy would work in your state.
Because the average landlord owns three properties, these “mom-and-pop” investors may overlook a single-asset LLC strategy. When pursuing a buy-and-hold strategy, it’s not uncommon to purchase assets that have been previously owned by other investors. Buyers should be cognizant of how general liens attach to all property owned by the investor even if it’s not the subject of a lawsuit.
Many landlords assume that unpaid utility bills from a former tenant aren’t their responsibility. Depending on certain circumstances and state law, that may or may not be true. Landlords shouldn’t rest on this assumption since many municipalities have the right to place liens on the property.
Here are two questions that can help determine whether a tenant or landlord will be footing the bill.
- Who opened the account? Often for single-family rentals, tenants are expected to open utility accounts in their individual names under the terms of a lease agreement. In Florida and other states, statutes protect the landlord from liability for an unpaid account if it’s in the name of the previous tenant. In this case, the landlord won’t be responsible and the municipality generally can’t place a lien on the property. However, these laws vary by state so check with a local attorney to confirm the laws in your market.
- Is the provider public or private? Municipalities providing public services are given specific rights under state statutes to place a lien against a property. While a private utility provider could eventually get a judgment lien against the property of the account holder, the chances of an unpaid utility bill becoming a lien is greater with a public provider.
Before buying a real estate investment property, make sure you understand how your state handles unpaid utility bills and liens. In states like Florida and Texas, the municipal lien functions as a general lien, and other issues, like code violations, can attach to the property as a lien too. Under some circumstances, one property’s problems may affect all properties owned by an investor within the municipality’s jurisdiction.
For investors with multiple properties, the non-homesteaded property is at a heightened risk of being subjected to judgment liens. Certain states have homestead protection statutes designed to protect a debtor’s primary residence from certain types of liens. Homestead protections vary by state so it is important to understand homestead laws in the markets you purchase real estate in.
Not to be confused with homestead tax exemptions, homestead protections aim to protect people from losing their homes when facing bankruptcy. Generally, creditors of unsecured debt like credit card balances, medical bills, and personal loans have a variety of ways to recoup missed payments. One way is to file a lawsuit, receive a monetary judgment, and record the judgment lien with the state or county.
Municipal liens may also be limited by homestead protections. In Texas, one state statute allows municipalities to place a lien on a property that incurs expenses when repairing, removing, or demolishing structures that violate building codes “unless it is a homestead as protected by the Texas Constitution.”
General involuntary liens like judgment liens will turn up on the title search, so it’s important for buyers who don’t want to inherit these liens to require a title search in the contract and work with title professionals to find and resolve these issues before closing. On the other hand, municipal liens may or may not be filed in the public record at the time of a title search, so a municipal lien search is also recommended in certain states.
While bankruptcy may provide a “clean slate” for a property owner in financial turmoil, a bankruptcy-related foreclosure doesn’t always wipe away all liens. A superior lien takes priority in payment over other liens, including liens related to the bankruptcy, in some states. Superiority is commonly based on whichever lien was recorded first, but each state may have slightly different statutes on which type of liens take precedence over others despite when it’s recorded.
Suppose an investor owns property within a homeowner’s association. The investor paints the shutters a deep plum instead of one of the pre-approved beige colors, so the HOA notifies the owner of a code violation and assesses a fee. The owner then disputes the fine and refuses to pay the fees.
Different states have different laws regulating how HOAs and COAs can recoup unpaid assessments, but in certain cases, the HOA is allowed to foreclose against the property after taking other measures designated by statute. After months of trying to collect the debt through letters and filing a lien against the property, the HOA decides to take more significant action and foreclose on the property. Depending on the state, an HOA lien may take priority over other all other liens.
When purchasing a property at an auction or from an investor, understanding how lien priority works is vital to a successful real estate investment strategy.
When buying real estate investment properties, it’s important to work with title professionals who are familiar with state and local laws around liens and understand the needs and goals of your business. A standard purchase agreement is straightforward, but if you’re using novations, assignment contracts, double closes, and other more complex transactions, not all title partners are built to help you grow.
Blueprint’s processes and technology are designed to accelerate the acquisitions and dispositions of single-family rental properties. We’re focused on developing a more tailored title and closing experience for investors, wholesalers, proptech companies, and lenders. Submitting and tracking your transaction from contract to closing is more transparent too, with our Status Tracker and API.
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