Common Investor Legal Mistakes

You can’t expect to reduce your risk of getting sued to zero, but you can take steps to reduce your risk as much as possible. In any situation where your money is at risk, ask yourself, “Is there a better way?” Know the legal and financial risks of the situations in which you place yourself, your business, your family, and your assets.

Without covering every issue involved, here are a few common mistakes that investors make, novice and experienced alike.

Poor legal forms—It’s amazing how short-sighted novice investors can be when it comes to shelling out money for good legal contracts. They often buy contracts at discount office supply stores, from Internet Web sites, or borrow them from friends. However, a real estate deal is only worth the paper it’s written on. Like the old expression, “every tax strategy works until you get audited,” it can be said that “every contract works until you have a dispute.” So invest in a good set of legal forms that apply to your practice and ask a local real estate attorney to review them. Also, make certain you fill in the forms correctly—a good real estate attorney will review contracts for just a few hundred dollars.

Too many people rely on real estate brokers to fill out contracts, which is fine for a “standard” deal. However, most brokers aren’t trained in legal matters and often create long contract addendums that are insufficient to protect your interests.

Illegal discrimination—The Fair Housing Act of 1968, as amended, prohibits discrimination on the basis of race, color, religion, nationality, familial status, age, and gender. Many state and local laws also forbid discrimination on the basis of sexuality or source of income and the Americans with Disabilities Act makes it illegal to discriminate against disabled people. If you harbor any such prejudices and would allow them to come into play when renting a housing unit, then you’re probably not cut out to be a landlord. However, many sincere real estate investors make honest mistakes that result in discrimination lawsuits. The best way to avoid these lawsuits is to be informed.

The Fair Housing Act may appear to be common sense and most people would never think of discriminating against people of different races or religions or on the basis of gender. However, it’s important to note that the Act extends beyond the screening process and into advertising as well, so watch the wording on your ads. This is where many landlords and property managers make critical mistakes. Some people scour the classifieds looking for inappropriately worded ads so they can pounce on them and threaten a lawsuit. While someone must have standing to bring suit, these scoundrels often work in coalitions to ensure that all of their bases are covered.

For example, if you own a rental property in a predominantly Jewish community, its proximity to the local synagogue could be a major feature. But if your ad says “within walking distance of the synagogue,” you could be sending the message “gentiles need not apply”—even though this wasn’t your intent. And keep in mind that you may not discriminate on the basis of whether a couple is married and whether children are to live in the unit. You may also not discriminate on the basis of age. Often, novice landlords aren’t aware of these areas of concern. And while it’s good that citizens are more aware of their rights today, it can create a bad situation for well-meaning landlords who are out of step with the law.

Be aware of your local laws and use good business sense. State law and local ordinances can extend similar protections granted under the Fair Housing Act to other groups. For example, California, Minnesota, and North Dakota prohibit discrimination based on source of income. In other words, landlords can’t discriminate against would-be tenants who rely on public assistance. Putting the political perspective of the landlord aside, such discrimination makes little business sense because people on welfare or social security are virtually assured of a fixed income.

The Americans with Disabilities Act (ADA) prohibits discrimination against the disabled and also requires landlords to make “reasonable accommodations” to disabled tenants. Who decides what’s reasonable? Typically, judges, if it comes to that. But while most landlords are aware of the ADA and would never stoop to discriminate against a person in a wheelchair, many are unaware that the ADA also protects mentally disabled tenants. A mental disability could also include recovering alcoholics and drug addicts. On the downside, these people can relapse; if they do, this can cause serious problems for you and other tenants. Everyone deserves a second chance and many recovering addicts become productive members of society. Those unable to recover typically have other problems and, thus, if you decide to reject their rental applications, it’s vitally important that you document additional reasons for rejecting their applications.

Improper disclosures—Improper disclosures are a common mistake for investors. It’s critical to be aware of the federal and state requirements for disclosures. For example, federal law requires a lead-based paint disclosure on the sale or rental of properties that were built before 1978. State laws may have additional regulations.

It’s become common practice for real estate brokers to use a property disclosure form as a general-purpose sell disclosure for all aspects of the house. Even if you’re selling your house on your own, be sure to use one of these forms (refer to the sample in Appendix 6). Whenever in doubt, disclose what you know, especially something the buyer or tenant may not know about, such as dangerous conditions, water damage, electrical issues, or plumbing problems.

Illegal solicitation of money—Many novice investors try to solicit money for investing via public advertising or mailings. This is commonly referred to as syndication. You may inadvertently cross over a variety of federal and state securities regulations when trying to raise capital. Chatting with friends over the dinner table about a real estate deal is one thing, but advertising to the public in mass may be considered a public offering. Before soliciting money from strangers, review your marketing, paperwork, and solicitation strategies with a local attorney well versed in this area of law. You may be able to get away with a good set of written disclosures if you solicit money on a limited basis, but it’s better to be safe than sorry.

Independent contractor liability—The IRS and your state department of labor are on the lookout for employers who don’t collect and pay withholding taxes, unemployment, and workers’ compensation insurance. If you have employees that are “off the books,” you’re looking for trouble. If you get caught, you’ll have to pay withholding taxes and as much as a 25 percent penalty. Intentionally failing to file W-2 forms will subject you to a $100 fine per form. The fine for failing to complete the Immigration and Naturalization Service (INS) Form I-9 varies from $100 to $1,000 per form. Your corporation or LLC won’t shield you from liability in these cases, either. All officers, directors, and responsible parties are personally liable for the taxes.

If you hire people to do contract work for you on a per-diem basis, they may be considered employees by the IRS. If any workers fail to pay their estimated taxes, you may still be liable for withholding. If these workers are under your control and supervision and work only for you, the IRS may consider them employees, even if you don’t. If this happens, you may be liable for back taxes and penalties.

To protect yourself, you should:

• Hire only contract workers who own their own corporation or get the business card and letterhead of any unincorporated contractors you may use so you can prove these workers aren’t your employees.

• Require proof of insurance (liability, unemployment, and workers’ compensation) in writing.

• Get written contracts or estimates on workers’ letterhead that states they’ll work their own hours and you don’t have direct supervision over the details of the work. (Refer to the sample independent contractor agreement in Appendix 7.)

• Have letters of reference from other people for whom the contractors worked to show that the contractors didn’t work solely for you. Keep these in your files.

File IRS Form 1099 for every worker to whom you pay more than $600 per year.

In addition to possible tax implications, an independent contractor can create liability for you if a court determines the contractor is your employee. For example, if your independent contractor is negligent and injures another person, the injured party can sue you directly. If facts show that you exercised enough control over your contractor, a court may rule that this contractor is your employee for liability purposes. As you may know, an employer is “vicariously liable” for the acts of his or her employees—the employer is liable as a matter of law without proof of fault on the part of the employer. Make certain you follow these guidelines when hiring contractors and pay particular attention to the issue of control.

Finally, under your state’s law be aware which duties are considered inherently dangerous, such as providing adequate security for tenants in a multiunit building. These duties can’t be delegated to an independent contractor without liability on your part, regardless of whether the person you hire is considered an independent contractor or an employee.

Quality Deals

I’ve been meaning to write this article for quite some time and those who have heard me speak in the last couple of years have already gotten an earful of this. This topic isn’t about a neat investing technique or new idea, but about a mindset. It’s my mindset and one that I believe will make many other people successful.

Back in 1998 when I took my first step into real estate investing, I was strongly influenced by others around me who believed you had to be a dominant force in your market to make real money. They stressed doing as many deals as possible and beating out the competition. The world around me was saying that the person who does the most wins. More deals lead to more profits which ultimately leads to greater success – all going hand-in-hand.

As a newbie, I took the teaching to heart and did over 100 deals in my first two years. I was proud of my accomplishments and knew many around me were impressed with my successes. However, when stopped to look at the big picture, I was doing a lot of deals and making more money than ever before, but I had little control elsewhere. My time wasn’t my own and the deals truly controlled me. In short, I wasn’t living a life that felt fulfilling.

I’ve talked with many investors across the country and always ask what draws them to real estate investing. The answers vary, but typically can be summed up in one sentence, “I want a better quality of life.” Over my years of investing, I have come to realize that QUANTITY does not lead to QUALITY. If you want real estate investing to provide you with a good quality of life, you need to pursue good quality deals, not a good quantity of deals.

What are quality deals? They’re deals that contribute to the advancement your goals. They get you moving in the direction that you want to go. Many investors start buying homes with no idea of what they really want to accomplish with investing. As a result, they buy anything that looks like a deal and, all too often, get pulled in directions they never intended to go.

Your goals should drive your decision making. For example, a person who needs money today and buys a property to keep it as a rental is contradicting or not fulfilling the original goal. Rental properties will not reap quick, fast cash today. Let’s say your goal is to free up your time so that you can do other things important to you. If you only want to work 20 hours a week and are taking on deals that require 40 hours a week, you’re not doing quality deals. You’re focused on quantity.

We need to make sacrifices to achieve the success that we desire, but need to be careful not to sacrifice the important things in life. If you are pursuing investing to achieve a better quality of life, focus on quality deals and not quantity.

Common Investor Legal Mistakes

You can’t expect to reduce your risk of getting sued to zero, but you can take steps to reduce your risk as much as possible. In any situation where your money is at risk, ask yourself, “Is there a better way?” Know the legal and financial risks of the situations in which you place yourself, your business, your family, and your assets.
Without covering every issue involved, here are a few common mistakes that investors make, novice and experienced alike.

Poor legal forms—It’s amazing how short-sighted novice investors can be when it comes to shelling out money for good legal contracts. They often buy contracts at discount office supply stores, from Internet Web sites, or borrow them from friends. However, a real estate deal is only worth the paper it’s written on. Like the old expression, “every tax strategy works until you get audited,” it can be said that “every contract works until you have a dispute.” So invest in a good set of legal forms that apply to your practice and ask a local real estate attorney to review them. Also, make certain you fill in the forms correctly—a good real estate attorney will review contracts for just a few hundred dollars.

Too many people rely on real estate brokers to fill out contracts, which is fine for a “standard” deal. However, most brokers aren’t trained in legal matters and often create long contract addendums that are insufficient to protect your interests.

Illegal discrimination—The Fair Housing Act of 1968, as amended, prohibits discrimination on the basis of race, color, religion, nationality, familial status, age, and gender. Many state and local laws also forbid discrimination on the basis of sexuality or source of income and the Americans with Disabilities Act makes it illegal to discriminate against disabled people. If you harbor any such prejudices and would allow them to come into play when renting a housing unit, then you’re probably not cut out to be a landlord. However, many sincere real estate investors make honest mistakes that result in discrimination lawsuits. The best way to avoid these lawsuits is to be informed.

The Fair Housing Act may appear to be common sense and most people would never think of discriminating against people of different races or religions or on the basis of gender. However, it’s important to note that the Act extends beyond the screening process and into advertising as well, so watch the wording on your ads. This is where many landlords and property managers make critical mistakes. Some people scour the classifieds looking for inappropriately worded ads so they can pounce on them and threaten a lawsuit. While someone must have standing to bring suit, these scoundrels often work in coalitions to ensure that all of their bases are covered.

For example, if you own a rental property in a predominantly Jewish community, its proximity to the local synagogue could be a major feature. But if your ad says “within walking distance of the synagogue,” you could be sending the message “gentiles need not apply”—even though this wasn’t your intent. And keep in mind that you may not discriminate on the basis of whether a couple is married and whether children are to live in the unit. You may also not discriminate on the basis of age. Often, novice landlords aren’t aware of these areas of concern. And while it’s good that citizens are more aware of their rights today, it can create a bad situation for well-meaning landlords who are out of step with the law.
Be aware of your local laws and use good business sense. State law and local ordinances can extend similar protections granted under the Fair Housing Act to other groups. For example, California, Minnesota, and North Dakota prohibit discrimination based on source of income. In other words, landlords can’t discriminate against would-be tenants who rely on public assistance. Putting the political perspective of the landlord aside, such discrimination makes little business sense because people on welfare or social security are virtually assured of a fixed income.

The Americans with Disabilities Act (ADA) prohibits discrimination against the disabled and also requires landlords to make “reasonable accommodations” to disabled tenants. Who decides what’s reasonable? Typically, judges, if it comes to that. But while most landlords are aware of the ADA and would never stoop to discriminate against a person in a wheelchair, many are unaware that the ADA also protects mentally disabled tenants. A mental disability could also include recovering alcoholics and drug addicts. On the downside, these people can relapse; if they do, this can cause serious problems for you and other tenants. Everyone deserves a second chance and many recovering addicts become productive members of society. Those unable to recover typically have other problems and, thus, if you decide to reject their rental applications, it’s vitally important that you document additional reasons for rejecting their applications.

Improper disclosures—Improper disclosures are a common mistake for investors. It’s critical to be aware of the federal and state requirements for disclosures. For example, federal law requires a lead-based paint disclosure on the sale or rental of properties that were built before 1978. State laws may have additional regulations.

It’s become common practice for real estate brokers to use a property disclosure form as a general-purpose sell disclosure for all aspects of the house. Even if you’re selling your house on your own, be sure to use one of these forms (refer to the sample in Appendix 6). Whenever in doubt, disclose what you know, especially something the buyer or tenant may not know about, such as dangerous conditions, water damage, electrical issues, or plumbing problems.

Illegal solicitation of money—Many novice investors try to solicit money for investing via public advertising or mailings. This is commonly referred to as syndication. You may inadvertently cross over a variety of federal and state securities regulations when trying to raise capital. Chatting with friends over the dinner table about a real estate deal is one thing, but advertising to the public in mass may be considered a public offering. Before soliciting money from strangers, review your marketing, paperwork, and solicitation strategies with a local attorney well versed in this area of law. You may be able to get away with a good set of written disclosures if you solicit money on a limited basis, but it’s better to be safe than sorry.

Independent contractor liability—The IRS and your state department of labor are on the lookout for employers who don’t collect and pay withholding taxes, unemployment, and workers’ compensation insurance. If you have employees that are “off the books,” you’re looking for trouble. If you get caught, you’ll have to pay withholding taxes and as much as a 25 percent penalty. Intentionally failing to file W-2 forms will subject you to a $100 fine per form. The fine for failing to complete the Immigration and Naturalization Service (INS) Form I-9 varies from $100 to $1,000 per form. Your corporation or LLC won’t shield you from liability in these cases, either. All officers, directors, and responsible parties are personally liable for the taxes.

If you hire people to do contract work for you on a per-diem basis, they may be considered employees by the IRS. If any workers fail to pay their estimated taxes, you may still be liable for withholding. If these workers are under your control and supervision and work only for you, the IRS may consider them employees, even if you don’t. If this happens, you may be liable for back taxes and penalties.

To protect yourself, you should:

• Hire only contract workers who own their own corporation or get the business card and letterhead of any unincorporated contractors you may use so you can prove these workers aren’t your employees.

• Require proof of insurance (liability, unemployment, and workers’ compensation) in writing.

• Get written contracts or estimates on workers’ letterhead that states they’ll work their own hours and you don’t have direct supervision over the details of the work. (Refer to the sample independent contractor agreement in Appendix 7.)

• Have letters of reference from other people for whom the contractors worked to show that the contractors didn’t work solely for you. Keep these in your files.
File IRS Form 1099 for every worker to whom you pay more than $600 per year.

In addition to possible tax implications, an independent contractor can create liability for you if a court determines the contractor is your employee. For example, if your independent contractor is negligent and injures another person, the injured party can sue you directly. If facts show that you exercised enough control over your contractor, a court may rule that this contractor is your employee for liability purposes. As you may know, an employer is “vicariously liable” for the acts of his or her employees—the employer is liable as a matter of law without proof of fault on the part of the employer. Make certain you follow these guidelines when hiring contractors and pay particular attention to the issue of control.

Finally, under your state’s law be aware which duties are considered inherently dangerous, such as providing adequate security for tenants in a multiunit building. These duties can’t be delegated to an independent contractor without liability on your part, regardless of whether the person you hire is considered an independent contractor or an employee.

Alternate Sources of Income and Why You Need Them

Being a professional landlord has to be one of the best career choices one can make. The benefit “package” is difficult to beat. As landlords we have it all: personal freedom, perpetual monthly income, asset values (and rents) riding on inflation, no “formal” office, outstanding tax treatment (no self-employment tax on rents, long-term capital gains), forced savings plan via property debt reduction, little need for actual employees (contractors instead), and on and on the list goes. Any single benefit mentioned above is reason enough for stating that professional landlording is one of the finest home-based business opportunities available today. Personally, I love the freedom and flexibility owning rental properties gives me (on average, only 2 hours of management per unit per month).

Since you already have the wisdom to own income-producing property, allow me to share a secret of many highly successful professional landlords. By the way, my definition of a professional landlord is someone who earns a large portion of their income or NET WORTH from income producing properties. For most, this threshold means only owning 4-5 properties, since it only takes a few hundred thousand dollars in controlled assets to account for the majority of a person’s net worth (estate), which eventually will translate into cash flow. (Sidebar: I told one millionaire landlord — “You can’t eat equity.” He retorted—“I am.”)

One big secret to successfully buying and holding long-term rental producing properties is this: Have alternate sources of cash flow working for you. It is no secret that rental properties can have their own ups and downs in income that come your way: unexpected vacancies, evictions, slow-pays, repairs and major mechanical failures (heaters, roofs, worn out rugs, long-term tenant moveouts needing substantial remodeling, etc). Because of the high cash demands of our business, I recommend investors have another cash-flow business that they operate in conjunction with their rental business. Not only will the cash flow business augment your existing rental income, but most importantly: The cash-flow business will fund future building acquisitions. Let me repeat that again because it is the critical part of the secret: Having a cash-flow service business will fund your future real estate down payments and purchases!

Real estate is an industry operated by independent contractors. For instance, virtually all builders are not really “builders” at all. They are managers and organizers that outsource virtually every aspect of the building construction to independent contractors who perform their specialty in putting the building together. The largest builder in my area doesn’t build anything. As a company they simply bring all of the parties and contractors together. They are construction “managers”. There’s a lesson somewhere here!

Where the opportunities lies for you is finding your own specialty niche somewhere in the real estate industry. (Sidebar: Your cash-flow service business does not have to be real estate related. The principal remains the same: Have some additional cash flow business operating synergistically with your rental properties.)

There are 2 major opportunities everyone thinks about when you talk about real estate businesses. Since these are reasonably obvious and well known, I will, for the sake of space and time, not cover them, although many folks make a fine living operating these as businesses. They are: buying and selling houses or being a licensed Realtor. I know successful several landlords who do one or even both of these businesses.

Being involved in several real estate businesses myself and knowing scores of active real estate entrepreneurs, allow me to throw some ideas and brainstorming at you to get you thinking about your own real estate service businesses you can start.

The first idea is to create a business where you acquire distressed income properties and create what I call Turnkey Investor Packages. I know several investors who purchase distressed multi-unit properties (usually vacant or nearly vacant) who then rehab the building and then rent out all of the units. They then “package” the building for sale completely “turnkey” to investors who don’t have either the time or experience to do it themselves. Some of these turnkey packagers then provide after the sale on-going management for the new owners for a fee. The profit goal is usually $25,000-50,000 per deal. In most cases, no license is required, except possibly for the management services and there are ways around that if needed.

My second idea: If you are the mechanical, physical work type, consider starting and operating a service whereby you detail rental properties for landlords. Also known as Apartment Preparation Services. The typical fee to clean and “prep” a unit is around $500 per unit. Do 2 units per week and that’s $1000 per week. Granted, this isn’t for everyone, but it could bring in an extra $30,000-50,000 per year to supplement your rental income. This may sound mundane, but there are many creative variations of this service that can help you earn even more. How about detailing houses For-Sale? How about doing this for $1000 per house? REO cleanup/securing services are another idea? Or, perhaps an advanced service for property sellers, charging $2500, whereby you “guarantee” to increase appraisal by $10,000.

Let’s suppose you are the super organized type—is it possible you could create a salable service where you help other landlords organize, systemize, computerize their home office and records? Perhaps for a fee—say $500, you would spend a long day in their office getting them professionally organized and systemized. You bet you could. You’d need to deliver some true value, but with some thought and creativity it could be very saleable. You wouldn’t need a license for this either!

Here’s a what-if idea. What if you became a rental cash-flow consultant. Suppose you were a master at operating a rental business and squeezing every dime out of properties. Do you think you could do a 2-day consultation for $1500-2500 if you guaranteed the client that your service would essentially be “free” from all of the newly found revenue in their business. You would have to be hot stuff for this to work, but if delivered and marketed correctly, I bet it would.

There are dozens of viable opportunities in real estate. As I mentioned earlier, real estate is a business dominated by independent contractors and specialists. You could be one of them: title searcher, real estate website publisher, storage garages, dealfinder/birddog/wholesaler, home inspector, broker, manager, marketing consultant, rehab/maintenance services, cash-flow consultant, tax appeal services, 1031 exchange services, eviction services, rent-to-own expert, mortgage broker, or any number of other creative variations or combinations. Don’t limit your income. Some diversification is wise.

How to Hire a Real Estate Attorney

No real estate course or seminar is a substitute for a good attorney. Finding a good real estate attorney may be difficult, since most attorneys are not themselves investors or familiar with creative transactions. Most attorneys will give you just enough advice to keep them from getting sued, but not enough advice to show you how to make more money out of a deal.

A good real estate attorney is one who advises you of the risks, suggest alternative ways of doing a transaction and charges a reasonable fee for doing so. A bad real estate attorney either says nothing, points out problems without offering solutions or systematically kill deals. This is why attorneys are frequently referred to as "deal killers".

Ask other investors in your area who they use as an attorney. Join a local real estate investors association and ask for referrals. Ask local real estate agents and title companies for referrals. Do not open up the Yellow Pages and pick someone who simply CLAIMS to be a real estate expert.

When interviewing a potential attorney, ask the following questions:

» Do you own rental property?

» How many closings do you do per year?

» What kind of unusual transactions have you done recently?

» Have you done any evictions? Foreclosures? Zoning board appeals? Condo conversions?

» Can you explain to me the following concepts: lease/option, wraparound mortgage, installment land contract?
Get a feel for the experience and personality of the attorney. A good attorney on your side is worth his weight in gold, especially if he can do creative closings.