160. Asking An STR Lawyer How Risk Exposed I Am! 😳 Interview with Katie Johnson

21:20Natalie Palmer:Whenever I hear people say this, they're like, you should have every single property in an LLC. I'm like, must be nice. Am I just, I don't know. Maybe I'm a little more slightly risk tolerant person, but I'm like, I don't want to open an LLC for every single property. But for 800 bucks, maybe it's worth it for the protection but i'm just as your portfolio grows that's a lot it is a lot yeah and then you said that's an annual fee too yeah our annual statement is 25 so no it's 800 a year cost of living there gosh wow my mind blown on this i know i know so so i currently so i own one investment property my husband and i and then i mostly co-host so our one investment i don't having an LLC.

22:03Natalie Palmer:Our CPA said the umbrella of insurance policy is enough. I do have an LLC for my co-hosting business. So that's how I've done it. But maybe I should just put our other property in one, but I don't know. You could. I mean, you only have one. Why not? I don't know. That's mine. And then with your co-host too, you could always just make sure your agreements are really tight in terms of your liability and making sure they're getting insurance for you as well. Yes. Okay. I do have that where I tell them they have to have insurance policy and they've added me the same way that you did. So I do have that.

22:37Natalie Palmer:Katie, walk me through some other scenarios. Like I honestly, I don't know what to ask here. Like I don't know what I don't know about how to protect ourselves as hosts. So you tell me like someone just comes in for an initial consultation and wants to know their risk profile. Like what is everything you would look at with them? I think we've covered a lot of it, but if we could talk too about like the scenario where you're thinking about investing with other people yeah and how you can structure that like i think the best way to structure is the way you're talking about doing it where you create an llc all together and then have an operating agreement with it but you can also do joint venture agreements i don't know if you've done any of those natalie no walk me through that yeah so a joint venture agreement would be where you just aren't creating a new llc it's two people coming together and doing a deal together and so it's just sort of like the terms of the deal in there um but the nice thing If you're not forming an LLC, what would that look like?

23:28Natalie Palmer:It's like both of their names are on the title. They both own the property 50-50. It can depend. Like I've done one where it was like one of the people was going to get the property. The other person was rehabbing it. You know, they just had different roles, that sort of thing. So it really just depends on what you want it to be. So you would help them in structuring the contract? Yes, that's what I did. Okay. So even if they're not in an LLC, at least the partnership terms are very clear on who's bringing what, who's doing what role, who gets paid for what, who's bringing what to the table. Yeah.

24:05And what the returns are, what happened. And then there's like a guarantee involved as well. Those are the different things that we did for that one. And then it's just sort of like worst case scenario type stuff is usually what you want to lay out both in the operating agreement and like a joint venture agreement.

24:19Natalie Palmer:And then with worst case scenarios, you're like writing this out how? Like you would say something like, you know, worst case scenario, regulation changes and we can no longer operate as an STR. Here is how we would handle that. Like you're just basically putting what the scenario is and then what the response would be. Yes. Or, you know, you've got eight investors, one wants out. How do they leave? What does that look like? You know, is there a penalty for leaving early? Are they tied for a certain period of time? That sort of thing. Do they get paid out? How do you pay them out? Or like, let's say for whatever reason, this project that you thought was going to be profitable is not profitable.

24:57And you need more money. Who pays for the capital call? You have some people who are not investing any money. Some people are doing like the sweat equity and then other people are doing the money, you know, having that clarity on who's going to add more money if there's needs more money. And if you have different levels and, you know, let's say you have like an investment where half the people are paying, half aren't just having that or if they're not paying equally equal amounts, just determining how you're going to raise the capital. If you ever have to raise capital again, it's good to have in your initial agreement so you don't have to fight over it.

25:29Natalie Palmer:This makes me feel better. This is all I just reviewed our operating agreement today and all of that is in there. So we did good on that one. Do you have like a dispute resolution clause to like what happens if there's a dispute? Like, are you going to arbitration? Are you waiting a jury trial? That's something that I would look for. What's your recommendation for that? I like arbitration. You know, arbitration is private. It's generally going to be cheaper, potentially, you know, just quicker than a court case can take like a decade and arbitration is quicker. So I usually do an arbitration clause.

25:58But then you're going to want to agree on whether you're going like with the arbitrator rules. There's two main arbitrators. And so which one are you going to go with? What rules are you going to go with? And then also like, where is the venue for this? So your property is in New York. You're in California. If you have a dispute, where is the venue. Is it New York? Is it California? You get to decide.

26:18Natalie Palmer:That actually brings up my next question. So if we have partners, you know, New York property and there's partners from, let's just say Florida, California, Texas, I don't know, all over the place, how would you recommend, like, we'll all form a new partnership LLC together in New York, but then how would you recommend that each individual partner comes into that LLC? like should they form an LLC on their end or they can list their personal name on there um if they are forming a new LLC would that be in the state of New York or in their home state yeah I don't know New York law well enough to know whether you would have to have it in New York um you'd have to see if there's any like requirement that they register with let's say they're hypothetically, let's say they form it in Florida.

27:10But New York has some requirement that if you're doing business in New York and you're an LLC from out of state, you have to register in some capacity. So they might have to register in some capacity with New York. But I would say they could form it either in their home state or in New York with consultation with their attorney. And then they could also do it individually. Like they could put themselves individually into this LLC. It's like really up to them.

27:31Natalie Palmer:So if there's already this New York LLC that's forming and that's kind of the buffer. That's like already a layer of protection between just all the partners personally having their name on the property. So what would be the reason to also have an LLC in your own home state that's then like listed on that? Well, then it's not your personal name again for the same reason. If something goes awry, you're talking about the LLC, not you. So if you have to file bankruptcy or something, the LLC is filing bankruptcy, not you. You know, if there's some issues that come up. I guess, sorry if I'm asking this like wrong, But I guess that's where I'm confused because like if there's already the formation of this LLC, I guess my question is like, how many LLCs do we need to be protected?

28:11Natalie Palmer:Like, couldn't people just go up if they really want to sue you? Couldn't they just go up the chain and be like, OK, well, who owns this one? Who owns this one? At a certain point, it's going to be your personal name on there. So how like how does this protect you? It's called like piercing a corporate veil, I think, is what you're talking about when you when someone goes through the LLC and gets to you. And so that just depends on how you're operating your LLC. And so they would make arguments that you're not operating it properly and that you're it's really you are the LLC. There's no difference between you and the LLC.

28:44And so then they would go after you personally. I think that's what you're you're kind of asking there. So best practices for that would be not to commingle your accounts, right? Like have personal accounts, have business accounts, have a business email, have a personal email. Phone, I think, is a little more tricky. You know, most people don't have two phone lines, but just trying to keep everything separate and like showing that it's really like a separate business, separate entity, you know, having profit and loss. Like if you have a bookkeeper or something like that, just like really operating it like a business is going to be your best bet if you're forming an LLC.

29:17Natalie Palmer:So if you were a partner on a deal like this, the way you would do it was you, Katie, would form an LLC in your home state of Michigan. That LLC, when it comes time to form our partnership LLC in New York, you would put not your personal name as one of the operating partners, but you'd put your LLC name. and then any distributions that get paid out, would you make like a new bank account that's explicitly for these distributions to go to? You wouldn't like direct deposit it to a personal account? Yes, that's how I would do it. But I mean, you know, however people, I mean, if people feel comfortable putting their personal name in, I mean, they could and then have their personal bank account.

30:01I mean, that's an option too. But personally, I would do my own LLC, create a new bank account, have it be a whole separate thing. And that's how I do it.

30:09Natalie Palmer:If you're doing multiple partnerships like this and whatever, 50K here, 50K here, 50K here, would you make a new LLC for each one of those? Or that one home state one you make could be listed for a New York property you're a silent investor in, a Florida property, a Tennessee property? Yeah, I'd probably consult my CPA and ask like how complicated I'm making my life if I do that. But if assuming it's not that complicated, I would probably just make multiple LLCs because they're so easy to make in Michigan. And then would you have distributions go, would you make like three separate checking accounts or three separate bank accounts or just three separate buckets in a bank account?

30:50Yeah, LLCs are all going to have separate bank accounts.

30:52Natalie Palmer:see this is like just a logistical nightmare i feel like like then how many bank account passwords do you have to remember and like go check where you have funds and stuff is there like a point where this just makes it like too complicated i want my life simple i mean if you want your life simple just do the one you could just do the one okay yeah okay i'm not like putting myself at major risk by doing that the the risk you're putting yourself at is like whatever that LLC owns is now, you know, like, so you have multiple deals, let's say that this LLC is invested in. Now one of them goes sour in some capacity and the other deals are still around, you know, whatever assets that LLC owns are at risk now, right?

31:37Natalie Palmer:So I guess this is, maybe this is what you were talking about, the piercing the corporate veil. So if something went south at, let's say that I had like 20 % equity, 10 % equity, across five different deals, all of those were partnership LLCs and then they all funneled into my one LLC that I have in my home state. If something went south or there was a problem at one of the properties that I've got 10 % in, wouldn't it stop at that LLC? Like that LLC, the partnership one and that bank account, isn't that all that the person could go after? Like how would they be able to then go after like the individual members in those LLCs?

32:15they are yeah they will plead whatever they want right like we're such a litigious country so it could be that they do sue that llc maybe they start with suing the llc they get documents they see who owns the llc and then they add all those people to the lawsuit whether you know whether they're successful or not i don't know i mean i haven't really been involved you know i'm more of a transactional side so i'm not in a litigation but yeah i know that's that's a good

32:38Natalie Palmer:question natalie for sure so at a certain point it just comes down to like your own personal risk tolerance and what you want to do. Yeah. And then insurance, I think we cannot undervalue insurance. Yeah. Like a huge, huge help for you if you're in these sort of scenarios, because that's the people who are going to be suing you. And that's what they go after. They go after the insurance policy limits. So the scenario I just laid out, what kind of insurance would that person want then? Because obviously the property itself will already have a STR insurance policy. But if If you do have that litigious person that goes and finds the individual members and who owns what and then goes after each of the members, would I need a certain type of insurance on my LLC, like a general liability insurance just for any business conducted within that?

33:29That's a good question. You probably could get it. I would consult an insurance agent. Like I have a couple of great ones that I work with who help me on these sort of insurance technical questions. But I think, yeah, I think you probably could get a general liability policy for the LLC and the general business it does.

33:45Natalie Palmer:OK, but would you need it or is just having that LLC between you, your personal name, like that being the extra layer of protection, would you need to throw an insurance policy on there? Goes back to your risk tolerance. This is so much. You're like scaring me a little bit, but I'm not sure. I'm so sorry. I feel like that's what a journey's due. It's terrible. Yeah. Okay. Okay. No, this is, this is good. So how about syndications? Is that something like, what would be sort of your advice on something like that where people aren't necessarily partners, but it's a little bit more of like a passive, like you're doing a whole fund and there's just multiple, you might not even know what money your, what property your money's getting deployed to.

34:25Natalie Palmer:Like if you just invest into a fund, what sort of protections would you recommend someone have for that? Yeah, that's a good question. I think probably personally is fine. You're like a lot further removed. I think people often invest personally for those. I mean, in a syndication, you're likely going to have to be an accredited investor. You know, now you're getting into the SEC, like the securities laws and all that. So that's a good question. But I think those you're so far removed from the actual deal, the actual decision makers. that's the people who are actual decision makers up top i mean those are the people who you know would be a more risk so in that case like you're whatever you invest 50k into a fund and you don't even know which property it's going to if there's i guess money at that point is so like fungible like if there was a slip and fall they can't it'd be hard to tie like your dollar amount that was poured into that is that kind of the idea oh i mean in terms of your dollar amount i mean it again goes back to the documents you've signed right okay what happens in this sort of scenario let's say it's a big big big problem like and the whole syndication goes bankrupt you might end up with no money right so that way that you invested um really depends on what happens you know these worst case scenarios um you could end up of course losing all your money and i think that's all disclosed to you likely when you're signing up okay that makes sense so if you're investing into a syndication, there's less risk, if I'm understanding this right, there's less risk tied to like a specific property having a slip and fall or something because you have it invested directly into a property.

35:58Natalie Palmer:You've invested into a fund. But if the whole fund goes bankrupt, then you're at risk of not getting paid back. Yes. Yeah. Okay. That makes sense. So joint ventures is something you brought up where you don't necessarily need a new LLC for this. It's just a partnership what are things that people should like out for there does it just really come back down to the contract in that case like if you have somebody putting in the sweat equity and then someone else fronts the capital um would you recommend like both parties sit down with you and it's a three-way conversation on what each party wants and you're drafting the contract there i think each party should probably have their own attorney oh okay yeah typically like when i've Represented people, they've had their own attorney on each side.

36:43Not always, but, you know, otherwise, I mean, they can be drafted super one-sided. Right. You know, you want to make sure you're protected. You know, things to look out for are similar things that we talked about with the operating agreement. Like, what happens if this deal goes bad? You know, what if we have any disputes? How are we going to resolve the disputes? I mean, you can even put, like, you'll resolve a dispute with a coin toss. like that happens depending really yeah yeah you could do that we'll write that in you're off paper scissors yeah rock paper scissors and then you know depending on like what level of dispute it is right um so you want to put that in there you want to put like the arbitration stuff or jury waiver uh indemnification just like standard different contract clauses that you're going to want in this agreement to protect you um and also the investment um so that's the sort of thing that you'd want put in the agreement and then also just ironing out like what are we doing here right i'm bringing this to the table you're bringing this to the table what's the plan what's the timeline are there penalties for not meeting a timeline i mean it's all very unique uh to what you're investing in so something like that what

37:52Natalie Palmer:would what would that formation process look like like each does one party start with their attorney and they write everything they want and then they send it to the other party's attorney and their redlining stuff or are they each coming to the table with like their own version and then trying to merge the two? Typically one person, you know, one attorney drafts it. And then initiative on that. And then there's back and forth. And then there's back and forth. Yeah. Okay. I know you just started a podcast talking about STR law. So like, what are some of the topics that people can learn more about?

38:21Natalie Palmer:What are some like the niche topics you'll be diving into there? Well, I'm interviewing other attorneys as well on the podcast, like who specialize in different things. So I'll probably have someone come on about securities. Like, I feel like that's a mistake that people make when they're like raising capital, whether they need to file something with SEC or not. I'll have that. But then also like an HOA attorney's coming on. That one was interesting too, because he talked about like how even if like they're allowing one person to do it, usually HOAs have like no waiver clauses, like so that they can't waive a prohibition in the HOA.

38:54So I thought that was interesting. So just various different attorneys I'm going to have on.

38:59Natalie Palmer:If you can leave us like with some sort of like warning, like what's just like a common scenario, like common nightmare scenario that people don't think of that leaves them exposed and vulnerable? I think like the scenarios we talked about earlier with like the deeds or like misinterpreting and zoning ordinance or changing the rules on you and not being grandfathered when you thought you'd be grandfathered. I think like a nightmare scenario is like the no regulation scenario. So like people, you know, who buy a property without regulation and then think they'll be grandfathered because it's like, okay, well, people are doing it now.

39:33And if they change anything, of course, I'll be grandfathered, right? As non-conforming use. But then what's happened is the township interprets their old, old zoning ordinance to say, well, actually, this zoning ordinance says that we don't allow for commercial use in residential areas. You're in a residential area. So you're not allowed to do it going forward. So that's happened a lot in Michigan. And I know that's happening in other places in the country, too. So I think the safest thing you can do when you're buying short-term rental is to buy somewhere with existing regulation.

40:02Natalie Palmer:And then what would you look for there? And I completely agree. This is something I've totally had my mind changed on in the early days of recording this podcast. I remember interviewing guests who were like, yeah, we bought a place and there's no regulation. They don't care at all. And I would cheer them on for that. And I have since learned that is actually a huge red flag because when they do impose regulation, you have no idea how extreme it's going to be. So I totally agree with you. I feel like it's like Goldilocks here, not too little regulation, not too much. What makes you confident to give a client the green light?

40:33Natalie Palmer:What level of regulation do you look for? What sort of requirements make you happy? Obviously, teetering into moratorium territory is not good either. Yeah. I like to see a place that has an ordinance that explicitly addresses short-term rentals. Okay. And explicitly allows them, has a permitting process, gives you a permit. And then also when I'm looking, I also look at the minutes of the township or city council or the board, their minutes to see what they're saying, to see if there's any like inklings or talks about banning them in this area. And Michigan is such a crazy issue right now where all these townships and cities and municipalities are just all starting to talk about changing their ordinances.

41:19And so I always like to look to see if like, hey, are there people coming to these meetings complaining about short-term rentals? You know, just to see what this general temperature on short-term rentals are. And of course, calling the township is really helpful in talking to the people are stopping by if you're local and just to get a feel for how does everyone feel about them right is this a place where people like them um you know that and if they're kind of thinking about changing it and that sort of thing you know that would be like a yellow flag red flag um

41:50Natalie Palmer:to watch out for in cases like that if you told a client like hey there's nothing explicitly banning this now, but I have a feeling it could come down later. Is there a move that somebody could make right now to protect themselves? Like maybe getting a declaration in writing from the city that like you are allowed to do this or I don't know, do you have like tips for somebody who's like sees this coming and wants to get ahead of being grandfathered? Yeah. So let's say, let's just do two scenarios. We'll do the scenario of no regulation. We'll do the scenario of regulation where you are there are permits so for the permit one i would make your offer contingent on getting a permit and then okay try to get the permit while you're under contract and so okay if there's inkling so that way like if like the moratorium scenario happens like mine they would have had it already yeah exactly so you just and then you have that permit before you close um sometimes the municipalities don't want to give you a permit if you don't own the property but you can what we did in ours actually because we started the process um mid under contract is have both owner the prospective owner and the owner sign the application and so you just kind of have to work it out with the township and then um on the no regulation scenario like if you're like you know what i'm i'm a risk taker i'm gonna roll the dice i'm gonna do this i would say the best thing you can do is talk to the municipality and if they say hey yeah we allow them everything's fine hunky-dory um nothing coming down the pipe or even we're thinking about changing things down the pipe or we're thinking about like just tightening this up to email them and say, hey, like just understanding you have no regulations.

43:28You currently allow them. I'm purchasing this property at this place. If I buy them, what's what's going to happen if you change the regulation down the line? And then hopefully they would respond something like, you know, you would be grandfathered. Just trying to get all that documented in writing is the best practice, I would say.

43:43Natalie Palmer:OK, that's great advice. I feel like even if somebody's already operating a place and feels that maybe there's a temperature shift in their market? Should they, even if they've already had a permit for years or something, is it just a good idea to maybe send an email and like a little refresher of like, just for her? Okay. Katie, this was so interesting. Thank you so much for walking us through all of this. And I will make sure to put in the show notes, your podcast as well. Yes. So it should be available on anywhere you can find podcasts, like Apple, Spotify, that sort of thing. It's called STR Law.

44:19And episodes will be coming out once a week on Thursdays. So I'll have a new episode every Thursday and I got a good lineup, pretty interesting. And if you're interested in being a guest on the podcast, I'd be happy to have you if you have some interesting legal insights or a story that you've dealt with, like a battle or success, not success, would love to have you so people can learn and perhaps avoid mistakes.

44:41Natalie Palmer:Awesome, can't wait to listen. And then my last question for you, Katie, is I know you are only licensed in Michigan, Illinois, and Indiana, but if somebody loved this episode, has questions, wants to talk to you, do you at least do consulting? Or if they're not in your state, could you refer people to someone else? Do you have like a network of attorneys that you could pass them on to? Yes, absolutely. So the best way to reach me for that would be my website, which is just my name, katijohnsonplc.com. And then on there, there's like a little like, you know, contact me form. And so if you fill that out, I'm usually pretty prompt to getting back to people.

45:17And I'm always happy to do a free consultation, even if you're out of state. Like, I can't give you legal advice, but I can certainly guide you in the right direction. And I do have a network of lawyers across the country. So I went to the University of Michigan. So I know a lot of friends in all sorts of different states.

45:32Natalie Palmer:Cool. Katie, this was so interesting. I have a feeling a lot of listeners are going to go start opening some new LLCs after this episode. So thank you for that. And checking our insurance policy because we cannot forget that layer with it. Yes, absolutely. Well, thank you for having me, Natalie. And with that, it is now checkout time. Thanks for listening and I'll see you back here next week. Lastly, as Airbnb hosts, we all can appreciate a good five-star review. So you already know a great review on this podcast would mean so much to me. Please subscribe, review, share, and connect with me in the show notes below.

46:06Natalie Palmer:Bye.

46:11Thank you.