When Property Investors Should Care about Legal Entities
Real estate investment and property management companies form legal entities to achieve strategic objectives and to manage risk. To insulate the investors and property managers, a separate legal entity typically owns each property separately.
The investors, in turn, own that entity. This most basic form of the corporate shield limits risk from liabilities associated with the property. The corporate structure is also an efficient way to channel investment capital from investors to various properties such that each property can attract a unique set of investors.
Without any more legal complexity, the baseline is one legal entity for every property. There are firms that do not create a legal entity for each property. There are many firms that have many more legal entities involved with a property. This article outlines the opportunities for legal entity management to improve success for real estate investors and managers in situations where they have more than one legal entity.
Legal Entities in Real Estate Investment
What is legal entity management and why does it matter for the real estate industry?
What is legal entity management?
Legal entity management is a set of practices and tools that allow general counsel and corporate legal teams to deliver on the promise of using entities to manage risk and deploy investment capital. Without legal entity management, your new legal entity is little more than a filing in a government office: necessary, but not sufficient.
At its core, legal entity management helps ensure that every filing and compliance obligation for each entity is satisfied on time and in any jurisdiction. Entity management also tracks changes in the ownership structure of the entire corporate family, not just the entity which is the direct owner of a property.
What are the benefits of legal entity management?
There are several benefits of legal entity management as a practice and a technology that apply to firms operating in any industry. For real estate firms in particular, legal entity management addresses three central challenges:
- The one-to-one (or one-to-many) relationship between real estate holdings and legal entities,
- The use of separate entities for ownership, operations, and financial engineering, and
- Complex ownership structures, including related and unrelated owners.
These benefits basically prevent financial losses by preserving the corporate legal protection of legal entities, and facilitate investment by supporting complex ownership structures.
How Property Investors and Managers Can Deal with Legal Entities
To improve the speed and quality of legal entity management, focus on three core practices:
- Centralize critical data and documents,
- Track complex ownership structures, and
- Work across jurisdictions.
Centralize Critical Data and Documents
Gone are the days when corporate secretaries and general counsel put organizational documents in a file and considered the entity formed. Document management is a vital part of legal entity management.
Entity documents include a wide range of documents such as: organizational documents, filings, important agreements, and insurance policies.
Some documents will have effective or filing dates but no expiration dates. Insurance policies and agreements, however, will have expiration dates. Legal entity management software should keep track of expiration dates to notify users automatically in advance.
Track Complex Ownership Structures
Real estate investors often use complex ownership structures based on tax objectives and investor requirements. Legal entity management is about keeping the alphabet soup of GP, LP, LLP, LLLP, LLC, C, S, and other straight.
Corporate organizational charts are the result of careful ownership tracking. Hand drawn legal org charts are often incomplete, deceptive, and out-of-date.
Work Across Jurisdictions
Many real estate firms operate in more than one jurisdiction. Jurisdiction is just a question of scale. Firms based in the United States, for example, invest in properties in more than one state. Given significant differences in law governing property and legal entities from one state to another, real estate investors must keep careful track of filings and obligations in each state.
International real estate investors must confront an even more complicated patchwork of types of legal entities, local property laws, and national tax regimes.
Legal entity management creates order out of the chaos. Not only does entity management keep track of corporate filings and records, it can provide a point of collaboration for individuals who are close to the work.
To illustrate how these principles work in practice, let’s look at several examples: family offices, investment managers, real estate partnerships, owner operators, and real estate intensive industries.
Family offices own real estate as a significant share of the portfolio when property investment is the primary strategy or the operating entities occupy real estate intensive industries. When family offices are active real estate investors, they often act as the General Partner (GP) on a project, whereas they might participate as a passive investor or Limited Parter in other projects, depending on their objectives.1
Family offices face several legal entity management problems in real estate investing.
- The members of the family might invest in the ownership vehicle directly or indirectly through their own entities,
- The ownership documents or joint venture agreements are unique to each situation, allocate different percentages among investors, further complicating the ownership structure, and
- There are both related and unrelated owners of the legal entity in focus. A related entity is simply one that that is also managed in the corporate registry (a controlled affiliate for example). An unrelated individual is either a trust or individual who is not in the corporate registry, but whose ownership still needs to be tracked.
Effective legal entity management allows you to see these complex relationships and easily manage them as they change. Joint ventures between family offices are straight forward because entity management can accommodate investors within the family as well as outside.
In cases where the family office is controlled by a single individual or entity, such as a family trust, entity management can provide a global view of the entire structure including all subsidiaries. It is also possible to zero in on a specific segment within the family office structure.
Professional Investment Managers
Professional investment managers must deal with multiple investor groups or clients where there is no common ownership. One investor group might own hotels in the American Southwest, whereas another group owns storage facilities in Asia.
Each investment group itself consists of a network of individuals and entities which own and control properties and other entities.
Legal entity management allows investment managers to view each investment group and collection of entities separately.
Investment partnerships, on a standalone basis or as part of a larger legal entity portfolio, require careful management to preserve the tax and risk management benefits.
In a common structure where a C corp is the General Partner and individuals or companies are Limited Partners, managers must track the owners of the C corp, maintain the GP, and each LP.
The situation becomes more complicated with the addition of management companies and administrative services agreements. More innovative structures like Limited Liability Limited Partnerships (LLLPs) also escalate the need for effective legal entity management.
Owner operators which have wide ranging real estate interests share some of the characteristics of family offices. There is usually a single or central ownership group. As such, legal entity management can show the entire corporate structure when each property (or group of properties) is owned by a separate legal entity.
Owner operators often have legal entities which do not own property but provide management services to the property-owning entities. In some cases, the ownership group might differ between the operating companies and the real estate owning companies based on tax and income benefits.
Legal entity management can show both the real estate owning entities and the operating companies.
Without robust legal entity management software and practices, the tax, legal, and risk management benefits of forming numerous entities around real estate ownership and operations can evaporate.
To preserve those benefits it is important to centralize critical data and documents, track complex ownership structures, and work across jurisdictions.
Family office investing trends: https://www.ey.com/us/en/services/transactions/ey-capital-advisors-real-estate-family-offices ↩︎