Thoughts on Investing in Real Estate - Part 3

So far we have discussed financing, tax issues, renting your property and zoning. The final piece of the puzzle is:

Insurance
Be aware that how the property is occupied can affect your insurance coverage. It is relevant whether the property is being owner occupied or occupied by tenants. If it is not occupied at all, your standard policy may not provide coverage unless the property is being visited / inspected weekly, or even daily. Make sure your insurance agent understands the uses to which the property is being put and that you understand the coverage that is being provided and what, if any, steps you are required to take to maintain the policy in force (i.e. hiring someone to check the property). If you are operating a business out of the property, make sure your broker is made aware of this. Commercial insurance will be different than purely residential insurance coverages. The more your insurance broker knows about the property and its proposed use, the better he/she will be able to assist you. Make sure you talk about insurance BEFORE you sign the Offer if you have any doubts about the insurability of the property, as you will not get financing without it.

These are a sample of the type of issues to be aware of when considering an investment in real estate. My recommendation is to get the experts involved from the beginning. Make sure your lawyer, accountant, mortgage broker, financial advisor and/or insurance agent know what you are doing. Take advantage of their education and experience. And then, enjoy your property.

Thoughts On Investing in Real Estate - Part 2

Here is Part 2 of Zarah Walpole's commentary on Investing in Real Estate. In Part 1, we learned about financing and tax issues. Now let's take a look at two other issues to be considered:

Renting
If you’re going to be covering some of your costs by renting the property to a tenant, you’ve become a landlord and will need to be conscious of landlord and tenant law. The law varies considerably whether you are renting a residential or commercial property. In either case, you need to know the rules that will apply to your situation. An absolute minimum requirement in either circumstance is to enter into a well drafted lease agreement. From a practical point of view, I cannot emphasize enough the importance of checking potential tenants’ references. Knowing how to legally evict a tenant is one thing, never having to do so is an even better thing.

Zoning
If you plan on changing the current use of the property (i.e. adding an apartment, putting in a business), it is vital to ensure that your proposed use is permitted. For example, municipalities have zoning by-laws that only permit commercial uses in certain areas. Here in Barrie, not only are basement apartments only permitted in certain zones but they also have to be registered with the City. Knowing the zoning of your property ahead of time and making sure that it fits with your plans is good business.

Stay tuned for the final part of our series on Investing in Real Estate.

Thoughts on Investing in Real Estate - Part 1

The following is the first in a three part series on Investing in Real Estate, by my Associate, Zarah Walpole. Thanks Zarah!

Real estate is hot right now. I have many clients purchasing a second property for recreational and investment purposes. I’m a real estate lawyer so, of course, I think property can be a great way to hold and grow wealth. However, it is also an area that you should enter with your eyes wide open and an awareness of the many pitfalls that can await the unwary.

Financing
First, you need to fully assess how you will finance the purchase. Different considerations come into play when mortgage companies consider properties that are owner occupied, a pure investment, leased to a 3rd party or a combination of the foregoing. Don’t assume your financing options are the same as when purchasing a home. When assessing whether you can afford your carrying costs, don’t forget to include costs such as property taxes, insurance, and maintenance fees, etc.

Tax Implications
Also, make sure you understand the tax implications related to the income earned while holding the property and the role of capital gains or losses when you the sell the property. For example, unlike the family home, the capital gains exemption will not apply. Consulting with an accountant to understand the tax implications and with a lawyer to determine if the property should be held personally, in a trust, or by a corporation can be an extremely important part of maximizing your return on investment.

Stay tuned for more on Investing in Real Estate, including renting and zoning issues!

Thoughts on Creditor-Proofing - The Matrimonial Home

Being in business carries its risks. As a sole proprietor or partner, you are personally liable for the obligations of your business. Even directors and officers are increasingly exposed to personal liability through legal and statutory obligations to shareholders, creditors, employees, the government and, in some instances, to the public. One of the risks of running a business, in whatever form, is that your assets, including your family home, could be exposed. Your first defense is to ensure your business (and its officers and directors, where applicable) is adequately insured. However, another possible line of defense is to transfer ownership of certain personal assets to a spouse who is not similarly exposed to such personal liability.

Before you transfer ownership of the family home to your spouse for the purpose of creditor-proofing, you should be aware of the following:

Timing is Everything
As a preliminary matter, the time to consider transferring ownership is well before any event that raises the prospect of personal liability has occurred. The courts can void a transfer to a spouse if it is done in order to avoid payment of impending liabilities. It is recommended that the transfer of a family home be done as part of a general plan to avoid the possibility of personal exposure that may arise in the future course of running your business.

Consequences of the Transfer – Separation or Death
You must be aware that there can be consequences to transferring your ownership to your spouse and these should be weighed carefully. If there is a marital breakdown and the spouses separate, the benefits of ownership only accrue to the title-holding spouse. There can also be consequences on the death of the title holding spouse, such as the need for probate and the payment of probate fees.

Protection of the family home from exposure to the potential liabilities of a business may be legitimate and intelligent planning. However, in deciding to do so, you should consider the effects of such a transfer in the event the of divorce or death. This decision should be made with the assistance of your lawyer and your accountant. That’s good business.

Allocating the Purchase Price

If you are selling all or substantially all of the assets of your business, or if you are buying the assets of a business, you will certainly have to come up with a purchase price that both sides can agree upon. However, the negotiating with respect to the purchase price should not stop there. The parties should be making an agreed-upon determination of how that price is allocated amongst the various types of assets. For instance, what is being paid for the goodwill or client list of the business verses the depreciated assets verses the leasehold improvements? It can make quite a difference to both sides, in terms of the tax consequences, and often the buyer and seller have opposite preferences. So the actual price can be influenced by how that price is allocated. Buyers will be more likely to pay more up front, for instance, if they can write the assets off quickly afterwards. It is important for both the buyer and the seller to consult with their lawyers and accountants with repsect to the allocation and to ensure that it is agreed upon either up front, or at the very least, prior to closing. Understanding the tax and legal implications of your decision to buy or sell at a certain price makes good business sense.

Bringing in an Investor Shareholder

I have a client who has a company and a fantastic business idea. But as with lots of great ideas, there is the reality of getting a product to market and, by reality, I mean costs. So, he has a friend who wants to invest in the great idea, throw some money at the company and reap the rewards if the idea flies. My client has asked me to prepare the paperwork to bring this friend of his on as a shareholder. Here are some of the issues we discussed. First, how much of the company is this guy going to take? After all, my client came up with the idea and has toiled for two years developing the product so that it is now ready to take to market. What is this worth? He's going to have to be able to come up with a method of determining how much his friend's money is worth in shares - does he get a 50/50 interest or say 15 - 20%? And should the shares issued to this investor be voting shares? The same type of share as my client or a separate class? Once we get this all sorted out, we have to talk about control issues and how (hopefully) my client is going to retain control over the company that is, in fairness, his baby. This means drafting a shareholders agreement to address issues like:

(a) What happens if one of them dies?

(b) What happens if the investor wants out - can he get his money back?

(c) Will the investor/shareholder be a director of the company? How involved will he be with the running of the business?

(d) What happens if my client gets an offer to purchase the company from a third party? Can the investor prevent the sale or should he get dragged along?

Businesses often need a "jump start" with an influx of cash and sometimes that cash will come from friends or family. The question is, how to structure this transaction in a way that will allow for the much needed cash infusion, provide some assurances to the investor, and also protect the original owner of the business - the guy with the great idea or the talent or the know how. Bringing in an investor as a shareholder is only one way to facilitate an investment. A good business lawyer and accountant should be consulted prior to any final decisions being made on the best way to structure this sort of deal.

Franchising Pros & Cons

Thinking about starting or buying a franchised business? There are certainly lots of franchise opportunities out there. And there is some important legislation out there, as well, which attempts to provide some protection for potential investors. In Ontario, that legislation is called the Arthur Wishart Act. One of the things the Act does is sets out a number of disclosure requirements for franchisors so that potential buyers have information pertaining to the history of the franchise and its current status. Franchisors are required to provide potential franchisees with a "disclosure document" which will provide background information and a sample franchise agreement for review prior to the potential franchisee making a final decision to move forward. Franchise Agreements may or may not be negotiable. Usually it depends upon the strength, popularity and age of the franchisor. But even if you can't change a thing in it, it still makes good sense to understand what you are signing and the pros and cons. If I am asked to review a franchise agreement, I will often go through the agreement, using two very simple notations:

1. - The letter "C" for control: areas which indicate that the franchisor has control over decisions effecting your business - such as controls over pricing or inventory; and

2. - The dollar sign ($): areas where the franchisor has the power to make you spend further money - such as forced upgrading to leasehold improvements or forced buying from franchisor-approved suppliers only.

Buying a franchise can often be a very lucrative way of starting a business. The upside should certainly be the fact that you will benefit from the experience of the franchisor and also from things like combined marketing, trade-name value, etc. The downside is that, quite often, you will need to give up some control over the business operations. Franchising is not for everyone. If you are consideraing it, speak to a lawyer and make sure it's a good fit for you. Knowing what the arrangement will be from the outset and being sure that it fits with your plans and your personality makes good business sense.