How to Use Single-Purpose Entities to Limit Investment Risk

For many investors, having a single-purpose entity is the starting point for securing lending on their real estate transactions. This type of entity is set in place to protect the real estate investor, capital partner, and the asset.

1.) What is a Single-Purpose Entity 

Lenders typically require borrowers to place their assets into an SPE structure to further secure against the various risks involved with real estate investing. An SPE is a corporation or LLC that holds the title to a single real estate investment property. A mortgage can then be placed on the property by the financing lender.

2.) How do single-purpose entities benefit the involved parties?

A single-purpose entity isolates the financed property from other potential creditors or lenders. This prevents others from seeking to use the subject property as a means to recover a loss or to satisfy debt claims. Not only does this structure protect the lender’s collateral from recovery claims made by other collectors, but it also is used to limit the business activities of the entity. The single-purpose entity protects the borrower’s portfolio by separating the asset from the other properties within the portfolio.

3.) What do single-purpose entities require?

For a single-purpose entity to own and operate an individual real estate asset, it must have a thoroughly outlined purpose clause and a set of covenants to operate. The purpose clause and a detailed set of covenants are important for the entity to be legally recognized to support this function. This can be presented in numerous formats, but should ideally be included in the formation documents with the Secretary of State.

A set of covenants is used to frame and clarify the separation between the single purpose entity and other entities. Standard covenants for a single-purpose entity include:

•         Maintaining separate finances and bank account.
•         Anti-commingling of assets between other entities or individuals
•         Barring guaranteeing obligations of other entities.
•         Requiring the SPE to maintain a separate tax identification number.

Single-purpose entities help to limit the risk associated with individual properties rather than a portfolio. As your portfolio grows you’ll want to keep your assets as secure as possible, and single-purpose entities can be a useful structure to add a layer of protection to secure your hard work.

*The information provided in this article does not, and is not intended to, constitute legal advice. Readers should contact their attorney to obtain advice with respect to any particular legal matter.

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