304: Rent Controls, Charging Orders & LLCs

This show is produced by the Hartman Media Company. For more information and links to all our great podcasts, visit hartmanmedia.com.

Welcome to the AIPIS show for accredited income property investment specialists and those who aspire to be if you're a real estate, mortgage or financial professional, this is the place for you. We'll explore innovative investment analysis, sales, marketing and income generating strategies for the most historically proven wealth creator income property. Learn from the experts as they show you how to build a better business and a better life.

It's my pleasure to welcome attorney Garrett Sutton back to the show. You know his name, he's been on many times before. He is a rich dad advisor, the author of several great books, really great books by the way. And I love how his books always have this little snarky sort of thing when it's talking about taxes and stuff. Garrett, welcome back. How you doing?

Thank you, Jason. I'm glad you picked up that element of snarking.

I love the snarkiness. I just, I laugh every time I'm reading or listening to one of your books. It's great. And hey, we don't even need to get snarky about this first topic today. And that is my home state. I have never seen a state try so hard to commit economic suicide as the Socialist Republic of California. What do you think about this new rent control law, Garrett?

Well, it's interesting, Jason. They passed it as kind of an emergency measure. You know how the government can only get things passed, controversial things as an emergency. And they say there's a 10 year sunset on it. But most common tables.

You mean like the Affordable Care act, otherwise known as Obamacare, at 2am on Sunday morning.

Right. And so, you know, they pass these on an emergency basis. This is the homeless crisis and the housing crisis in California. And you know, it's done in this big hurry. And of course this law is going to be permanent. So they say there's a 10 year sunset. But most commentators think that after 10 years the law is going to get even more draconian. So, you know, this is the first step in statewide permanent rent control in California.

Yeah. And what's interesting about politicians both on the left and the right, I'm not just picking on the lefties here, is that their policies, whether by intention or not, create the problem and then they stick a band aid on it and act like heroes in solving it. So the policies of California, for example, are really overly draconian. Building codes, environmental restrictions that prohibit building anything. And when you do that, of course you're going to have a shortage of housing when you make it so hard to develop anything. Right. And so now they have a shortage. They got a homeless problem, and we're here. The cavalry is here to the rescue. Rent control and the. That'll make the shortage even worse, Right?

Well, they never connect the dots. I mean, they do make it very difficult to build. I mean, California does have a beautiful environment. You certainly want to protect that. But at the same time, you have to balance the needs of society for housing. And so the balancing act is out of whack. And like you say, the cavalry's coming to save the day with rent control. And the average guy thinks, oh, this is great, but the developer, the person who's actually going to put up money to build housing stock in California, and.

The banks finance them and the investors that finance them, they're not going to do it. Right.

They're going to look at this law and say, okay, this is the first salvo. It's only going to get worse, and I'm not going to develop any more housing in California. That's the result of what's going to happen here.

Yeah. So an evening bigger housing crisis and either even bigger housing shortage. But what's interesting, Garrett, is, you know, looking at the face of this law, at least on the rent increase provision, which I believe is 5% per year, most investors listening to this would say, well, that isn't so bad. I actually wish I could raise my rents 5% a year. I can only get, you know, 3 or 4%. And, you know, sometimes when interest rates are really low, I can't even do that. So they're thinking, this is no big deal, it's no problem. But folks, the way this always works, it's a slippery slope. Once they get in the door with this and they've now got a platform, a wedge, they can then, you know, just boil the frog as it goes. You know, in the old metaphor, there is, you know, you put a frog into boiling water, it's instantly going to jump out to save itself. You put it in nice warm water, it sits in there like it's a bath, and you gradually turn up the heat and. And of course, the frog boils, and that's what the government always does. I remember years ago, the tragic San Francisco earthquake, you know, one of many. But I'm talking about the one maybe in the 80s, I think.

89. Yep.

Right.

During the World Series. Right.

August 17th. It was my girlfriend's birthday. I remember it well. And, you know, they raised the sales tax after that by a penny, you know, from 6 to 7%, they said it would sunset, they said it would go away after a year or so. Of course it never did because the sales tax in most places around 9, even 10%. Now these things just never go backwards, do they? They never go away, they just get worse.

Right. So on the, on the rent increase, it's 5% plus CPI and a 10% max.

So if that's even I, that's not bad. No investor is going to balk at that. Right.

Well, but let's say we have a bout of inflation, right? And expenses go UP and the CPI 7%, the max you can do is 10%. But like you say, this will, this will get cut back the next round.

Yeah.

There's also an exemption for apartment buildings built within the last 15 years. Those are exempt. And so for example, a property built in 2005, you can raise the rents until 2020. You have a 15 year exemption. So a building in 2021, that 2005 building has been around for 16 years and then it's subject to rent control. And I think the rationale there is they're saying, okay, we understand that builders are not going to want to build with rent control, so we're going to give them 15 years to get as much rent as you can. It's a rolling 15 year window. But what's going to happen is at the end of that 15 years, the, you know, 14th and 15th year, the people are going to raise the rents, you know, at a huge amount. And so it's kind of, it's going to distort the market. And that's what rent control really does, it distorts the market.

First of all, I want to go back to the rent increase issue that you talked about. So cpi, of course is the Consumer Price Index. It's an indicator of inflation. And so if we go back to like Jimmy Carter era inflation and the official inflation rate is always understated, I think all of our listeners realize that. But if we go back to where we have like 13% inflation, which we did in the past, you can only raise it 10% no matter what. And what happens in all of these rent controlled areas and, and it's just been proven over and over, these are facts, these are not opinions, is that landlords and owners, investors don't want to improve their properties. You know, every couple of decades you should just do a rehab of your house and make it nicer. Right. And what happens is since you can't raise the rent enough to Pay for the rehab cost of improving the property. You just let the property decay. There's no incentive. And so you see these ramshackle old, just decrepit places that'll, you know, they'll pass an inspection just barely. The quality of life goes down and you get this stagnant market. Years ago I had one of our video editors on the show and he lives in San Francisco and Garrett, you wouldn't believe his story. And it's on the podcast. You can, you can find it from, you know, by going to jasonhartman.com and using the search engine there. And he lives in a place that he and his wife moved into in the 90s, I think 97. And forgive me if I don't get the numbers exactly right, but I think they said they were paying now like $2,400 a month and the landlord just won't fix anything up. And they'd really like to move, but what happens is they can't move because there's no way they can get anything to compete with that below market rent control rate. And the market is so tight because nobody just like them will give up their super cheap rent controlled apartments. And it just makes for a stagnant economy. And so think about that again.

It just distorts the market.

It distorts the market. But think about the ripple effect. All the real estate brokers that don't make any money because nobody's moving, it inhibits the economy. And think of all of the leasing services that don't make any money because you have a stagnant market with no velocity of money. Think of all the home improvement people, all the decorators, all the everything. It just makes the whole thing stagnant.

That's a very good point. There is quite a ripple effect when people aren't moving around. When the free market is constrained, a lot of people do suffer. So it's going to be interesting. Oregon adopted statewide rent control recently. California being the largest state. I wonder what people are going to think three or four years from now when the effects of this law are analyzed, how many more houses were built or apartment buildings were built as a result of this law, or not built. It's going to be very interesting to see how it plays out. California is a dynamic market, but people have a right to put their assets wherever they want to. And I'm going to say that a lot of developers are not going to be building in California.

So the housing shortage will get worse. Now another thing, I think Californians and folks, look, this is my home. State. I loved California for the vast majority of my life. I mean, it is a beautiful state and you know, it's got a huge economy, but you know, a huge population. So automatically you're gonna have a big economy just by virtue of having a lot of people there. But here's the next thing they're coming for and they're already gunning for it. And that's to overturn Howard Jarvis's Prop 13. And if Prop 13, I would submit to listeners that that has been one of the things that has allowed the California real estate market to do much of anything. Prop 13, you know, otherwise, I mean, if that goes away and there's no limit on what, what they can do in terms of raising property taxes, you've got a state that is terribly managed from a fiscal perspective and you've got a situation where they're just looking for money anywhere they can get it. The government is just hungry for money there. And I tell you, if Prop 13 goes away, that is going to be really bad news for real estate investors and the state.

Well, if Prop 13 goes away, property taxes will skyrocket for, you know, that segment of the population that has been taking advantage of Prop 13. And if you own 100 unit apartment building that you've had for quite some time, the property taxes are going to soar and you're going to be subject to this minimal increase that you can pass on to your tenants. And so it's a double whammy.

It's going to be a double whammy. You can't raise the rent except by a certain amount to pass through the expenses of the increased taxes, increased maintenance costs, whatever. And so yeah, it's just going to be, it's just going to be bad. So look, investors, we've been helping people for the last 15 years, I've been helping people take their equity out of California and other places, but California being a big part of our business and move it to more landlord friendly and investor friendly places around the country. That's what we do. And so whether you are in California or not listening to this, this is important to the entire world because you can see the example of what happens and these two policies are going to be, it's going to be really tough. It's, it's going to really put a burden on investors there. And you know, we can help you do a 1031 tax deferred exchange. And we've got a couple of other new vehicles that I'll be discussing at our upcoming Profits in Paradise event that can help you get out of that California nexus and really do some great things. Increase your cash flow, just improve your position overall. Garrett, should. Should we wrap up on this rent control or anything else you want to say about that? Because we've got a couple other things on the.

Well, there's another issue involved in the new law, and that is the ability to evict tenants.

They made it harder, right?

Yes. So the new law limits a landlord's ability to evict tenants who've occupied a unit for at least 12 months to list just causes. So on these just causes, these are at fault causes. The owners first have to give notice of a violation and an opportunity to cure the violation prior to issuing a notice of termination.

Okay, so you're saying a tenant violates a covenant of the lease, and when you say at fault, you mean the tenant is at fault. Right. And you have to notify the tenant now, give them an opportunity to cure. And I'm sure there's a certain number of days in there each time. Well, the tenant just keeps violating the covenant. Tell us more.

Well, some of the at fault causes are damaging the property. Now, if a tenant's damaging the property, I would prefer to have him evicted immediately instead of giving him a notice of violation and an opportunity to cure. So, you know, in Nevada and other states, you can get people out very quickly, but damaging property, you should be able to evict that tenant promptly. The other thing, Jason, is criminal activity on the property. All right. When criminal activity is directed at the owner or agent of the property, you have to give them notice to stop. I mean, how many criminals stop when they get a notice?

So. So now they're. They're making the landlord be the cops, Right? Basically.

Right.

And so if a landlord is dealing drugs on your property, or if they're just having big parties and making noise and disturbing the peace, or if the tenant is. Yeah, the tenant is.

I mean.

Yeah.

Dealing drugs, you have to give them notice not to do it again. And so, you know, how often is.

That going to work? Yeah, you can't make.

No, this is California, and like you said at the top of the show, Jason, I mean, you wonder why they put these policies in place. And, you know, part of me thinks that there's an intentional desire to have people leave the state. Why would you put policies in place like this unless you actually wanted people to leave the state? And in that context, they're doing a really good job.

Yeah, they're. They're just. People are just. They've been fleeing for, you know, at least a good 15 years, if not more. And yeah, boy, they're just, it's like, you know, like I said at the beginning, why, why are they trying to commit economic suicide? It is, it is absolutely crazy. So now this has another effect for investors listening. I mean, this will hasten the move out of California. It'll make the capital flow even more so out of the state. What does that mean? That capital will flow to the markets that we've been recommending for the last 15 years and it will buoy those markets even more. So if you think there's an inventory shortage of good investment properties in, in the markets you see@jason hartman.com, this will constrain it even more because there will be more California money moving into these markets, which, you know, if you already have properties in those markets, it's going to be great for you. If you get in soon, early now, whatever, it's going to be great for you. But if you wait, you know, that's just going to pump up the prices more. That's the likelihood of what's going to happen. So, yeah, that's overall good for our investors. But the important thing is to act, act quickly.

There's one more wrinkle here, Jason, and that is when you do a 1031 out of California, the state of California will say, okay, you've done a 1031 from Los Angeles to Miami. And when you sell that Miami property, we assert the right to collect our state tax that you should have paid us if you sold the property in la. We assert the right to collect state tax when you sell the property in Florida. Now, I don't know how they're going to know when you sell that property, but, you know, I just don't know what kind of mechanism the state has for finding out when that property was sold.

But your client should know because the California Franchise Tax Board has a data exchange agreement with the irs. So when you, you know, you got to put it on your state return, but even if you didn't, it's on your federal return. So that's how they're going to know, right?

Well, I don't know. I just haven't heard of them being successful in reaching those types of monies. Certainly if you're not a California resident, they wouldn't normally be able to find that out unless they really get aggressive with that sharing of the irs. If you're a California resident, the money flows back to you in California. Any. So they're gonna catch that. But if you're not a California resident. I just don't see right now how they're going to be able to tax that gain that you had on the California sale.

That's something. Now, this is what I call the economic Berlin Wall, and I've been talking about this for a long, long time on the show, how California is trying to stem the capital flow and dig their greedy claws into your wallet as you're exiting. So.

Right.

It's, you know, I mean, I think I'm the one that made that expression up the economic Berlin Wall, which is exactly what it is. Really crazy. Okay, Garrett, let's talk a little bit about estate planning and asset protection for a moment. And I want to go back to something that interestingly came up in a conversation with somebody recently, one of our listeners or clients, and that's about Florida, my new home state. And years ago, they changed the law in terms of how people were using entities to protect their estate and their assets. Right. What happened there? And that's a famous case. I think it's called the Olmstead case.

Yep.

Tell us more.

And so Mr. Olmstead was scamming people with credit cards, and the Federal Trade Commission went after him and sued him personally. And, you know, the federal government has all sorts of money to pursue these cases. And they got a judgment against him. But then when they came to collect, he said, oh, well, my assets are in Florida LLCs, and all you're entitled to is the charging order. This is the good asset protection we rely on in Nevada, Wyoming and Delaware. Florida had such a similar law. The case went all the way to the Florida Supreme Court. And in kind of a tortuous decision, I mean, the Florida Supreme Court had to bend over backwards to find that Mr. Olmstead had to give up his money to the Federal Trade Commission. And what they did was say, all right, Mr. Olmstead, you are the single member, the one owner of this LLC, and we're not going to give you the charging order protection because you're just the single member of this llc. And the whole idea of the charging order is to protect the innocent member so that when we come after you and you have a partner, we can't go in and force a sale of all the assets because that's not fair to the innocent partner.

Yeah, right, right.

Well, Mr. Olmstead, you don't have a partner, so we're not going to give you the charging order protection. And this is, you know, this is the language that you see in a lot of court cases with regard to Single member llc. Some states, California, other states do not Protect Single Member LLCs. Interestingly, Jason, in response, Wyoming, Nevada and Delaware put in their state statute that they protect single member llc. Mm.

Yeah. Okay, so what you mean is the charging order is the vehicle by which a creditor comes after someone or comes after an entity, whether it be a corporation.

Well, no, there are two ways. One is a foreclosure, where a California court says, all right, you caused the car wreck, let this person sell the assets inside your llc. California and other states are very weak that way. So foreclosure is one remedy. The charging order is another, different remedy. The charging order says, we're not going to let you go in and sell all the assets inside the llc. Instead, we're going to give the person who was in the car wreck a charging order, which is a lien on distributions. So if Jason's LLC distributes money to Jason, the car wreck victim stands in Jason's shoes and gets that distribution.

Right, which is fair charging order, right.

Yeah, that's fair.

Yeah. But it does, right?

Correct. Correct.

Yeah. So Olmstead, the Florida Supreme Court said, yeah, I mean, he had this scam artist, had an entity, right. And they said, let it be liquidated to pay the creditors, which was a good decision in the Olmstead case. Because he was a criminal, Right?

Well, that's the thing, these types of cases. Bad facts make bad law. He was a bad guy and the Federal Trade Commission was going after him. A lot of people had been scammed by this guy. So, you know, a party of you says, yeah, he should have had to give up his assets. But then that means everybody else in Florida is subject to this law, too.

So what's interesting about that is that the court probably should have deferred. The Florida Supreme Court probably should have just deferred to the Fed Feds to, you know, put the guy in jail and take his assets and give them back to the people that were scammed, like in the Bernie Madoff case, for example. But instead they changed the law to hurt everybody, even the honest players that were doing things right. So that wasn't fair, was it? Yeah, well.

And it sure resulted in a lot of new work for Nevada, Delaware and Wyoming. I mean, during that time period, we had a lot of people setting up Wyoming LLCs to hold their Florida LLC, because a lot of these properties are held by one owner. And a one owner LLC in Florida is not protected. However, the one owner Florida LLC is owned by the one owner, same owner, Wyoming llc. And in the Outside attack with the car wreck, you have the Wyoming protection that Florida used to provide but now doesn't. So there's a way to deal with it.

Yeah, really, really interesting. Okay, Anything else you want to share today? I think you had one more thing on the agenda, but I can't remember.

Well, just. We need people to be aware of these land trust promoters that are out there, you know, saying that if you have a land trust and you're the beneficiary of it, like the owner of it. And I've read where people say that when you transfer that beneficial ownership to someone else, you sell that interest at a profit, that you don't have to pay tax on it, and that is outright evasion of taxes. You do have to pay tax on any gain. So just beware of these promoters.

Yeah, yeah. There's a lot of really scammy promoters of tax schemes and asset protection schemes and estate planning schemes. And so what you're saying is these folks say, okay, set up a land trust and put your property into the land trust and sell it. And just don't tell the IRS that you had a big capital gain, so you don't have to pay any taxes. That what they're really telling people.

Yeah.

Unbelievable. That's just complete. People gonna go to jail for that.

Right?

Wow.

Right.

Wow.

Yeah. It's really bad advice. If you sell your beneficial interest in a land trust. That's a taxable event. If you have a gain, you got to report that to the IRS. And most CPAs would not allow that to happen. But, you know, some of these fly by night operations. There's always a certain percentage. We've seen it, Jason. Of people who just think that they have to defraud the government. You know, there just a certain element out there that wants to do that. It just lands you in trouble.

That is a very bad idea. Folks remember the old expression the long arm of law. And that arm is very long, and it has a very good memory. So do not mess around. Do not mess around with the long arm of the law and the long memory of the law. You know, what's really scary about this, Garrett, is that because of the law of agency and the way that works. You know, I remember learning about that when I was 18 years old in real estate school. You are responsible when you hire a professional who should protect you and who should know. And they could even be a CPA or a lawyer. They can still get you into trouble because they don't know what they're doing right. You know, I Mean, lawyers over the years that I've hired have certainly gotten me into trouble. And it's like, oh, my gosh, you know, I had to pay, like, a sanction fee or something because the lawyer screwed something up. And, you know, they sometimes sanction the lawyer, too, but, you know, there goes $3,000 down the drain because.

Well, here's another example.

The idiot. There was a.

There was a group out of Nevis, you know, which is a Caribbean island, right? And they. This is maybe 15, 20 years ago, they put on seminars in Sacramento and central California cities, and their target market were dentists. I don't know why dentists were targeted, but they had all of these dentists essentially evading their taxes through the use of Nevis structures. And, you know, when the government finally caught onto it, these guys disappeared. They couldn't reach them in Nevis. They were probably in South Africa by this time. And all the dentists, you know, paid huge fines. Some of them went to prison. So you can't say, well, the attorney recommended I do this. Like you say, Jason, it's an agency thing. You are ultimately responsible, that is, for the advice.

You know, that seems like a very unfair thing in the law because, you know, I can see if you hire some slacky, unlicensed person being responsible. But when you hire a professional that has passed the bar exam or the CPA exam, you know, as a consumer, a layperson, you should be able to rely on them, but I guess not, huh?

Well, I mean, some of these people will have all these, you know, crazy structures and everything. And if they do, you want to get what's called an opinion letter. You want to get a letter from the law firm saying, this is legal and you should rely on it. And that can be your get out of jail card free. If you have an opinion letter, a written document saying that I, as a lawyer, advise you to do this in some of these crazy structures, that would help you.

Yeah, but let me. Let me just say something on that one. First off, law firms are very reluctant to write opinion letters. Second, they'll charge you a fortune. And third, when they write you one, it's gonna have a ton of wiggle room and disclaimers in it so that they're not on the hook.

Exactly right. But here's the thing. If they won't write the opinion letter, that's a sign shouldn't participate.

Well, fair enough. That's a good. That's a good point. All right, Garrett, give out your website.

It's corporatedirect.com and we offer a free 15 minute consult if you want to see if we can assist you. And the number is 800-600-1760 so you can talk to one of our account reps. Free 15 minute 80061760 good stuff.

And you will be speaking at our at least that's plan. We don't have a date or anything yet, so you know it's subject to change. But the plan is that you'll be speaking again at our upcoming Meet the Masters event next year, right?

Right. There are always great events, Jason, and I really hope that the dates work out so I can come down.

Good stuff. Well, we'll try and make that work and look forward to seeing you there. Thanks everybody. Happy Investing. Visit Jason Hartman.com for more on lots of these topics. Also check out our properties and our upcoming events@jason hartman.com Happy investing.

Thank you so much for listening. Please be sure to subscribe so that you don't miss any episodes. Be sure to check out the show's specific website and our general website, hartmanmedia.com for appropriate disclaimers and terms of service. Remember that guest opinions are their own and if you require specific legal or tax advice or if advice in any other specialized area, please consult an appropriate professional. And we also very much appreciate you reviewing the show. Please go to iTunes or Stitcher Radio or whatever platform you're using and write a review for the show. We would very much appreciate that and be sure to make it official and subscribe so you do not miss any episodes. We look forward to seeing you on the next episode.