 Welcome to Inside Hawaii Real Estate, a show dedicated to providing up-to-date information used to Hawaii homebuyers, sellers, and investors. I'm Will Tanaka with my co-host, business partner, and wife, Leone Lam, a realtor with over 20 years' experience in various leadership roles in the Hawaii real estate industry. Thanks, Will. Will is a lawyer with a background as the former head of a Hawaii title and astral company. Another full-time in real estate, we work together as a team to bring you the latest in Hawaii real estate. And we're really excited about today's topic. Will and I are looking forward to learning more about legal entities. You've heard of LLCs, partnerships, sole proprietorships. Well, we're going to be talking about various ways that legal entities can hold title to Hawaii property. Plus, we're going to delve in, and just a little bit, we're going to talk about real estate investment trust, the realm of that. And so, we're super excited. And yes, we're very, very excited to have our special guest, Daniel Lam Esquire, partner at one of the big law firms in Hawaii, Goodsill Anderson-Quinnon Stifle. And can I just say that I'm proud to be a former colleague of Daniels at the Goodsill Law Firm years ago. And, you know, Daniel's expertise is in venture capital, mergers and acquisitions, M&A, legal entity structure that we're going to be talking about today, securities regulations, corporate and governance. Man, he's your go-to business attorney. Welcome, Daniel Lam. Welcome, Daniel. I will. Hi, Leone. Thanks for having me on the show. Thanks for joining us. You know, I'd say that in the vast majority of real estate transactions, buyers will take title to their property in their own name for sometimes more commonly now in their individual trust if they have one set up. So, you're a business attorney and we're hoping to learn various ways that legal entities can hold title. So, to kind of start it off, why would someone want to put a property into a legal entity versus into their individual name or into their trust? Can you share about that with us? Yeah, sure. You know, that's a good question. You know, I would say that, you know, I think the biggest answer or the biggest reason why, you know, people would want to put real estate in an entity as compared to just holding it individually is for liability protection. Right? So, I know we hear that phrase thrown around a lot, but, you know, at its core, it's basically that, you know, if you are, I think, using property as a way to produce income or let's say you rent it out or you have an investment property or you're doing something of the nature, running a business through it, then every person you deal with, whether it's a, you know, a counterparty to a contract, a tenant, you know, if there's a problem, right, if someone gets injured or if there's a contract dispute, something like that, you know, then if you don't own the entity through some limited liability protection mechanism through, you know, most commonly through an entity, then, you know, your personal assets could be at risk if there's ever a problem. So, I would say that's the biggest reason why, you know, people would put their property into an entity. Ah, okay. Got it, got it. So, let's kind of, you know, get into these various types of legal entities. So, sole proprietorships. So, I've heard of that and I think people have heard that, but in terms of the benefits, the protection that you may or may not provide, well, what are your thoughts on that of holding Title II real property in sole proprietorships? Right. I would say that, you know, I would not recommend holding property in a sole proprietorship if, again, you're using it for some sort of, you know, business operations or income-producing purposes, because like I mentioned on the limited liability side, for sole proprietorships, you know, there is no limited liability, right? So, essentially, sole proprietorship is another fancy way of just saying that you own the property in your personal name, right? And that's, I think, the key point there, where if you don't have the time or effort or the need really to form something, go through the steps to form a company, you know, with the DCCA, you know, with the tax entities, right? Go through the steps, then that's kind of what you're left with, right? Then you can just call this sole proprietorship, which is really just an individual operating an unincorporated business for profit, right? And the benefits there is that, like I said, there's no cost, there's no administrative burdens, you can really just get it off the ground and just start running your business without forming anything, you can hold Title in your name, can hire employees, right? You can do all that stuff, you know, but really, you don't have any liability protection. I think that's one of the biggest pitfalls of using a sole proprietorship, which again, these days are falling out of favor and most businesses now are, you know, incorporated or formed as an LLC. That makes sense. And then so you're talking about liability, limited liability. So, you know, limited liability corporation, why would someone choose an LLC? I mean, obviously you just kind of outlined about the liability aspects, but are there other benefits to that? Yeah, I would say, I mean, so you mentioned LLCs and, you know, there are a number of different entities that we can touch upon, but, you know, starting with an LLC, I'd say that's the most, that's the most, you know, popular these days amongst small business owners or even real estate investors, just because it's set up very, you know, accommodating to, you know, whether you're a single, a single member, a single person, business owner, or you have multiple partners, you know, various different management structures, it's very flexible with the way you can set it up from management rights to economic rights to exit rights, if you have more than one partner, you know, and it still provides a limited liability protection that we were talking about. And, you know, basically it's, I think the difference between that and let's say a corporation is that, you know, LLCs are newer, they're a creature of contract, meaning members have the freedom to contract how it's governed, basically, whereas corporations, it's much more rigid and formal with, you know, what the statutes require with, you know, annual minutes and meetings and that sort of thing, that's just one difference. But, but again, I mean, you can set it up, whether it's, you know, on management structure, like I mentioned, whether it's member managed or manager managed, right, and from there, I mean, there's different nuances where if you could have passive members, you could have one manager, you could have the members involved in management, so it's very flexible there. One key, I think, advantage of a LLC versus a corporation, a C-Corp is that an LLC is a path through entity, right, so a path through entity, meaning that all the income and loss and profits that come through the entity flow right up through to the owner's tax returns. So every item of income just gets taxed one time compared to, let's say, a corporation, a C-Corp, where, you know, the income is taxed once at the corporate level, and then when you make a distribution or dividend up to the owners, then it's taxed again at those individuals personal, you know, on their taxes. So that's, I think, one of the reasons why, you know, small businesses and especially real estate investors would choose an LLC over a corporation, and there's some other reasons why not to, you know, use a corporation for it to hold real estate, but we can, you know, want to get too far ahead of ourselves right now, can cover that in a second. Yeah, so, hey, Daniel, just to kind of unpack the LLCs a little bit, so let's say that, you know, a doctor, she has her own office right now, it's in a sole proprietorship, right? Carol Kimura MD, right? The office is under her name. Now she's like, okay, you know what, maybe I need some liability protection. So like she herself could be a single member LLC, just one person, you don't need multiple people, is that correct? Right, that's correct. So that's one of the reasons why I think, you know, the LLC is much more, I think, popular these days than let's say a limited partnership, right, for that reason, and that for a partnership, you need, by definition, you need to have more than one person that's operating a business together for profit. So as an LLC, there's no similar rule or requirement, basically. So you can have, in your example, a single member that forms an LLC, that's essentially the single, the managing member. So it has all the decision making control, all the profits and loss goes right to that member, you know, but it's a separate entity for legal purposes. And there's some protections from liability because of that, for instance, if there's a contract with a renter or a third party, and there's a dispute and that entity gets sued, you know, if as long as everything was done properly and the entity was set up correctly, and all the taxes are paid, it's adequately capitalized, and essentially, the owner treats it like a separate entity, then the idea is that, you know, courts should also treat it as a separate entity. And if there's any liability, generally to that LLC, then it should stay at that level. And in that situation, the doctor's personal assets, you know, as long as they're not commingled with the LLC's assets, then they should be protected. Now, the one caveat with that, right, and this is that example was, let's say, liabilities for a debt or a creditor. Liabilities for actions now is something different, right? And that same example, if they're a doctor, and they're, you know, practicing medicine, and they, you know, leave a sponge or something in, you know, the patient's leg when they're operating, you know, just because they're operating through an LLC, you know, doesn't necessarily absolve that person from liability, right? Because the actual action, the actual, you know, the claim is related to something that that person actually did. So I think there, you know, you can appreciate the nuance there. But I think in general, there is just, you know, a more protection, you know, when you have an entity that provides limited liability protection, which all entities do, for the most part, right, except for general partnerships, you know, which we can, again, talk to in a second, about in the second. Would you see like any concerns about holding property in an LLC? I mean, those are some really great benefits. Obviously, you mentioned taxes, you mentioned protecting your own things, your own personal assets, and things like that, right? As long as you're not the cause of the damage. But do you feel like there's anything that, you know, to be concerned about? You know, that's a good question. I mean, I'd say the biggest thing is maybe the administrative, you know, efforts that you need to do, right? You have to form the entity, which it's not a lot. But then there's annual reports that you have to do and file with the with the DCCA. Like I said, it's a pass through entity. So the entity, the LLC doesn't pay its own taxes. But there is an informational return, usually if there's more than one partner. And then you start getting into, you know, K ones and tax returns for multiple members. But if it's just a single member LLC, you know, everything just flows up to the individual's own personal tax return. So there's not, I think, a whole lot more to do there. So you know, there's really not much of a downside. I think, especially if it's a, I'd say, you know, fairly fairly straightforward LLC, I mean, you can still do everything you can just as if you're doing it yourself, just with the added protections of of, you know, liability protection. So you talked about partnerships, the various types. So partnerships, you know, I hear about law firms or medical offices or, I mean, some investors, you know, they so-called partner up, right? And maybe for a partnership. So can we kind of dig into that a little bit deeper in terms of why would someone, you know, would want to go into a partnership, a legal partnership? And what are the best some of the benefits of that? Yeah, no, definitely. I think, you know, partnerships, I think, have been around for some time now, as we all know. So prior to LLCs becoming, I guess, the new thing 20 or 30 years ago, right? I mean, people that wanted the association that was more flexible than a corporation with pass-through benefits, like I mentioned, how an LLC provides for tax purposes, you know, use partnerships often, right? Because similarly, well, LLCs under the tax code, you know, generally the default rule is their tax as partnerships. So from a tax perspective, they're treated the same. But just from a, you know, from a legal statutory standpoint, they're a little bit different, right? In the sense that going through first, you know, we'll start with general partnerships. You know, basically, general partnerships, there's nothing that needs to be formed with the state. It's really just an association of two or more people that are engaged in business for a profit, right? So similar to a sole proprietorship, just if you or I were just to start a business and just, you know, start operating without forming anything, that would be a sole proprietorship. Same thing with the general partnership, and there's rules and statutes on that. But I would say those are those are less prominent because just like a sole proprietorship, there's unlimited liability for general partners in a partnership. So there's real no benefit to doing that with a partner without formalizing their arrangement that provides some limited liability protection, which is why limited partnerships, you know, were formed. And that's something where it's a general partnership and then you file something with the state to kind of form the limited partnership. And what that means is, you know, again, two people or two persons in the business for a profit, but in a limited partnership, one of those partners has to be a general partner. So you can have multiple limited partners, a lot of LP that you might be familiar with, but there always needs to be one general partner. And typically, the general partner has a management authority to do the day to day limited partners are more right, limited in their management rights. But because of that, general partners by law have unlimited liability, right? So the policy there being that limited partners entrust all of the management and activity operation decision making control to the general partner. So they have some responsibilities and they're subject to unlimited liability. Now, what general partners normally do is they basically just form another entity such as a limited liability company or a corporation, which itself provides limited liability protection, right? So then that if that's the general partner, then although it's going to have unlimited liability, the actual individual operators of that general partner would be, you know, isolated somewhat if that general partner entity is also, you know, it just happens to be an entity that has limited liability to protection itself. I'm kind of confusing, but you know, you can see all, you know, there's, it's rare that you'll get a general partner that's just out there individually anyway. But I mean, kind of the question probably that would come up as well, I see limited partnerships, I see LLCs, right? Like what's the difference or why would one choose one versus the other, right? And I think, again, it really depends on the facts, but what I would say in general, you see limited partnerships now more for, you know, large investment real estate funds that we'll talk about, and where you have a lot more maybe passive limited partner and, you know, general partners that are more experienced institutional real estate investment funds that say that this is just a more traditional model. So I think a lot of, you know, people and constituents are familiar with the structure. But with that said, I mean, there are a lot of LLCs now that are run like LP real estate funds. And so I've worked on a number of, you know, LLC real estate funds as well. So I would say that, you know, there's not a whole, you know, there's not one specific reason why you want to use LPs over LLCs in this situation other than, you know, that's kind of a larger scale institutional, I think, level real estate investment funds are I think typically are still using LPs often. Okay, so you know, before we get into real estate investment fund topic, and you know, I'm excited to learn more a lot more about it. So if it was just like Leonie and myself husband and wife, for example, then would you say of all the options we talked about, and let's say corporation that's just too complicated, would it just be an LLC then? Yeah, I would say so. I mean, just because there's more options on right, like, you could have a manager managed LLC, where both you could be managers, you could have a member managed LLC where both of you are member managers, but then it's difficult to like bring on a third party investor, let's say, you could have a manager managed LLC where, you know, one of you was a manager, but in order to do a certain enumerated list of things, it would require the consent from the other party and without veto rights. And you know, there's different ways you can kind of, you know, get into the details again on the three buckets, I'd say, you know, the economic management and exit rights, right? Exit rights, meaning, you know, if a partner leaves or wants to, you know, get out of the business, I mean, the rights to kind of buy or sell or, you know, exit transfer restrictions, that sort of thing. But but yeah, I think I say like, I mean, most people are using LLCs these days, especially for real estate. I mean, I know we're running out of time here, but quickly just by contrast, like explain why, you know, in a corporation, let's say, you know, of course, there's two levels of tax there, right? On a C Corp, right? The CNS Corp, that's basically a check the box for an IRS tax classification, but starting with C Corps, that's like the typical large corporations that you see and you hear two levels of tax, right? So income that comes in taxed at the corporate level. And then if you send money out through distributions, dividends to shareholders, it's taxed again, hence the two layers of taxation. So that's already an issue holding real estate, right? If because then tax twice, if you're getting real estate, let's say rental income, right? It's going to be taxed at the corporate level. And then again, when you actually take the money out to, you know, to the investor. So that's one reason why you wouldn't want to do that. An S Corp would get around that because an S Corp, it's a corporation, but it's taxed as a, it's a pass through entity. So similar to LLCs and partnerships. I mean, you'd get that one level of taxation that flow through. So that would be okay. But I think what an S Corp doesn't kind of get around though, is that for corporations, if you contribute a property into the corporation, let's say you own a property, you want to move it to an entity. If you contribute it into a corporation, sometimes that's a taxable event where you have to recognize gain on that sale. Whereas if you, if you do that in an LLC or partnership, you wouldn't necessarily have to recognize that taxable event at that time. Same thing when you take the property out, you know, there's, there's times when property needs to be transferred out of the entity, right? Without prior to liquidating it, let's just say, you know, partnerships breaking up and, you know, someone's going to get cash, you know, or transferring out the interest in the property, whatever. In LLC in a, in a partnership that pass through generally, it's not a taxable event. But again, in a corporation, you know, if you move property out of the corporation, then it can be a taxable event, which means even though you don't sell the actual property at that time, you're just moving it out. The shareholders, you know, might be taxed on that at that time, which is usually not what anybody wants. So this is why, you know, one key takeaway is I mean, you'll notice that most real estate funds are, you know, holding companies. I mean, unless they're really large, large scale companies with a ton of, you know, operations other than just real estate, they're not many, if any, you know, corporations that are holding real estate. Oh, right on. Okay, so you talk about real estate investment funds. I want to get into that. So what is a real estate investment fund? I mean, just in plain language. Yeah, I would say it's, you know, it's just an entity that takes capital from more than one person in order to leverage the additional cash or capital to, you know, purchase and either develop or manage income producing real estate, basically. So, you know, Leonie mentioned earlier, you know, just like a hui or a syndication, right, I think is a lot of people call it these days. In the real estate scene, right, basically get a bunch of people together, invest money, and, you know, either buy and develop property, flip it, rent it. I think there's a lot of different sizes and types, structures of these real estate funds, but at its core, I think that's, you know, kind of sums it up, I think for all of them. I mean, there are a lot of securities laws and things to kind of keep in mind, you know, but basically, I mean, there's a lot these days, opportunities, I think, especially in the whole idea of real estate and, you know, I think fund formation and making sure if you're an investor, and you're presenting with an opportunity, right, that you really know all your rights and obligations and what you're getting yourself into. And again, on the other side, if you're the one that's creating the fund, you have the idea, right, I mean, that's just half the battle, right? You have to do it in a way that is compliant with the law that will mitigate, you know, risk to yourself and to the enterprise. And, you know, Hoy's built a lot on relationships and reputation. And, you know, I think it's important that, you know, documentation and structure is really thought out from the beginning. So it's sets everybody's expectations, you know, at the get go. And after that, you know, people can just worry about the business and, and, you know, hopefully not have to look back at the documents, you know, once they're drafted. So say that, you know, we wanted to start the Lam and Lam Real Estate Investment Fund. I like that. Me too. Where's me? Where's me? And, yeah, so like, how would, how would I get started or how would we get started with that together? Like, there's two of us, maybe we'll, we will think about letting him join into, you know, but what would be the beginning stages for us to get that together? Yeah, you know, that's a good question. You know, I think, I think it always starts with, you know, the business first and then back into the legal stuff, right? So I think first you need to have the idea, right? So whether the plan is to, you know, like, what's the, what's the investment strategy, right? Is a strategy to find, you know, kind of distressed properties, right, and kind of fix it up and, and then flip them or sell them or is it to develop in and create, you know, income producing real estate, right? Is it to, you know, develop, you know, a care home, assisted living, you know, just all whatever it is, I think that's, that's where you start, right? And then you kind of have to think about the financials, right? Because investors, a lot of them, they want to look at what's their ROI, what's the projected return. And I think it's important if you're leading a fund or starting an entity, real estate investment fund, you know, on the security side, you don't want to misrepresent or promise one thing, right? So it's difficult. So a lot of it, it's, you got to use projections and forward looking statements and a lot of aspirational language, that sort of thing. You know, but again, anyway, you got to just, you know, draw that up and, you know, generate interest, you know, through people you know, you don't want to advertise an investment opportunity because there's securities issues there. But basically, when you get all that together, you got to just again think about the three buckets that I mentioned before, right? Economic rights, management rights, and exit rights of everybody involved. And, you know, that's how things start with a term sheet and, you know, documents going back and forth. But, but yeah, it all starts with the idea. And I'd say the projected financials and then you'll know if it's a good idea or not, right? And then kind of back into the, to the legal documentation. Very cool. I like, so it basically starts with a business plan, like you have to have that together and then you kind of get into the legal setup and everything. Right, right. That makes sense. We learned so much. I wish we had a lot more time, Daniel, but any last words or, you know, we're almost out of time, but any last messages to reviewers before we finish it off? No, you know, just, you know, thanks for having me. You know, Will and Leone, I had a great time, you know, first time on Think Tech and, you know, I feel honored to be a guest of both of you all. So, you know, thanks for everyone for listening and tuning in and, you know, any questions, you know, feel free to reach out to Will and Leone and, you know, looking forward to talking to you all again. Thank you so much, Daniel. We really appreciate you. Thank you. Thank you, Daniel. All right.