Away From Home

There’s a lot more to real es­tate in­vest­ing than think­ing lo­cally

Financial Planning - - CONTENT - By Charles Paik­ert

There’s a lot more to real es­tate in­vest­ing than think­ing lo­cally. Some ad­vis­ers are help­ing clients in­vest in char­ter schools, part­ner­ships and even prop­er­ties to be listed on Airbnb.

When it comes to dis­cussing real es­tate with clients, ad­viser Michael Martin is able to draw on his own hard­earned ex­pe­ri­ence. In 2001, Martin, prin­ci­pal and founder of Mar­ius Wealth Man­age­ment in New York, left a ca­reer at Smith Bar­ney to spend what be­came a decade as a real es­tate in­vestor, buy­ing, re­hab­bing and sell­ing prop­er­ties in New York and Florida.

“I learned some valu­able lessons, I can tell you that,” Martin says. For­tu­nately for his clients, they are lessons he is now able to im­part to them.

The na­tive New Yorker had some home runs rent­ing, buy­ing and sell­ing prop­er­ties in the Hamp­tons, the fash­ion­able beach towns on Long Is­land.

“I knew what renters and buy­ers wanted in a Hamp­tons house, and where they wanted to be,” he says. “I knew how far a house could be from the train track, for ex­am­ple. And af­ter see­ing a house for the first time dur­ing the day and be­ing ini­tially sold on it, I would al­ways go back at night or week­ends to un­cover any neg­a­tive sur­prises, such as crazy neigh­bors, loud noises or un­pleas­ant odors from, say, a nearby duck farm.”

But Martin didn’t fare as well in Florida.

In 2005, he over­paid for what ap­peared to be de­sir­able va­cant lots fronting

a canal in Coral Gables, Florida. What Martin now owes on his mort­gages is more than the fair mar­ket value of the lots. His wa­ter­front prop­er­ties are, in real es­tate lingo, now un­der­wa­ter.

Martin learned the hard way that “va­cant lots do not pro­duce rental in­come if the num­bers turn against you at mar­ket highs, es­pe­cially if you need to de­rive in­come while you wait for the mar­ket to im­prove.”


Don’t mort­gage va­cant lots,” Martin says, “which I did. Don’t have your wife on the mort­gage, too, which I did.”

Martin also warns against repli­cat­ing two other mis­takes he says he made: suc­cumb­ing to FOMO — a fear of miss­ing out — and be­ing “per­suaded and in­flu­enced by a com­mis­sion-hun­gry sales­man.”

Martin re­turned to the ad­vi­sory busi­ness in 2012.

“I re­al­ized I liked be­ing an ad­viser bet­ter,” he says. “Real es­tate was ul­tra­com­pet­i­tive, and it’s easier to dif­fer­en­ti­ate your­self as an ad­viser.”

Af­ter two year at Wells Fargo Advisors, he started his own firm in 2014. When high-net-worth clients say they want to in­vest in real es­tate, ex­clud­ing their pri­mary res­i­dence, Martin doesn’t mince words.

“Real es­tate is not for the faint of heart,” he ad­vises them. “It’s a very fickle mar­ket. You can’t be emo­tion­ally at­tached. And the lack of liq­uid­ity is a huge is­sue. You’re mar­ried to a prop­erty un­til you’re able to sell it, and the op­tions for liq­uid­ity are far less than any other in­vest­ment.”

Martin and other wealth man­agers stress the need for a de­tailed and can­did con­ver­sa­tion cov­er­ing as­set al­lo­ca­tion, risk, tax li­a­bil­ity, in­come needs and the con­se­quences of own­ing an illiq­uid as­set.

Ad­vis­ers gen­er­ally rec­om­mend that high- and ul­tra­high-net-worth clients al­lo­cate any­where from 5% to 30% of a port­fo­lio to real es­tate as an as­set class, with many caveats, of course.

Age and in­come needs are pri­mary con­sid­er­a­tions. For older clients who


will need in­come, Ross Fox, found­ing part­ner at Car­dan Cap­i­tal Part­ners in Den­ver, puts “a higher em­pha­sis on cash flow ver­sus to­tal re­turn. We want to have se­rial liq­uid­ity events in in­vest­ments that ma­ture over time.”

For HNW clients, Fox rec­om­mends al­lo­cat­ing ap­prox­i­mately 5% to 15% of as­sets into real es­tate in­vest­ments out­side their pri­mary res­i­dence. For any­thing ex­ceed­ing 15%, clients should “have an affin­ity with the space” — that is, be real es­tate pro­fes­sion­als them­selves.

Be­ing caught at the wrong end of an eco­nomic cy­cle is a ma­jor risk, cau­tions Derek New­comer, direc­tor of in­vest­ment re­search at Bea­con Pointe Advisors in New­port Beach, Cal­i­for­nia.

Prop­erty lo­ca­tion is an­other crit­i­cal vari­able. “If you have a real es­tate as­set in Hous­ton, and the en­ergy busi­ness takes a dive, you’re left very ex­posed,” New­comer ex­plains. One way to mit­i­gate the risk, he ad­vises clients, is to di­ver­sify their hold­ings with mul­ti­ple as­sets in dif­fer­ent ge­o­graphic ar­eas.


Clients should closely scrutinize main­te­nance costs, Fox notes. They must an­a­lyze tax obli­ga­tions. And while real es­tate in­vest­ments can pro­vide tax re­lief in some cases, Fox and other ad­vis­ers say this should not be a pri­mary rea­son to buy prop­erty.

“You can cer­tainly re­ceive fa­vor­able tax treat­ment for some in­vest­ments, but clients can get too cute by half by try­ing to [min­i­mize] their taxes,” Fox says.

Lois Basil, prin­ci­pal of the Basil Fi­nan­cial Group in Chicago, says her real es­tate ad­vice doesn’t vary much, no mat­ter what her client’s tax bracket. “I think there’s a place for real es­tate in every port­fo­lio, whether mass af­flu­ent or high net worth,” Basil says. “Lever­aged real es­tate is an ex­cel­lent hedge against in­fla­tion, and tax ef­fi­cient. Our goal is to have our clients’ net worth di­vided one-third in­ter­est-earn­ing, one-third eq­ui­ties and one-third real es­tate.”

Only af­ter risks have been dis­cussed and un­der­stood can the po­ten­tial ben­e­fits of real es­tate in­vest­ments be pre­sented to clients, ad­vis­ers say. In­deed, it’s im­per­a­tive.

For wealthy clients, real es­tate is sim­ply “too big to ig­nore,” says Alex Stimp­son, found­ing part­ner and CO-CIO of Cori­ent Cap­i­tal Part­ners in New­port Beach, Cal­i­for­nia. “Real es­tate plays an im­por­tant role as part of over­all as­set al­lo­ca­tion in their port­fo­lios,” he says. “It pro­vides risk diver­si­fi­ca­tion be­cause it has a low cor­re­la­tion to the stock mar­ket.”

Real es­tate is also a good source of in­come diver­si­fi­ca­tion, he adds. While cor­po­rate bonds are yield­ing around 3%, real es­tate in­vestors should be re­warded with a higher yield — an ad­di­tional 2% to 5%, Stimp­son says — in ex­change for tak­ing on lower liq­uid­ity.


This “illiquidity pre­mium” is a key con­cept when dis­cussing real es­tate with clients, says Marty Bick­nell, chief ex­ec­u­tive of Lea­wood, Kan­sas-based Mariner Wealth Advisors.

Just as clients need to know the risks as­so­ci­ated with an in­vest­ment that isn’t pub­licly traded, clients “with the pa­tience to ride out eco­nomic cy­cles” can also ben­e­fit from illiquidity, Bick­nell says, although the pre­mium he seeks is less gen­er­ous than Stimp­son’s.

“The illiquidity pre­mium should be around a 2% to 3% in­crease over more liq­uid al­ter­na­tives,” he says. “If not, it wouldn’t make sense to tie up the cap­i­tal.”

A lead­ing way clients can in­vest in real es­tate is through pub­licly traded REITS. But with yields at his­toric lows (the Van­guard REIT In­dex Fund yields a lit­tle over 4%), ad­vis­ers in­ter­viewed did not rec­om­mend REITS as an op­ti­mal real es­tate strat­egy.

Di­rect in­vest­ments or in­vest­ments in a pri­vate fund were pre­ferred real es­tate ve­hi­cles, and in­vestors can ben­e­fit greatly from the cap­i­tal­iza­tion rate [see side­bar], say Stimp­son and other wealth man­agers.

“The cap rate is a pow­er­ful pre­dic­tor of fu­ture re­turn and fu­ture risks,” Stimp­son says. “What you see is usu­ally what you get.”

What are some of the com­mon and not so com­mon real es­tate strate­gies wealth man­agers are em­ploy­ing for clients? See ex­am­ples be­low.

Real es­tate is “a very fickle mar­ket,” says Michael Martin of Mar­ius Wealth Man­age­ment, and it might not be ap­pro­pri­ate for some clients.

Be­ing caught at the wrong end of an eco­nomic cy­cle is a ma­jor risk in real es­tate, says Derek New­comer, direc­tor of in­vest­ment re­search at Bea­con Pointe Advisors.

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