Have you ever wondered why family offices allocate such substantial portions of family portfolios to real estate?
According to The 2019 U.S. Family Office Real Estate Report, a survey of over 200 family offices conducted by Family Office Real Estate Magazine, the most important investment objective for family offices as cited by their directors is the preservation of wealth, followed by income generation and asset appreciation. Given these objectives, it should come as no surprise then that family offices are drawn to the commercial real estate class.
Before diving into why commercial real estate is ideal for preserving wealth, let’s dive into what preserving wealth means exactly – particularly as it relates to the ultra-wealthy because it’s my opinion that what the ultra-wealthy consider “wealth preservation” differs from how the rest of the investing public views it.
First, some background. There’s a running joke about family office money: The first generation makes it, the second generation spends it, and the third generation blows it.
According to a study by Williams Group wealth consultancy, 70% of wealthy families lose their wealth by the second generation, and 90% by the third.
Those staggering numbers explain why many family patriarchs and matriarchs are so preoccupied with preserving wealth. Preserving wealth in the traditional sense means managing your assets in such a way to maintain their value or ensure their value doesn’t decrease or erode. This is not what the ultra-wealthy considers to be preserving wealth. It’s not merely about maintaining asset value. If that were the case, the ultra-wealthy could simply stash their wealth in a CD or money market account that kept up with inflation to preserve asset value.
For the ultra-wealthy, preserving wealth means much more than merely preserving asset value.
Preserving asset value is a defensive strategy not built for the long-term. It doesn’t look beyond the current generation. The ultra-wealthy want to create multi-generational wealth to create a lasting legacy. Whether their motives are selfish or altruistic, the fact is the ultra-wealthy don’t want what they built to be gone by the third generation.
For the ultra-wealthy, preserving wealth means maintaining a certain income level and lifestyle for their children, their children’s children, etc. Providing for succeeding generations that will grow in numbers in most cases requires doing more than just preserving asset value. Annual distributions for three children living on $1 million per year will be starkly different for 11 grandchildren living at the same level in 20 years.
Not only does a wealth preservation strategy have to take into account the growth in the number of heirs but inflation as well.
For the ultra-wealthy, preserving wealth means going on the offensive and investing in a way that ensures assets not only grow over time but also provide a legacy for one’s family. That’s why commercial real estate is ideal for preserving wealth. Backed by tangible assets, real estate is ideal not only for asset preservation but historically has appreciated well ahead of inflation and the S&P 500 while providing recession-resistant income streams.
Here’s why family offices love commercial real estate investing:
- It’s a hard asset.
- Consistent income stream.
- Asset appreciation.
- Leverage can be used to multiply assets and income streams.
- Tax advantages include depreciation, interest deductions, cost segregation, and 1031 tax deferral strategies, and all have a compounding effect enhancing returns.
The multiple compounding effects of income, appreciation, leverage, and tax benefits all combine to make real estate not only ideal but essential for creating multi-generational wealth.
If the first generation embraces commercial real estate investing as part of a sound wealth preservation strategy, then why does 70% of this wealth disappear by the second generation and 90% is gone by the third? The answer may simply be education. Typically, the second generation has no idea how the first generation created the wealth and are therefore clueless as to how to continue building that wealth or how to maintain it.
That’s why the ultra-wealthy turn to family offices. They want to avoid this fate. They hope to not only preserve wealth but to create a legacy of knowledge for continued generation and growth of wealth – knowledge and strategies that can be passed down from generation to generation through education and advice from family office managers and directors.
Investors without the luxury of a family office to manage their investments can still benefit from their wealth preservation strategies. For families that want to build and maintain wealth, real estate is essential because it’s a tangible asset, generates income, and appreciates over time.
However, a sound real estate investment strategy alone will not ensure multi-generational wealth. It’s also crucial that succeeding generations understand and incorporate these strategies as well. Family patriarchs/matriarchs should involve heirs in their real estate investments. They need to ensure that these generations are engaged in plans for the future, are apprised of the potential pitfalls that can arise, and are made aware of all the investment opportunities floating out there.
A sound investment strategy involving commercial real estate along with education for succeeding generations provides the best chance of avoiding the fate of the 90 % that lose their wealth by the third generation. The financial benefits of real estate give you the best chance of not only creating wealth but preserving it as well.
We invite you to partner with us to generate and preserve wealth to create a lasting legacy for your family. We can help you get started today.