By the sheer nature of their business, real estate investors are higher risk-takers. However, these individuals tend to be very conservative with their non real estate-related assets and shy away from the stock market. We find this to mainly be a “control” issue. While this “barbell” approach to their household asset allocation helps mitigate risk when their business is in a downturn, it still may not be optimal with regards to taxes and long-term returns. By slightly decreasing their allocation to cash, while increasing the yield on the cash they keep in their “liquidity fund,” we can add a diversified allocation of global stocks, both in retirement accounts and tax-managed portfolios. Since these individuals tend to focus on real estate investments, we want their exposure in this area to be diversified as they age. To facilitate this, we allocate proceeds from their core real estate business to institutional real estate funds which are focused on other sectors of the real estate market (i.e., rather than investing in more multiple-family real estate, we add holdings focused on commercial, industrial, or forest and timberland). This also allows access to larger deals, which further diversifies our clients geographically, thus helping to balance the local concentration of their current real estate business by spreading exposure over the U.S. or even globally. We do this by focusing on the following:
Add value services to real estate investors:
- Ongoing, year-round tax planning: If your financial advisor has never asked to see your tax return, you need a new financial advisor.
- House hacking for first home: For example, buy a 4-plex and live in one unit free.
- Access to due diligence on crowdfunding and institutional real estate fund/platforms/programs
- Global equity, direct indexing tax-managed separately management accounts
- Tax-advantaged alternative investment strategies: new return stream + tax losses to offset other income/gains
- Mortgage debt analysis: The right side of the balance sheet is just as important as the left, but for some reason, most financial advisors ignore it.
- Other niche services:
- On-demand notary
- Paper-shredding services
- Financial planning for adult children
- Real estate-specific services:
- Owner-occupied commercial for the business
- Local rental properties for college funding goals
- Securitized out-of-market properties
- Institutional real estate funds that focus on other sectors of the real estate market
- Tax-advantaged alternative strategies that provide tax savings that can be used to offset income/gains from the business or other assets in their portfolio
- Global equities tax-managed portfolios with securities backed lines of credit attached for liquidity management needs
Case Study
Client: Established real estate investor, approaching retirement age, with very little liquidity and 90% of the family’s net worth in local residential real estate deals
Recommended Action Plan
- Liquidity Fund: We recommended moving existing cash (earning next to nothing in a bank savings account) to an FDIC-insured high-yield savings account (up to $25 million in FDIC insurance). This investment is liquid if cash is needed to fund your next real estate deal but also safe for emergencies.
- Retirement Portfolio: We recommended the following:
- A 401(k) with both husband and wife as the only participants
- Funding up to $56k each per year
- Target value at retirement: $750k each invested 100% in low-cost stock funds
- Hiring their children for clerical work and funding their Roth IRAs each year
- College Funding: We analyzed and advised on the purchase of single-family home rental properties purchased for each child’s college education funding goal, with accelerated mortgage paydowns to match when the children would be entering college.
- After-Tax Liquid Investment Portfolio: For diversification, we advised our client to start slowly building some exposure in the stock market and other non-real estate return streams through an initial allocation to:
- Tax management, direct index SMA with securities backed line of credit attached to fund real estate deal when necessary
- Tax-advantaged alternative investment strategies focused on harvesting alternative risk premia and tax losses (both ordinary income and capital losses)
- Real Estate Portfolio
- We advised on the development of a real estate holding company:
- XYZ Enterprises, LLC (real estate holding company, pass-through)
- $30 million total value with LTV of 60%-70% ($10 million in equity)
- Residential and locally focused
- Refinanced the loans using a lender who specializes in lending to this type residential portfolio
- We started an allocation to an outsourced institution real estate portfolio, which includes:
- Globally, publicly traded REIT index funds
- Private real estate index funds (NCREIF ODCE focused)
- Crowdfunding deals
- Direct private funds
- Local private partnerships
- We advised on the development of a real estate holding company:
- Estate Planning/Charitable Intentions
- We advised on strategies to get the assets outside of their estate utilizing the following vehicles:
- Qualified Personal Residence Trust (QPRT) holding their personal residence
- Irrevocable Life Insurance Trust (ILIT) funded with annual gifts
- Grantor Retained Annuity Trusts (GRATs) for highly appreciating assets
- Intentionally Defective Grantor Trusts (IDGT) holding commercial real estate property (main tenant XYZ Enterprises, LLC, formerly owner-occupied property)
- Charitable Remainder Trusts funded when thinking about selling a highly appreciated property
- Donor-Advised Fund and Qualified Charitable Distributions: Review the funding each year to maximize the tax deduction or lower taxable income in high-income years.
- We advised on strategies to get the assets outside of their estate utilizing the following vehicles:
End Results
- The client’s increased liquidity
- Added diversification to assets other than local real estate
- Legacy and charitable intentions covered and constantly monitored
*Please Note: Limitations: The above case study is hypothetical and not involving an actual client. No portion of the case study should be construed by a client or prospective client as a guarantee that he/she will experience the same or a certain level of results or satisfaction if Taxable Wealth is engaged, or continues to be engaged, to provide investment advisory services