It’s estimated that there are 5,300 family offices globally, accounting for about $9 trillion in assets. According to the 2019 USB/Campden Wealth Global Family Office Report, about 17 percent of family office wealth is tied up in direct real estate investment and management, while a third of respondents planned to increase their investments in direct real estate.
The ultra-rich have always invested heavily in property. Two centuries ago, international banker Nathan Meyer Rothschild advised investing one-third of assets in real estate. In times of low returns in most asset classes, real estate continues to generate comparably attractive returns. And now, direct investment is trending (versus investing in shares in a fund or a publicly or privately held company).
What’s driving this move to direct investment? And will family offices also be heeding Rothschild’s other advice to “buy property when there’s blood on the streets”?
Family Offices Focus on Preservation for Future Generations
Family offices are typically concerned with preserving long-term wealth for future generations. Many of these offices are created with the proceeds of entrepreneurial businesses, as founders often wish to separate and protect family assets from their business activities, which may be subject to disruption. Family offices also facilitate generational changes and allow for professional, dedicated management of accumulated wealth.
But professional management doesn’t necessarily mean outsourced management. Family offices are becoming more sophisticated and bringing professional management in-house. Plus, they offer reduced fees to clients, given that most have paid the industry-standard 2 percent management and 20 percent performance fees for decades.
Reduced costs aren’t the only incentive for direct investment, however. Family offices’ investment horizons extend beyond those of investment companies, which tend to invest in funds on a five- to six-year timeframe. Research by Bain and Co. found that selling a direct investment vehicle after 24 years yields a return of almost two times that of a short-duration fund. This is due to reduced trading costs, more tax-efficient exit planning, and improved capital deployment.
The Coronavirus Pandemic Offers a Learning Opportunity
Younger generations are playing a more active role than ever in family offices, particularly in philanthropy. Here, they direct family funds to sustainable or impact investment, rather than giving money away (often their parents’ and grandparents’ approach).
Many family offices were slow to invest in real estate during the recession following the 2008 financial crisis and have lived to regret it. The coronavirus pandemic is once again offering the “blood on the streets” scenario that usually comes once a century. Many offices are building up cash to take advantage of distressed sales and diversify their real estate portfolios. Now is an ideal time to involve younger family members in real estate investment strategy decisions.
What Do Investors Need to Consider?
The financial repercussions of the pandemic are only just beginning to show, and the pandemic could potentially be a precursor to an even greater crisis. At this point, what should real estate investment strategies entail?
All things considered, real estate has performed relatively well overall during the pandemic. But individual categories have had vastly different results; for example, hospitality and office space have been hard hit while industrial has performed well. Some experts suggest following a conservative approach, paying attention to how the pandemic, disruption technology, world politics, and climate change have affected fundamentals like:
- Job opportunities
- Remote work opportunities
- Migration patterns
- Cost of living
- Quality of life
Investors should introduce and consider a range of “what if” scenarios, looking at reduced rentals and higher vacancies to ensure they’re not overcommitting in the short term.
International Real Estate Investments
Direct real estate investment requires specialized, experienced human resources and access to a deal pipeline. Some family offices enter into real estate “club deals” to combine resources, often creating partnerships or joint ventures for individual projects. This can be a sensible way to lower risk, provided family values and risk profiles match. But even club deals can still mean investments are geographically concentrated in traditional, known locations with limited upside.
Family offices seeking to diversify their real estate portfolios by location should consider local partners. Overseas real estate investments may present above-average returns, but a local expert will provide a context for the investment. They can also advise on location-specific tax and legal requirements. It makes sense for family offices to invest in real estate. Although indirect investment remains an option for passive investors, direct investment offers greater control and flexibility. Involving younger family members early on, collaborating with other family offices, and partnering with local experts can help ensure family fortunes are preserved for generations to come.