Bárbara Schuck is a principal of Bridgemer Investment Properties, Zollikon, Switzerland
One of the top concerns of a family is confidentiality in its investments. Real estate investment means that, through an appropriate investment vehicle, the ultimate owner of property is protected from identification, liability and reporting requirements, says Bárbara Schuck
Whether you consider the world's largest family businesses or other private wealth groups, you'll find one thing in common amongst families, namely a significant part of their wealth is in real estate investments - income generating assets such as office buildings, shopping centres and apartment buildings. So what of the various aspects of real estate investment for owners of family businesses? One aspect to consider is the need to recognise and overcome 'home market' bias.
Home market bias
Home market bias is the preference shown for investments close to home. This closeness can be based on geography or knowledge. The recent volatility in stock and bond markets has made the recognition of home market bias even more important than in the past. Portfolio concentration in stocks and bonds accentuated the losses incurred in the market downturn. In order to achieve excellent returns from investments, families must not hinder the scope of what is available to them.
As an owner of a family business, practically all of your economic focus and energy is on your business. That is how the family business was created. Because of this focus, families tend to delegate their asset management to private wealth advisors. However, advisers themselves are subject to home market bias. Professional fund managers tend to pick stocks of companies that are headquartered closed to them. Employees tend to buy stocks in their employer-company. The apple rarely falls far from the tree.
The first step to any successful real estate investment, whether in your home market or elsewhere, is to contact an experienced local adviser. You don't go to an ophthalmologist to have your knees checked so why go to a bank or stockbroker for real estate investment. The single most important act you can do as a business owner is choose the right management. Your investments are no different. You cannot select the right investment if you do not see what is available. A home town adviser turns the home market bias into the home town advantage.
Real estate is an ideal investment class to overcome home market bias and to generate stable income streams with portfolio diversification. A well-balanced portfolio should contain real estate because of its low and negative correlation to stocks and bonds and its positive performance in weak financial markets. This also means that real estate should be geographically diversified.
One of the top concerns of a family is confidentiality in its investments. Direct real estate investment means that through an appropriate investment vehicle, the ultimate owner of the real estate is protected from identification, liability and reporting requirements.
For security reasons, the ability to be anonymous is valuable. But the benefits of privacy and security often come at the cost of control. However, privately held real estate provides both these benefits as well as effective control and reporting over the investment. The interests of the property manager can be aligned with the interests of the owner imposing an immediacy of supervision on the property manager that is unparalleled in the stock and bond market.
Real estate provides the confidentiality and control you want. It can provide the diversification, stability of cash flow and performance you desire. And, it provides the resilience necessary for the survival of your family's wealth. Studies have shown that real estate can sustain returns that outperform both stocks and bonds under varying conditions.
Cash flow of real estate
Real estate can be an excellent source of income. Its relatively low volatility is not surprising due to the contractual nature of the underlying income streams. These committed revenues together with fixed or reimbursable costs provide stable earnings extending over long-term leases.
Not only a source of capital appreciation, real estate is a well-known hedge against inflation. An owner of bricks and mortar with fixed debt and a steady cash flow is impacted less by changes in inflation, interest rates and the business cycle. Key economic factors such as supply, local industrial activity and employment growth patterns can be evaluated to identify the right market in which to maximise capital appreciation.
These key characteristics of real estate as an asset class as well as the ability to participate in real estate investment through a variety of structures make it a wise choice for investors interested in earning predictable returns and securing their capital for the future.
Purchase of investment real estate
Some of the key issues surrounding the purchase of investment real estate are assessing the credit worthiness of the tenants, evaluating the lease contract terms, engaging experienced property managers and confirming the structural integrity of the property. But before the due diligence is performed on the specific property, you need to determine in which market you will invest. The differences between countries, states and cities allow for diversification within the real estate asset class.
Information about the country and its markets needs to be available and reliable. There should be a high degree of transparency in obtaining data from independent sources including public agencies and industry associations. For example, in Canada and the US, the widespread availability of market data allows the analyst to focus on the realities of the market rather than guessing based on random observations.
The analysis of the relevant information requires local know-how to put the data in its proper frame of reference. The old adage "never underestimate the importance of local knowledge" is especially true. Insight into the future growth or shrinkage prospects of significant employers in the locality is important. The analysis must enable one to understand the impact of current and projected macroeconomic and demographic trends.
A region or country's political and social stability is also worth considering. Real estate is not moveable. The political and social environment must, on a long-term view, be stable. The real estate investment will be denominated in the local currency and depending on the currency, it may be sensible to consider this as part of the diversification benefits. Alternatively, hedging should be available.
One of the most important keys to economic prosperity is population growth. A constant renewal of consumers and the work force with upgrading of skills leads to increased demand for goods and services. This, in turn, leads to increased demand for real estate with consequential increases in income generation and capital appreciation. Liquidity is crucial and so the real estate market should have good turnover. A well-developed network of professional real estate agents creates liquidity. This facilitates dissemination of market information and intermediation between buyers and sellers. Alternatives to disposition of a real estate investment include expansion and redevelopment. Sale of a partial interest can be used as a diversification strategy. The income performance of real estate enhances liquidity.
Well-developed legal and financial systems are important. Protection of property rights is critical to ensure that the investor does not take on unnecessary risk. Well-functioning financial systems ensure that payments are made efficiently and that local financing can be put in place with relative ease.
A strong local economy is always beneficial. The local economy should not be defined in terms of a political boundary like a state or city limits but rather the more important regional characteristics that allow groupings to be made based on the predominant economic activity of an area. Studies of real estate portfolio diversification strategies have consistently found that within a country, regional characteristics are more important in determining return on investment than political boundaries. Economic market segmentation allows the adviser to determine the basis and relative strength of the region. This, in turn, is used to maximise return by identifying regions with the highest potential for quality tenants, quality leases and capital appreciation.
The decision to invest in a particular property should be based on the underlying factors that create the return, rather than the return itself. The real estate markets of Canada and the US are ideal to implement the recommendations of many seasoned and successful family investment experts who advocate real estate for its cash flow, transparency of financial and market information, resilience and proven performance.