Once a family has its real estate portfolio in place, it faces the issue of ownership. Should it be owned by the family or the company? James Moore asks how this issue can affect family dynamics and how it can easily be resolved
Real estate plays an important role in the investment portfolio of any business-owning family. It does, however, present particular challenges, not least the question of how it should be owned. Property has long been a favoured target for avaricious finance ministers around the world and this regularly causes headaches in large numbers of family offices, particularly if family members enjoy the distinction of being non domiciled residents of high tax jurisdictions where the world's chancelleries increasingly see an opportunity to raise tax and political capital.
So the question of whether a family's real estate assets should be owned by the family directly, by the family business or through another structure, such as a special purpose vehicle, is a crucial one to answer. Not least because real estate can also be a highly emotive issue that can lead to intense and often bitter disputes.
The property portfolio of Sainsbury's, the British supermarket group, played an important role in the battle between various bidders and the Sainsbury family last year. That portfolio, valued at around $16 billion, made a bid virtually self-funding if it was securitised. But members of the Sainsbury family, while now only minority shareholders, still held sufficient shares to be able to block the bidders.
How a family structures their property holdings can be a highly complex area, particularly given the way that the goal posts on the tax playing field continue to be changed.
Alan Clarke, a director of and real estate advisor for Solution Partners, the Credit Suisse business that focuses on assisting private bankers who advise family offices and ultra high net worth individuals with complex requirements, says: "Typically each individual situation will be driven by personal circumstances and each will be different."
In most cases, he says, special purpose vehicles should be created for families in which to hold their property. There will often be several of these – one for each of the territories in which the properties are held – and should be independent of the family business.
"What you should be thinking about is ring fencing them, so if there is a problem in one, the contagion cannot spread to the others. They have the advantage that they enable a property asset to be divided, between siblings for example, and transferred between family members."
Jonathan Burt, a senior advisor with Barclays Wealth Advisory, a unit of Barclays Wealth set up to help families and very high net worth individuals set structures for their wealth in the most tax efficient manner, highlights the differences between property types and their location. "As a general rule there are distinct differences between the taxation of residential and commercial property so it is not unusual to find that there are different solutions for different types of property," he says.
Burt, who is a former partner with global law firm Baker & Mackenzie, adds: "One typical issue that must be faced is the cross border nature of many transactions and the differences in tax and inheritance rules in different territories." Another factor he says families must consider is whether they are living in a property or not and where they are domiciled. "Solutions can be quite different based on these considerations," he says.
Richard Weber is the managing director of Weber Grundstücksverwaltung, his family office that specialises in combined asset and property management services. He provides real estate advice to other family offices, and strongly advises that whatever structure is used, it should be held outside any family business.
"If someone (or a family board) is successfully running the family business it does not necessarily mean that he/they have the same success within the real estate business," he says. "For real estate you need to have a long-term view combined with specific know how – namely a combination of market, technical and finance expertise."
Of course, direct property investment is not the only answer. "You have to look at a client's objectives and their needs and how much control they want," says Clarke. "Some want to invest directly in real estate, others are happy to invest indirectly through specialist funds and benefit from the skill and expertise of dedicated fund managers and the diversification across a portfolio of properties."
Weber says it depends how much involvement the family wants and how much risk it wants to take. "Direct investments imply that you are very close to the properties in terms of risks and rewards/yields – here you have the challenging opportunity to develop and manage the family's real estate portfolio. In return this means that you are an active investor with full responsibility.
"Indirect investments (closed funds, open-ended funds, REITS) imply that you are a passive investor. You are not very close to the property and have a more or less financial view on the investment. If, for example, the market is going down, you simply sell your open-ended fund or REITS shares. Risks are much more limited but at the same time rewards/yields are also less attractive compared to direct investments."
Both agree that decisions will be strongly influenced by the specific law and tax restrictions/incentives in a particular territory and an assessment of the structures that are available. In Germany, for example, open-ended funds are a well established investment vehicle. Real Estate Investment Trusts (REITS) on the other hand, are the new kids on the block. But although they have little track record so far, their flexibility as an asset class can make them extremely attractive.
One approach, which has been increasingly finding favour among family offices, is for a number of them to club together to buy particular properties. Andrew Tailby-Faulkes, an international tax partner with the accountancy firm Ernst & Young, who advises family offices, explains: "A number of family offices now often come together to buy a property, such as a hotel. This has the advantage in that it enables them to spread their investment and risk and retain a certain level of direct property investment in their portfolio.
"Of course, this can be complex. You need to be able to set up a structure so that a family that wants to cash in its investment, for example, is able to do that. Each family's stake needs to be kept secure as well. But I would say that this type of co-investing by family offices is on the rise."
Ultimately, Burt says the structure and vehicles used to manage real estate have to depend on a family's needs and be tailored to the most advantageous tax position. This will be the case regardless of whether the property is held by the business or by the family.
An issue that will face many families is how to assess the value of their property assets when one or more members want to cash out – or in a situation described by Tailby-Faulkes when one of a group of partner families wants to cash out. This is not always easy.
Weber argues that families need to ask themselves why they need to assess the value of their real estate before going ahead. They also need to accept that if it is because one or more family members want to cash out, compromises will have to be made. Starting the process with this in mind can prevent disagreements from escalating into all out warfare later on in the process.
It is all too easy for disagreements to break out, particularly if those members seeking an exit feel that the valuation methodology used is detrimental to their cause. Therefore, he says, using an internationally agreed standard should pay dividends.
"In certain countries the law suggests how to assess real estate in terms of market value," Weber explains. "A much better idea is the globally established approach by the Royal institution of Chartered Surveyors (RICS) in the UK. The RICS market value certainly is an objective starting point within the internal family discussion about what the true/fair value of a real estate is."
However, he continues: "You have to address one problem: emotion. Institutional investors have a rather abstract view on market values. But within the family there is always the risk that certain family members feel unfairly treated because of a lack of real estate market know how. As a result you might have to adjust the RICS market value in order to achieve peace within the family."
For the most part, everyone agrees it makes sense to use bespoke solutions for dealing with property, usually involving individually designed special purpose vehicles that take into account a family's taxation arrangements and the legal complexities of whichever country their property is in.
But given the recent tax crackdown on non domiciled residents in Germany and the UK – which has the potential to cause a great deal of financial pain for many families and force them to look at the structure of their holdings – Burt also has an important final point.
"Keep your property holdings under review. There are an array of examples of changes to taxation regimes that have forced people to rethink their arrangements." He cites the changes to the taxation of non domiciled residents in the UK as a good example. "After 6 April 2008 the gains made on a property held through a non resident company by a non-domiciled resident became taxable in the UK," he explains.