When you work for a family office, there are three things that you can virtually guarantee the patriarch or matriarch will say to you: 1) Don’t lose money; 2) don’t lose money; and 3) don’t lose money!
According to The 2019 U.S. Family Office Real Estate Report, a survey of over 200 family offices conducted by the magazine I founded, the most important issue for family offices when it comes to their real estate investing is the preservation of wealth (41%), followed by income production and asset value growth (26%). This makes sense on many levels.
As many of us know, there’s a common saying about family office money: The first generation makes it, the second generation spends it and the third generation blows it. According to one oft-cited study, 70% of wealthy families lose their wealth by the second generation, and 90% by the third. These comments support the demand for family offices wanting to preserve while still growing their wealth, and I believe real estate is the best vehicle to help them do just that.
Real estate is the primary source of wealth for many families and what I see as the second most significant area of wealth creation for family offices after the primary industry that they created their wealth in. Why? In my view, it is because of the fundamentals that real estate provides:
1. It is a hard asset.
2. It can provide an income stream, asset growth or a combination.
3. You can leverage your investment, thus increasing your return potential.
4. It carries tax advantages, and not just one, but many. For example, you have depreciation, interest deductions, and strategies such as cost segregation and the ability to defer your taxes, which create a compounding effect that can genuinely enhance your portfolio’s return.
So if real estate — an arguably sound strategy for maintaining and growing family office wealth — is a major part of family office generational planning for future generations, then why did our survey find that over half of the next generation has no desire to be involved in the family office? Perhaps the answer is also the reason why only 30% of the wealth created by the first generation gets to the second, and only 10% makes it to the third.
People know that the first generation tends to be more focused on returns when it comes to their investments. In contrast, millennials may be more willing to take lower returns if they are participating in a social impact investment. However, if that were the culprit, wouldn’t it make sense for more members of the next generation to want to remain involved in the family office and their finances in order to steer investments in this direction?
We may not be able to know. But we can use real estate as a link to start to involve the next generation in preparation for the future. Real estate works for this because it is a tangible asset, easy (versus other investment types) to understand, and can help provide an income stream or create greater wealth that will allow future generations to focus more on impact investments.
For families that want to maintain their wealth, the next generations need to have education on not only different types of investments, but also on the family’s history to know where the money originated and how it grew. They should also make sure that the future generations are involved in what the plans are in the future, the pitfalls that can come up and the opportunities. On the investment side, a great place to start is in real estate.