I interviewed dozens of single family offices for my most recent book and many of these families manage properties directly or invest in real estate through REITs and funds. During my conversations with these single family office executives, I learned a few common pitfalls that family offices sometimes walk into when investing in real estate.
Pitfalls to Avoid in Real Estate
1. Ignoring Tax Consequences
It is very important to consider the long and short-term tax consequences of your real estate investments. You may be able to invest in a more tax efficient way by using a fund structure or alternative vehicle for your real estate investment. Foreign real estate investments can be especially hazardous in terms of tax liabilities and potential penalties, so it is important to consider your options if you decide to expand your real estate portfolio overseas. I know of many investors, particularly Asian families, that are actively buying U.S. real estate properties and they are especially sensitive to local tax regulations like the Foreign Investment in Real Property Tax Act of 1980, for example.
2. Lack of Diversification
The housing meltdown and financial crisis exposed a number of investors who had an extreme exposure to a particular property market or type of real estate. Investors who exclusively held Las Vegas real estate properties, for example, were particularly hurt when Nevada real estate valuation crashed. Different real estate markets recovered at different times and Nevada was one of the hardest hit and the slowest to recover. Investors with a balanced portfolio of different asset allocations and real estate holdings in different cities and markets are less likely to fall victim to the collapse of one city’s overheated property market. Las Vegas suffered from extreme drops in valuations and mass foreclosures, which made it difficult for a property owner with a portfolio over-weighted toward Nevada real estate to refinance all of its properties and write off losses if the entire portfolio was sinking.
3. Running Before You Walk
It can be tempting to dive into the deep end of real estate, especially when financing is readily available and the opportunities seem particularly exciting. However, I would caution that single family offices should remember to walk before you run and not commit yourself to these long-term investments if you do not have the experience to manage the properties, structure the deals, and make sure that you meet the demands of real estate investing. One way to walk before you running is to invest through a co-investment structure, club deal private investment fund, or otherwise leverage the expertise of experienced real estate investors. This might be a safer, less time-intensive way to invest in real estate, but if you still prefer to make real estate investments directly through your family office, you can hopefully learn the real estate investing game through the experience without having to go it alone on your first deal. You can partner with experienced real estate investors and other family offices with a strong real estate team to help you ease yourself into real estate, rather than biting off expensive, time-intensive, and complex real estate investments yourself.
For more lessons from family offices, order my latest book: “The Single Family Office: Creating, Operating, and Managing the Investments of a Single Family Office.”