Challenges Faced by Wealthy, Multi- Generational Family Real Estate Enterprises

Transcription

1 Challenges Faced by Wealthy, Multi- Generational Family Real Estate Enterprises Mark B. Rubin * Families who have created wealth over time through real estate development and ownership have even greater opportunities, but very di erent challenges, when their focus shifts to preserving that wealth. As the author explains, in many instances, using appropriately trained professionals to guide in the process and electing to create a single family o ce, or retaining the services of a specialized multiple family o ce organization, will enable a family to maintain its legacy as new generations emerge. Many family-owned real estate enterprises have demonstrated extraordinary skills and success. While their achievements have arguably been augmented by favorable tax and securities laws, and a long-term commitment to a core strategy, they have also been fortunate, opportunistic and capable in achieving success over time. However, these private enterprises are not without their challenges. Many ultimately realize that the strategies and organizational structure that brought them their prosperity in the past may need to be re-examined to ensure continuation of the family's legacy. These families also recognize the need to strengthen and develop their human capital and governance practices to preserve and manage the aggregate wealth, oversee its deployment in the future, and serve the interests of a larger group of stakeholders. There may also be di ering desires among family members regarding connectedness and a desire to sustain the previously de ned strategic vision. In response to these complex needs, there is a growing trend among families with significant wealth to create formal organizational structures that allow them to manage the diverse desires of the family members into the future. These organizations are often generically referred to as family o ces. Of course, there are varying forms that a family o ce can take based upon each unique family situation; what follows are the functions that all o ces generally must address. The Functions of a Family O ce In many successful families, signi cant wealth has been built around a privately held family business which the family alone controlled. That business was often tasked with providing many of the personal and investment services the owning family, or * Mark B. Rubin is a Senior Managing Director at FTI Consulting and is based in New York. A member of the FTI Real Estate Solutions practice, he leads the rm's Private Client Advisory practice and has served on the boards of the Family Firm Institute and private enterprises. Mr. Rubin may be reached at mark.rubin@fticonsulting.com. 58

2 Challenges Faced by Wealthy, Multi-Generational Family Real Estate Enterprises families in some situations, required. However, in the absence of a privately held family business entity, whether as the result of a liquidity event or otherwise, the need for these services must be met by the family members together with third-party professionals and advisors who can consider the broad spectrum of nancial and human capital requirements. Regardless of the nature of the events that created the need for considering a family of- ce, the necessary functions of the o ce can be summarized as follows (see accompanying table): TABLE OF KEY FAMILY OFFICE FUNCTIONS 59

3 The Real Estate Finance Journal - Investment Management: Typically, investment policies and practices are well developed and their past success has served as the basis for creation of the underlying wealth. A more fully developed in-house investment function, complete with an advisory group for oversight, often results shortly after a liquidity event. Alternatively, many family o ces choose to outsource the bulk of the investment function and simply handle reporting internally as an administrative function. - Administrative Practices: Tax matters and investment reporting discussed above form the core of any family o ce. From that core, philanthropy, managing banking relationships, insurance considerations, and a broader category of personalized, or concierge support are often also undertaken by those working for the family o ce. Determining what services will be performed in-house and which will be outsourced is an important decision for all family o ces. The administrative function must also consider operational responsibilities, including technology, HR, and real estate needs for the o ce. - Governance: Succession and next generation engagement are essential for any sustainable family o ce and the process of developing related policies, including making key leadership appointments, should be values based. Often, key succession policies were originally based on the personal philosophies of the founder and senior family members, and may not adequately address current strategic requirements and next generation realities. Creating an advisory board (non-governing) to assist with consideration of major policies and human capital development is common. When to Consider a Family O ce Families tend to focus on the need to satisfy family o ce functions when critical trigger points are encountered in the course of the life of the family and/or the central enterprise. Some of the most frequently encountered trigger points are the following, and often more than one tends to occur in close time proximity: E Responding to opportunities to sell or merge proposed by third-parties; E Changes in external economic or regulatory conditions; E Diversi cation and/or pursuit of new opportunities for value accretion; E Retirement or planning for management succession; E Partnership discord or dissolution; E Liquidity needs; E Divergent objectives and desires of individual members or stakeholders; E Dilution of distributions to individual family members due to growth in the number of recipients after multi-generational growth; E Changes in marital status of business leaders; E Death; E Other family member/stakeholder transitions. As a general rule of thumb, a totally inde- 60

4 Challenges Faced by Wealthy, Multi-Generational Family Real Estate Enterprises pendent single family o ce is only cost justi- ed when the overall wealth exceeds $100 million. With increased regulatory requirements, the wealth necessary to justify the development of a family o ce could be even greater. Once a family, or group of individuals, identi es the desire for family o ce alternatives, an accurate analysis of nancial and human capital needs can often best be performed or facilitated by independent, experienced professionals, rather than by family members. Such individuals can gather unbiased information from key insiders, trusted advisors, and public sources in a totally con dential environment while remaining impartial. This often requires the ability to separate the facts from rumors and opinions (generally held by various family members) so that an accurate assessment and analysis can be made. Results should be presented in an objective manner that does not violate the trust or con dentiality of any individual participants. In addition to understanding what each individual desires from the family o ce, as well as what each imagines their personal involvement in operations and governance will be, families whose wealth was created or sustained through the ownership and operation of real estate assets must also consider: E The complexity of real property in estate tax planning; E Potential regulatory tax changes; E Variability of cash requirements (especially associated with certain asset classes that require periodic expenditures for leasing, tenant improvements or maintaining the competitive quality of the property); E Changing physical market conditions; E Opportunities for value enhancement through repositioning or redevelopment of existing properties; E Opportunities for value enhancement through trading activity (buying new properties or selling existing investments). Because of the inherent complexity of a family o ce where real estate is the core business, the traditional cadre of professional consultants consisting of CPAs, attorneys, realtors and investment advisors may need to be augmented by professionals with unique skill sets that focus on and are sensitive to human capital needs. These needs include personal training and development, governance processes, interpersonal dynamics and addressing philanthropic interests. The process to support numerous and often subtle changes can be brought about through executive coaching of senior leaders, facilitation of internal strategy deliberations or formal consulting services. Consultants may be retained to address alternative strategies related to individual assets or asset classes, or the rami cations of fundamental changes to the underlying structure of the enterprise such as conversion to indirect ownership and management in a public vehicle. It should be noted that there is a signi cant di erence between traditional consulting disciplines, in which the professionals do the majority of the basic analytical work and present their conclusions for consideration by the client, and a coaching modality in which the professional assists the client's principals to explore alternatives and develop their own conclusions through a heuristic process. Both approaches have value and application in appropriate circumstances, particularly when several generations of owners are involved. Throughout this process, it 61

5 The Real Estate Finance Journal is critical that the family have access to advisors that are sensitive to the needs of both the nancial and human capital components and are able to integrate a wide range of support. Case Studies To demonstrate the kinds of assistance professional consultants can provide during the establishment of a family o ce, examples drawn from real world engagements may be useful. For our purposes here, we will use hypothetical companies and scenarios as examples. The Waters Corporation was owned and managed by two families who successfully built a large industrial and multi-family portfolio over the course of two generations. An honest assessment of the availability of future family leadership, health considerations of current senior leaders and an interest by one family to liquidate its holdings, led Waters to engage a real estate advisory group to help consider its strategic and tactical options. Underlying this assignment was the understanding that these decisions would have an impact on the real estate portfolio as well as on the structure of the families' leadership and governance practices going forward. The work proceeded in a series of phases, as follows: Phase 1 Assessment: In addition to meeting with each of the stakeholders, key management and non-involved family owners, the outside consultants reviewed historical nancial data and modelled out several possible alternatives going forward. A macroeconomic review of the marketplace and research of comparable companies/assets was conducted. Groups of key stakeholders were included in scheduled meetings, including a number of younger family members as the families recognized the signi cance of these decisions on that cohort. This phase concluded with a presentation of a preliminary set of options which considered industrial properties and the multi-family portfolio independently for each of the following possibilities: 1. Portfolio re nancing for liquidity; 2. Joint-venture recapitalization; 3. Transformational corporate merger; 4. Capital raise combined with new outside leadership; 5. Sale of the Company; and 6. REIT IPO. Phase 2 Tentative Decision: After a series of meetings during which these options were discussed and further analyzed, the need to consider and exploit the current capital market environment for the multifamily portfolio in particular became evident. Considerations included the recent downward trend in cap rates, the reasonably high barrier to entry in key markets (in which much of the portfolio was located), and the amount of investment capital being targeted to this asset class. Structuring any potential transaction also needed to consider the low tax basis held by the ownership group as a whole, as well as anticipated changes in tax rates. It was further agreed that signi cant tax issues would force a substantial portion of the non-multifamily assets be integrated into a more institutional platform where the existing management team, largely nonfamily, could continue to work and create wealth. Ultimately, it was decided that the market would be tested for the multifamily assets and a merger candidate (or existing REIT) would be considered for the balance of Waters' portfolio holdings. Phase 3 Capital Markets Representation: A formal asset valuation process was conducted by the advisory group, including understanding market comparable transactions and likely deal structures and terms that would be o ered by potential buyers. Possible buyers were identi ed and the sale process was managed throughout. Ultimately, the multifamily properties were sold outright. The remaining assets, primarily industrial and mixed use, were contributed in a tax-deferred manner to a public REIT. Because this was an extension of the asset class for the REIT, it also made sense for management contracts to be negotiated for the appropriate management company personnel, including both family and non-family members. Phase 4 Organizational Development: As is true in many such cases, in addition to addressing the signi cant real estate-speci c 62

6 Challenges Faced by Wealthy, Multi-Generational Family Real Estate Enterprises strategic decisions, the various Waters' stakeholders recognized the need to develop an organization that was capable of overseeing the ongoing administration and governance of the assets in which they chose to continue to co-invest. In this case, that included both the REIT shares, as well as a substantial portion of the liquid assets retained, after-tax. This phase of the consultation assisted with the creation of a dedicated multi-family o ce structure to manage these assets and the interests/needs of the families. After identifying what internal management resources still remained, the consultants assisted the family leadership to determine what additional resources would be hired/ outsourced to ensure optimal nancial and tax management, strengthen their human capital resources and develop a suitable governance structure. The creation of the Waters family o ce was not a quick or simple process, but by working with an external advisory group, the family was guided through their essential decision making processes while getting an unbiased objective opinion when the con icting desires that invariably exist among family members arose. This helped the Waters family avoid common pitfalls and lay out a concrete plan of action. In another ctionalized example that we will call the Gordon family, a third-generation family real estate business had previously sold its entire portfolio and property management company to a public buyer. As the senior leaders' employment contracts were nearing their expiration, the Gordons engaged a private client tax and advisory services rm to help the family consider the alternatives for overseeing and preserving their wealth. Although their nancial wealth was now primarily liquid, the family was very focused on the impact of the dramatic changes that this liquidity would have on the next generation of family members, many of whom had joined the rm in recent years. Two of these younger family members led the consulting project. With the consultancy's guidance, each family member's input was solicited through surveys and in-depth conversations. During this process, their individual desires, academic training, experience, skills and aspirations were identi ed and documented. Financial modelling was performed under various growth, asset class, and distribution policy assumptions. Meetings were held with the family's other professional advisors and a variety of estate planning alternatives were explored along with their respective longterm implications for the family. The family members leading the work with the consultants subsequently reported back to the larger family group which ultimately reached consensus on several principles, including the following: 1. Approximately 20 to 25 percent of the liquid assets created in the transaction would be distributed to individual family members for them to personally determine how to invest, spend, or give philanthropically; 2. A centralized o ce would be established where the family's ongoing joint activities would be overseen. The cost of oversight of the activities would be funded by the earnings of those activities; 3. The o ce would be led by the former leaders of the real estate management company and that leadership was intended to be transitioned to other family members over a period of three years; 4. Non-family leaders would be hired as needed and allowed for in the annual budget approved at the yearly family gathering (see item 8 below); 5. Ample space would be made available for family members to work from the o ce; 6. An advisory council would be created to meet at least quarterly to provide advice regarding the family's investments. In selecting members to the advisory council, the family would also consider how to con- 63

7 The Real Estate Finance Journal tribute to the human capital development of family members; 7. Administrative activities for individual family members, beyond oversight of the jointly invested assets, would be conducted by the centralized of- ce on a fee-for-services basis. These activities included income tax planning and tax return preparation, estate tax planning, banking and general nancial oversight; 8. An annual family gathering would be organized with a speci c agenda, including each person attending, to provide a personal and professional update. A portion of the agenda would be allowed for nancial updates, and approval of the annual family o ce budget; 9. It is anticipated that a mechanism will be created to support individual future business desires of family members as approved by the advisory council; possibly a family bank. Conclusion In summary, families who have created wealth over time through real estate development and ownership have even greater opportunities, but very di erent challenges, when their focus shifts to preserving that wealth. As each successive generation has the opportunity to contribute to the existing legacy, they are wise to consider, in advance, possible future trigger points (often a matter of when they will occur rather than if they will occur) and their impact. Often, utilizing appropriately trained professionals to guide in the process and electing to create a single family o ce, or retaining the services of a specialized multiple family o ce organization, will enable a family to maintain its legacy as new generations emerge. 64