Recently, I was invited to attend a meeting of the “McKenzies,” a family of long-time business owners.
Since coming to Canada over 45 years ago, they had done well by owning a specialty manufacturing business. But the bulk of their wealth has come from real estate, almost all of it in the Greater Vancouver area.
Now that mom and dad were ready to pass on the family business to their four children, the family wanted to gather perspectives on whether this focus on real estate would serve them well in the future.
Here are some observations and comments – some “food for thought” about real estate – that I shared with the McKenzies as the first step to determining how much exposure to real estate the family should have.
The performance of residential real estate in Vancouver has been exceptional (although not without volatility). This is no doubt one of the reasons – even if it’s unacknowledged – why the family believes real estate will be a good investment in the future.
But I asked the McKenzies: what would their opinion on real estate be if they lived in Winnipeg, for example? Or St. John? Or Thunder Bay? Would we even be having this discussion?
The point hit home for Mr. McKenzie senior. As it turns out, one of his cousins had emigrated to Canada at around the same time he had. But instead of going out West, the cousin had settled in Hamilton, where he had established a successful welding business. I asked Mr. McKenzie what his cousin’s perspective on real estate investing was. Mr. McKenzie thought for a moment, then answered: “I don’t think he has one.”
And that was my point. Before increasing their real estate holdings, the McKenzies need to ask themselves whether their hometown bias is interfering with an objective determination of portfolio needs.
Now that the primary goal of the McKenzie family has shifted from wealth creation to wealth preservation, diversification might make more sense than it did in the past. Even if the family wants to keep its real estate exposure, it can still diversify: by balancing the portfolio between residential, commercial and industrial real estate; by investing in other markets; or by investing via a pooled structure (limited partnership, private equity fund or publicly-traded REIT).
Real estate can be an excellent investment. This is what kick-started the McKenzies’ real estate portfolio: their operating business bought the buildings where it conducted business. The tax advantages of such a move can be significant and can easily improve both capital gains and after-tax cash flow.
The McKenzies had always been owners of real estate. But as I pointed out, there are opportunities for those who can provide real estate financing and mortgages as well. This can be an excellent way for high-net-worth families to maintain exposure to real estate, but move up the capital structure into an income-oriented investment that generally provides more security.
Over the past few years, many wealthy individuals have taken advantage of the economic turmoil to buy bargain-priced real estate. This is particularly true in the U.S., where opportunities in multi-family dwellings and offices in select markets have been very attractive and will likely continue to be for the next one to three years. But, as part of an overall wealth management plan, a decision about making real estate a core holding deserves much greater consideration.