The private sector real estate business has inherent complexities unique to other privately-held businesses. Associated with this distinctiveness are problems and opportunities, which magnify as the business develops and grows.
The more the business grows, the more critical it is to pay close attention to the owner’s personal financial affairs. Unfortunately, though understandably, the business is what generally gets all the professional attention, when in fact the owner’s financial affairs have become a business of its own. As this happens, the integration of business and personal financial affairs becomes critical to averting problems and maximizing opportunities. Below are some thoughts on how to gain the understanding of your personal financial affairs necessary accomplish this:
- Consolidate Affairs: By their nature, private sector real estate business owners have a variety of complex entity structures with a multitude of investors. Most can describe the provisions of these entities, few understand all the implications, and almost none have the required grasp on how each individual entity interacts as a business, which impacts both their personal financial and estate plan. To get a more complete picture, start by creating wiring diagrams to detail each real estate entity: location of property, legal/voting rights of control, partners and % ownership, buy-sell provisions, whether their ownership interests are held in trust, among other provisions critical to understand how everything comes together for the business owner, spouse and heirs. Creating a sound financial plan and predictable and estate plan is impossible in the absence of this perspective.
- Pro-Forma Analysis for the Non-Professional: While private sector real estate business owners have detailed financial models for their investments, those who are strictly investors are oftentimes left analyzing a detailed and at times confusing pro-forma. Working with an advisor to deconstruct the deal assumptions (normalizing optimistic assumptions if necessary) and review the entity ownership agreement (e.g. capital calls or personal liability) can assist the investor in discovering the risks of various deals and subsequently assess the viability of an investment.
- Replacement Income: When it comes time to sell a property that will not be or only partially 1031 exchanged, the question becomes how the income from that property will be replaced. It’s often not easy to replicate in the initial years; however, investing in high quality companies that grow their dividend can provide a growing revenue stream and capital appreciation over a long enough time horizon, which could come close to mimicking the yield of the real estate. Complimenting those quality dividend growth stocks with fixed income, MLPs, high yield equites, and the like can help provide higher initial yield as well as portfolio diversification*.
- Personal Financial Statement: Taking into consideration the above and all other financial details, a personal financial statement consisting of a balance sheet and cash flow can be put together. This top down look at your financial affairs and the moving pieces should form the basis of your investment decisions – both in real estate and elsewhere. This analysis can provide perspective on (but not limited to): real estate concentration and subsequent asset diversification*, implications of buying or divesting of a property, retirement, personal liability, investment portfolio risk, guidance on other large purchases, and long-term financial goals and objectives.
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*Asset allocation or diversification do not guarantee a profit or protect against a loss.Please see important disclosures here.