10 Tips to Grow & Protect Real Estate Wealth - Building and Protecting Real Estate Wealth

Top 10 Tips to Grow & Protect Real Estate Wealth

1. Have a clear understanding of your overall financial goals, risk tolerance, income requirements, and tax implications before making any real estate decision.

You can have extensive information on a particular property and market and still make a “wealth draining” decision if you have not carefully considered all possible real estate alternatives within the context of your unique tax and financial situation.
Tip: Real estate agents and brokers specialize in sales and/or leasing of a particular property type and geographic market. Great real estate agents and brokers provide invaluable knowledge and insight into a local market but that is only one component to make smart real estate decisions that grow and protect wealth. Remember, real estate agents and brokers generally do not get paid unless a sale or lease transaction is done. Naturally, there will be a bias to only consider options that include a real estate transaction. Successful real estate investors understand that building and protecting real estate wealth requires unbiased and expert advice as to:
Buy, Sell, Hold, 1031 (tax deferred) Exchange, Refinance or Redevelop a Property
Before and After Tax Impact on Cash Flows for all Alternatives
Ownership Structure (LLP, LLC, partnership, individually, living trust, etc) benefits and limitations
Amount of Financing (leverage) for the Investment to Maximize Cashflow and Tax Benefits for a Particular Investor without adding undue risk
Financing Structure and impact on operations and holding period
Decision making when properties have multiple owners with different goals and objectives
Partnership Buy-Outs
Redevelopment and repositioning of property
Estate Planning and Wealth Transfer planning
Property Management Operations
Building Facilities Maintenance and Capital Improvements
Lease audits to ensure proper rental collections and expense recaptures
See Solution Path for more information.

2. Balance real estate holdings by geography and property type to protect against market downturns.

Balanced real estate portfolios provide for wealth accumulation while managing the risk of downturns in individual property types and markets. It’s the same concept as having a balanced portfolio of stocks and bonds that is appropriate for your personal financial situation. For instance, when most people retire their investment portfolio is often re-weighted to include less individual stocks and a higher percentage of fixed income investments and annuities.
Real estate portfolios should be balanced in much the same way, that is, changing to reflect the requirements of the investor for their stage in life. Real estate, like all investments has a certain level of inherent risk. However it would be rash to simply sell the real estate, pay all of the built up taxes and using whatever is left over to buy bonds and treasury bills. Instead, adjust your real estate holdings to match your requirements when you enter a new phase of life (see #3 below).

3. Match real estate investments to your tax bracket and cashflow requirements.

As a rule, newer properties that are net leased to strong national tenants provide more stable cashflow but with limited upside potential. Net leased retail properties have been very popular with retirees for many years due to their stability and limited management responsibilities associated with newer properties. At the other end of the spectrum is raw land, which in most cases is a negative cash flow investment through the holding period (remember property taxes and levies) and provides very limited tax benefits (depreciation can only be taken on structures, not land). Well located land however can have phenomenal upside potential for patient investors if it is developable and in the path of growth.
Carefully consider and analyze the “best case”, “expected” and “worst case” financial scenarios for the property. Would the “worst case” scenario force you to sell the property to meet personal financial obligations? See Real Estate Investment Analysis for tips and strategies on how to select real estate investments that are most appropriate for your unique situation.

4. Understand the difference between Property Management, Asset Management and Portfolio Management.

Tip: Be wary of sellers and real estate agents that claim to have properties that are “management-free”. This erroneous claim is often made for properties that are single tenant, have net leases, or both. Successful real estate investors must pay close attention to the physical, financial and economic factors of the property and local market at all stages of the investment.
Property Management: Responsible for the regular, ongoing operations of an investment property. Property management companies often specialize in particular property types, for example shopping center management. Common duties are collecting rents from tenants, ensuring that tenants are in compliance with their lease terms, paying expenses of property, preparing monthly or quarterly reports of property operations and cashflow. May or may not do leasing activities on property. Typical fees for property managers run between 3 to 5% of the gross rents collected.
Asset Management: Provides strategic direction for a particular property based on the stated goals and requirements of ownership. Ensures that property management and leasing activities and proper and aligned with strategy. Often selects leasing broker. Supervises budget preparation by Property Manager. Reviews and approves all potential new leases, construction and capital improvements to the property. Asset managment fees customarily run between 1-2% of the gross rents collected and is usually only done for large investment properties.
Portfolio Management: Ongoing analysis of multiple real estate investments, associated financing and structure, buy and sell decisions, and 1031 Tax Deferred Exchange decisions, as it relates the unique financial and personal goals of each Investor. Real estate portfolio management is the most overlooked of the 3 components and is critical to the long term success of real estate investors. Real estate portfolio management is the core focus of Carter Commercial Group and we guide our clients to the most appropriate and qualified Asset Managers, Property Managers, Real Estate Leasing Agents, and Real Estate Sales Agents for each property in the portfolio.

5. Consider tax, legal, liability, succession and management issues when determining how to hold title to investment real estate.

Tip: Holding real estate in your name (or your name plus LLC, LLP, etc.) makes investors targets for frivolous lawsuits as property ownership is public record in most parts of the country. There are over 24 million lawsuits in the US each year. Using those numbers, the average American can expect to be sued 3 times in their lifetime. Since it makes no sense paying a lawyer to sue a poor person (and lawyers wouldn’t take a contingency case unless the defendant had easily visibly assets) real estate investors that don’t protect the privacy of their investments will be disproportional sued. Don’t put a target on your head for frivolous lawsuits.
Note: If you’re a business, avoid titling real estate in the name or the corporation. Beyond the negative aspects of adding debt to your company’s books (assuming you’have financed the property) any suit related to the property will flow through to the company. You will also face these negative situations:
Separate Taxable Entity which will pay Corporate Tax Rates
No preferred capital gains tax treatment
No ability to pass through losses to personal income tax
Ultimately, the decision on how to hold title to a property depends on many factors including the number and type of owners in the property, the goals of the investor, and whether that property correlates to a business of the owner. Creating and properly maintaining a real estate holding company (entity) to hold title to your investment real estate is a critical component to protect your real estate investment from lawsuits against you personally and from lawsuits against the property that is in the entity from spilling over to you personally.
Properly structured real estate holding companies (LLCs, LLPs, etc) provide asset protection but alone they will not protect you from the time and expense of probate.

6. Put real estate into a Living Trust to avoid Probate.

What is Probate? Probate means court supervision of your estate at your death. Probate is expensive and takes time, so most people like to avoid it whenever possible. Simply having a Will does not avoid probate.
What is a Living Trust? A living trust is a legal document that replaces what you think of as your will. The living trust makes sure your assets go to the people you choose. It also avoids probate upon death or a conservatorship proceeding if you become incapacitated. Properly prepared it allows couples to eliminate or substantially reduce taxes, and eliminate the time and expense of a probate.
Note: Many people that have trusts fail to officially put their properties into the trust (“funding the trust”) which can force them into a probate. In some counties you can petition the court to include the asset in the trust but its prudent simply to place the property in the trust to begin with.
Tip: Putting your property into directly into a trust for example, “John and Jane Doe Living Trust” does not provide asset protection (see #5 above). The preferred method is often to place the property into the entity (LLC, LLP, etc) and make the Trust the primary shareholder in the entity. As always, consult your tax and legal advisors for advice on your particular situation.

7. Leverage and Financing Terms make a huge difference in investment performance and risk.

Investment financing is considerably more complex than residential financing and all options should be carefully considered. Some important considerations when financing investment real estate include:
Personal Liability and Recourse
Rate and Term
Fees on Loan Origination
Fees on Loan Assumption (if applicable)
Lock out term (property cannot be sold within a certain period after loan is made)
Assumability and costs involved
Pre-Payment and/or Defeasance (a form of pre-pay for securitized loans)
Reserves and Impound Requirements
Amount of Financing (leverage) expressed as a percentage of Purchase Price
How to structure investment real estate debt and equity to maximize a real estate investor’s returns and minimize risks is too broad a category to go into depth in this article. Suffice it to say that it primarily depends on the needs and sophistication of the investor, the goals and risk tolerance of the investor, the expected holding period of the real estate, and any future cash requirements during the holding period (for capital improvements, leasing commissions, etc.).

8. Document all leases, lease addendums and agreements.

Good property managers and asset managers will ensure that this occurs.
Tip: If you are self-managing your property, make sure that you memorialize any verbal agreements with your tenants with a written document that is signed and dated by all parties. Make sure that you or your property manager conduct annual lease reviews and expense audits are done to ensure proper rent and property expenses (sometimes called Common Area Maintenance or CAMs) are being paid. You will also want to physically inspect the property on a regular basis to ensure that no undocumented subleases exist and no unapproved or illegal activities are being performed on the property.

9. Anticipate tax implications on transfer either by gift, sale, or inheritance.

“The hardest thing in the world to understand is the income tax.”
- Albert Einstein
How long will you live? How long will your spouse live? As you get older, what medical care will you and your spouse require and what will the cost of that be? How much cash and/or income will you require annually to meet all your needs and still have enough for emergencies? What will the Estate and Gift Tax rates be for the year that you die?
Unfortunately, the above questions cannot be answered definitively as the tax laws are as unpredictable as our own mortality. The answer lies in a regular review of your personal and financial situation, the current and expected tax laws, and modifying your real estate portfolio and trust(s) regularly to ensure that they meet your current and longer term goals.

10. If you’re planning on leaving real estate to your family when you die, pay special attention to the unique financial needs and real estate investment experience of each recipient(s) (beneficiaries).

“A dysfunctional family is defined as a family with more than one member”.
- Anonymous
It is often better to name a professional trustee for a situation where the beneficiaries do not have a strong working relationship. In the vast majority of cases however, professional trustees are at a loss when it comes to handling real estate assets. They are illiquid, difficult to forecast value, and generally create a management crisis when left to more than one family member.
Tip: Look at real estate investments as you would a business succession plan. Create an exit plan in advance for beneficiaries that, due to their personal or financial situation, are not good candidates for owning investment real estate.
Red Flag: People that are not financially responsible, lack business experience or are constantly struggling to make ends meet are generally not good candidates for owning investment real estate. This is due in large part to the cyclical nature of real estate and the simple fact that forecasting cash flows is an imperfect science. There are too many variables that real estate owners cannot directly control, such as the success or failure of the tenants in the property. Giving investment real estate to an irresponsible person rarely makes them responsible and often creates more problems as they attempt to make short term decisions (related to cash flows) with a long term asset (real estate).
There are ways to structure investment real estate portfolios so that the income streams are more consistent over longer periods of time. In this way, a person can give real estate to the “less experienced” and provide for a relatively clean exit path should they desire to cash out of the investment. The structuring process begins with Investment Management, moves to Asset Management, and finally Property Management (see #4 above). This process is constantly in motion as adjustments are made to adjust to changing markets, property conditions and the real estate investor’s personal financial situation.