Family offices understand the importance of real estate and will continue to use this asset within their portfolio. However, I see too many family offices not maximizing the additional tax benefits that are available to them through real estate investment, nor are they conducting the detailed due diligence that is needed to make the best decisions possible — or perhaps, they may be overlooking the type of sponsors they invest with.
Key Tax Strategies Family Offices Should Know
Tax-wise, the most significant benefits available to investors are the 1031 exchange and 721 exchange. These are codes designated by the IRS that allow for a property to be sold and the funds reinvested into another similar property (or fund) while deferring the taxes owed. Although family offices tend to like to hold investments for the long term, which would not necessitate the need for a 1031 exchange, family offices also prefer investing into value-add and opportunistic deals, which does not typically coincide with the long-term preference that family offices want.
The only way to combine these desires to realize the maximum advantage as an investor is to use the 1031 exchange after a development or value-add deal has been stabilized and 1031 into another property upon the sale. By using this strategy, family offices are better able to meet both objectives.
The Importance Of Your Own Due Diligence
Secondly, the amount of due diligence that is being done by family offices before getting involved in a deal is not always at the level that I argue it should be. In my observation, the majority of family offices use limited software to conduct their due diligence (or none at all), or worse, hinge their decisions on the advice of the brokers, whose objective is to make a sale rather than to make the smartest investments for the family office’s best interest.
A rising tide may lift all boats, but the question is, when the market sees a downturn and eventually a recession, will this due diligence that family offices did hold up and weather the storm? Or, will the outcome on the other side of the storm be different than what they expected? I often hear of family offices saying something like, “But I am investing with [insert name-brand investment company here], so I have nothing to worry about.” Although large institutions have name recognition, that doesn’t always mean that you will end up with the best team to manage your real estate investment.
Let’s look at it another way: The No. 1 university in America to turn out current CEOs of Fortune 500 companies is not Harvard, not Stanford, not Notre Dame. It is the University of Wisconsin. The point is that just because there is a certain legacy or assumption associated with an investment firm with a household name, that doesn’t necessarily mean that your own due diligence is not needed, or that your investment with the firm will be a slam-dunk. Many lesser-known companies also have considerable track records that make for just as good, if not better, real estate investments, so family offices should consider these firms among their options.
Capitalizing on available tax benefits and conducting proper due diligence with the right sponsor can help family offices get more out of their real estate investments. You don’t want to make the mistake of underestimating the Wisconsin Badgers.