Financial Planning
When it comes to discussing real estate with clients, adviser Michael Martin is able to draw on his own hard-earned experience.
In 2001, Martin, principal and founder of Marius Wealth Management in New York, left a career at Smith Barney to spend what became a decade as a real estate investor, buying, rehabbing and selling properties in New York and Florida.
“I learned some valuable lessons, I can tell you that,” Martin says. Fortunately for his clients, they are lessons he is now able to impart to them.
The native New Yorker had some home runs renting, buying and selling properties in the Hamptons, the fashionable beach towns on Long Island.
“I knew what renters and buyers wanted in a Hamptons house, and where they wanted to be,” he says. “I knew how far a house could be from the train track, for example. And after seeing a house for the first time during the day and being initially sold on it, I would always go back at night or weekends to uncover any negative surprises, such as crazy neighbors, loud noises or unpleasant odors from, say, a nearby duck farm.”
But Martin didn’t fare as well in Florida.
In 2005, he overpaid for what appeared to be desirable vacant lots fronting a canal in Coral Gables, Florida. What Martin now owes on his mortgages is more than the fair market value of the lots. His waterfront properties are, in real estate lingo, now underwater.
Martin learned the hard way that “vacant lots do not produce rental income if the numbers turn against you at market highs, especially if you need to derive income while you wait for the market to improve.”
‘DON’T HAVE YOUR WIFE ON THE MORTGAGE’ “Don’t mortgage vacant lots,” Martin says, “which I did. Don’t have your wife on the mortgage, too, which I did.”
Martin also warns against replicating two other mistakes he says he made: succumbing to FOMO — a fear of missing out — and being “persuaded and influenced by a commission-hungry salesman.”
Martin returned to the advisory business in 2012.
“I realized I liked being an adviser better,” he says. “Real estate was ultracompetitive, and it’s easier to differentiate yourself as an adviser.”
After two year at Wells Fargo Advisors, he started his own firm in 2014. When high-net-worth clients say they want to invest in real estate, excluding their primary residence, Martin doesn’t mince words.
“Real estate is not for the faint of heart,” he advises them. “It’s a very fickle market. You can’t be emotionally attached. And the lack of liquidity is a huge issue. You’re married to a property until you’re able to sell it, and the options for liquidity are far less than any other investment.”
Martin and other wealth managers stress the need for a detailed and candid conversation covering asset allocation, risk, tax liability, income needs and the consequences of owning an illiquid asset.
Advisers generally recommend that high- and ultrahigh-net-worth clients allocate anywhere from 5% to 30% of a portfolio to real estate as an asset class, with many caveats, of course.
Age and income needs are primary considerations. For older clients who will need income, Ross Fox, founding partner at Cardan Capital Partners in Denver, puts “a higher emphasis on cash flow versus total return. We want to have serial liquidity events in investments that mature over time.”
For HNW clients, Fox recommends allocating approximately 5% to 15% of assets into real estate investments outside their primary residence. For anything exceeding 15%, clients should “have an affinity with the space” — that is, be real estate professionals themselves.
Being caught at the wrong end of an economic cycle is a major risk, cautions Derek Newcomer, director of investment research at Beacon Pointe Advisors in Newport Beach, California.
Property location is another critical variable. “If you have a real estate asset in Houston, and the energy business takes a dive, you’re left very exposed,” Newcomer explains. One way to mitigate the risk, he advises clients, is to diversify their holdings with multiple assets in different geographic areas.
WHEN NOT TO RECOMMEND REAL ESTATE Clients should closely scrutinize maintenance costs, Fox notes. They must analyze tax obligations. And while real estate investments can provide tax relief in some cases, Fox and other advisers say this should not be a primary reason to buy property.
“You can certainly receive favorable tax treatment for some investments, but clients can get too cute by half by trying to [minimize] their taxes,” Fox says.
Lois Basil, principal of the Basil Financial Group in Chicago, says her real estate advice doesn’t vary much, no matter what her client’s tax bracket. “I think there’s a place for real estate in every portfolio, whether mass affluent or high-net-worth,” Basil says. “Leveraged real estate is an excellent hedge against inflation, and tax efficient. Our goal is to have our clients’ net worth divided one-third interest-earning, one-third equities and one-third real estate.”
Only after risks have been discussed and understood can the potential benefits of real estate investments be presented to clients, advisers say. Indeed, it’s imperative.
For wealthy clients, real estate is simply “too big to ignore,” says Alex Stimpson, founding partner and co-CIO of Corient Capital Partners in Newport Beach, California. “Real estate plays an important role as part of overall asset allocation in their portfolios,” he says. “It provides risk diversification because it has a low correlation to the stock market.”
Real estate is also a good source of income diversification, he adds. While corporate bonds are yielding around 3%, real estate investors should be rewarded with a higher yield — an additional 2% to 5%, Stimpson says — in exchange for taking on lower liquidity.
THE ILLIQUIDITY PREMIUM This “illiquidity premium” is a key concept when discussing real estate with clients, says Marty Bicknell, chief executive of Leawood, Kansas-based Mariner Wealth Advisors.
Just as clients need to know the risks associated with an investment that isn’t publicly traded, clients “with the patience to ride out economic cycles” can also benefit from illiquidity, Bicknell says, although the premium he seeks is less generous than Stimpson’s.
“The illiquidity premium should be around a 2% to 3% increase over more liquid alternatives,” he says. “If not, it wouldn’t make sense to tie up the capital.”
A leading way clients can invest in real estate is through publicly traded REITs. But with yields at historic lows (the Vanguard REIT Index Fund yields a little over 4%), advisers interviewed did not recommend REITs as an optimal real estate strategy.
Direct investments or investments in a private fund were preferred real estate vehicles, and investors can benefit greatly from the capitalization rate, say Stimpson and other wealth managers.
“The cap rate is a powerful predictor of future return and future risks,” Stimpson says. “What you see is usually what you get.”
There’s industry agreement that human advisers’ jobs are relatively safe from robots. However, there’s also agreement that advisers need to adopt new technologies to stay competitive.
“I truly believe [technology] is going to be the very thing that ensures longevity in our profession,” says Danielle Fava, product strategy and development director of TD Ameritrade Institutional.
“I think as investors are learning so early about financial advice they are much more likely to interface with a financial adviser in the future when their wealth grows and their needs become more complex.”
Automating processes will save advisers work and give them more time to focus on their clients, says Alan Moore, co-founder of XY Planning Network. Bloomberg News
During a webinar hosted by Financial Planning about the latest digital wealth management tools for advisers, Fava and other industry experts discussed how advisers can stay on top of emerging digital wealth management trends and tools and make their practices more efficient.
AUTOMATE MUNDANE TASKS
Anything in an adviser’s daily routine that can be automated should be outsourced to technological tools, says Alan Moore, co-founder of XY Planning Network. According to Bloomberg, 58% of an adviser’s role can be automated with artificial intelligence.
Not only will that save advisers from mundane, repetitive tasks, Moore says, it frees them to focus on their clients, the actual service that sets them apart from digital-only robo advice.
“Clients are not coming to [advisers] because they are the best at opening an account or the best at rebalancing,” Moore says.
Fava agrees, suggesting that rather than trying to best robo advisers, advisers should shift their focus to aspects of their organization that requires a human touch.
“[Some companies] are saying, ‘What I am selling is not investment management. What I am selling is a relationship,’” she says. “[Those advisers] are figuring out how to repurpose their value and that is really imperative.”
There are tools already that can simplify relationship building with clients too, says Sean McDermott, project manager at research firm Corporate Insight.
Virtual meetings can take place anytime via video chat and chat bots can help answer routine questions. In his research McDermott says he’s found a growing number of advisers using video chat for initial consultations and their clients are satisfied with telephone consultations afterwards.
Another easy automation is password management software, McDermott says. Using that tool is simpler than trying to remember 70 passwords or having to input and look them up individually on a spreadsheet, he says.
Moore suggests advisers to download the browser extension, RescueTime. He says while using the app, advisers will see how much time they spend on tasks that can otherwise be automated.
Using the app, Moore says he learned he wasted time playing email and phone tag with clients, so he installed a client portal for his practice. The portal allows advisers and customers to track financial goals and schedule appointments. When advisers are on the same page with their clients about goals, he says, meetings are more effective.
“Data monitoring is key to communication,” McDermott says.
NEW TOOLS, NEW CLIENTS
Large advice firms are aggressively investing in digital advice operations and introducing new technologies to make the advice process more efficient, such as Cetera’s new facial recognition software feature.
Corporate Insight’s McDermott notes that client demographics are changing too — not only is the future client going to be younger, they will also be savvier about their financial behavior, he says, and about the services they elect to manage their wealth.
RIAs need to take heed of such trends, says XY Planning Network’s Moore, especially older firms that have been resistant to change.
Moore acknowledges that there are many firms doing financially well and their current customers are happy without having to evolve their practices. But that isn’t sustainable, he adds.
“Advisers have to understand that the future of financial planning and our profession in general is very much what we like to call the cyborg adviser,” Moore says. “We are just going to get better at what we do. We are going to become more efficient and provide greater value to more clients. But technology can’t be rejected. It’s here to stay.”
Machines threatening human beings is not a new thing. It’s been a theme of countless science fiction movies, and folk stories like John Henry vs. the Machine. It is being talked a lot today in the “modern economy” and not just as it relates to coal miners.
Tech has become a hot topic in the finance industry too. Folks are wondering what the advancement of tech and artificial intelligence means for the future of financial services and how investors manage their money.
My general opinion is that tech is and will continue to give investors better and more options at a lower cost than ever before. I think that is most evident in the shift towards independent RIA firms. Many of these firms would not have been able to exist 15 years ago, but today technology allows sole proprietor RIAs to compete with the biggest wire houses for clients. For this piece, I want to address a specific element of tech and investing. I want to look specifically at tech and portfolio management.
“Won’t portfolio managers be replaced by algorithms?” That is the question that was recently asked me, and my answer is very simple “no.”
Technology, and algorithms will enhance and make portfolio managers more efficient than ever before, but they will not replace the human element. There are two extremely important concepts that explain why.
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The markets are a function of supply and demand.
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The markets are discounters of widely known information.
Supply & Demand
Algorithms can be used to evaluate supply. Computers can look at all the data in the world on publicly traded companies, and all the economic data, etc., etc., but ultimately a human will need to make an interpretation of that data as it relates to demand. Demand is emotional, demand it is sentiment driven, and that makes it uniquely human. My dad once told me “that something is only worth what someone else is willing to pay for it.” His statement is 100% spot on when it comes to capital markets.
Discounter of Information
All known information is factored into the market. That means that once information is known it becomes obsolete, unless it is interpreted in a unique manner. Therefore, I could create an algorithmic formula for managing 100 client’s portfolios that works great. However, once I start using it to work with a really large pool client portfolios or I do not constantly change the formula my algorithm will become obsolete, because it is based on assumptions and interpretations that will be discounted into the market. Think about a fish that can only swim in a straight line or turn left, how long will it take the shark to figure out that the fish always turns left?
Geeks have been trying to be smarter than the markets for years, always convinced that they have what it takes and that “this time it’s different.” Success investing in capital markets will always be more dependent on the stomach than the brain, and that means humans will always have a place in portfolio management.
– Wyatt Swartz
6/21/2017