Family offices are becoming bigger players in global real estate markets. Thomas Wiegelmann and Morten Bennedsen explain why.
Family offices exist for the purpose of investing and managing funds to sustain long-term wealth and prosperity. The wealth controlled by billionaires worldwide is estimated around $9trn.
It is estimated that there are about 5,300 single-family offices, of which three-quarters are in North America and Europe. In addition, there are many multi-family offices which service up to hundreds of wealthy families.
Strategic allocation to real estate
Already 200 years ago, the banker Nathan Meyer Rothschild proclaimed that "one should wisely invest a third of one's assets in property". Today, in times of creative monetary policy and monetary dilution, private investors and family offices are remembering this wisdom.
"According to the UBS/Campden Wealth Global Family Office Report 2019, the direct real estate allocation in the overall investment portfolios is on average around 17% among the survey participants. According to the study, in Europe it is as high as 19%," says Morten Bennedsen, André and Rosalie Hoffmann chaired professor of Family Enterprise at INSEAD.
A third of the family offices surveyed also plan to increase their direct real estate investments in the short term.
Rationale for real estate
Bennedsen continues: "Given the comparatively low correlation with the stock markets, real estate is particularly suitable for a diversification of family offices' portfolios of equities, bonds and other alternatives."
Thomas Wiegelmann, managing director of Schroder Real Estate Asset Management adds: "A key objective for most families is to ensure a sound legacy for future generations. Besides the ambition to generate appealing returns, family offices are particularly mindful of value preservation.
Therefore, real estate exposure should - and in most cases does - represent a key part of a family office's overall investment portfolio allocation.
"In times of low returns in almost all major asset classes and despite cap rates being close to their lowest levels in many key real estate markets, real estate - especially in key European markets - continues to generate comparably attractive net yield spreads (against the respective 10-year government bond rates) . But it is our experience that family offices are not only about striving to generate attractive returns, but also about conservatively preserving the wealth for future generations.
He continues: "Many wealthy families are entrepreneurs and often run significant family businesses. A key motivation is therefore the desire to separate and safeguard assets from the operational family business and to build a long-term and professionally managed real estate exposure.
"This trend is also accentuated by the sometimes significant challenges for family businesses due to disruptive developments that may significantly influence the stability of business models and markets.
In addition, generational changes and handover situations in family businesses are often the reason to decouple part of the wealth from the operational family business.
"Real estate allows family offices to cover a wide range of investment strategies with the corresponding return and risk potentials - from ‘core' or ‘core plus' to ‘value add' to ‘opportunistic'."
Wiegelmann explains: "It is particularly attractive for many family offices that real estate can achieve stable and comparatively robustly predictable cash flows - and thus solid distributions."
Bennedsen adds: "In practice, family offices tend to initially focus on lower risk profile core opportunities. If they have then gained confidence in the asset class, family offices may consider opportunities on the higher end of the risk curve to optimise returns."
When it comes to strategy, Bennedsen says a family office "…might consider indirect investing, which typically involves buying shares in a fund or a publicly or privately held company, or direct real estate.
"It is important for executives of family offices to build their strategy and operations in the context of the key features between direct and indirect real estate investing, which might have significant impacts on control, risk, returns and diversification. In any case and specifically given the cyclical nature of real estate markets strategic planning, sound market analysis as well as risk management should be on a family office's radar during all phases of the market cycle.
"An indirect investment is often seen as a comparably uncomplicated and quick solution for rather ‘passive' family office investors," explains Bennedsen.
"The advantage is that a higher degree of diversification can be achieved, especially for investments in larger fund portfolios. It also provides investors access to products in special geographies, strategies or special types of properties. A further benefit is that fund managers are typically regulated and should operate based on ethic codes and governance standards. Furthermore, and in case of listed funds, family offices often rate the higher liquidity of shares and a subsequent exit as favourable.
"From a long-term family-office approach, the term of a fund is a crucial and sensitive aspect to be considered," Wiegelmann adds.
"Investors have to be aware of these risks in case market conditions and values developed unfavourably around the predefined exit period. Another limiting aspect may be the limited flexibility of indirect real estate investments in the event of changes in fund strategy or investor preferences."
Transparency, Bennedsen says, should also be taken into account. "Before the 2008 financial crisis, many funds were structured as so called ‘blind pools‘. Investors thus provided a manager with capital without knowing in advance how exactly investments were made along often broadly defined investment principles and criteria. In some cases, this went wrong."
Since then, the academic says, family offices and wealthy private investors have placed more emphasis on transparent structures and direct influence.
"The key advantage of direct investments in real estate is therefore that investors can decide for themselves and control key value drivers of real estate investment - they take their destiny in their own hands," Wiegelmann continues.
In particular, the decision concerning the real estate investment strategy (to be reviewed regularly), the specific investment criteria and selection of properties to be acquired, the decision when to invest or dispose, the definition of letting strategies or when and how value potential for properties is to be raised through development or modernisation measures can be controlled by the investor.
At the same time: "Direct investments will only achieve the desired success if a family office has established sufficient human resources, relevant experience and access to attractive investment opportunities," Wiegelmann explains.
In particular, a bespoke and geographically diversified (or even global) investment strategy, according to the expert's experience, is often lacking.
Bennedsen notes that family offices carry out many direct investments in their well-known regional markets. This often creates a geographical concentration. Wiegelmann adds: "One of the best ways to enter an unfamiliar market or asset class without taking on unnecessary risk is to partner with a local expert whose knowledge of the market and established networks can help understand its characteristics and provide access to attractive (off-market) investment opportunities.
"Choosing a partner with proven track-record is crucial and sometimes a challenge for family offices."
A third way of investing into real estate is the so-called club deal. Several private investors or family offices invest together as part of a partnership or joint venture.
"This has the advantage that smaller cheques have to be written compared to sole ownership, concentration risk can be reduced. As a result, the cluster risk may be reduced and the co-investors can use the expertise of a trusted and well-known lead investor," explains Wiegelmann. For this to work in the long term, it is important that values and investment approaches are consistent with all partners.
Overall Wiegelmann concludes: "Quality real estate might not only preserve wealth but may deliver reasonable capital growth and long-term income streams, which are important considerations when it comes to multigenerational strategies and ambitions.
Family offices and the private-wealth sector will continue to be a key player in global real estate markets. "This development is particularly driven by the expanding family office wealth base as well as increasing allocations to real estate as part of their alternative assets."