The big sell

(January 2006) These have been exciting times for real estate investors. Property values have risen dramatically over the past five to six years in almost every market in the country. And whether they have invested directly in the property market, or have simply watched as the value of their homes increased, your high-net-worth (HNW) clients havelikely participated in the boom.

But times change. With interest rates rising, it may well be the time to sell real estate holdings. In fact, the most recent edition of the Merrill Lynch/Capgemini World Wealth Report suggests that many HNW individuals have already reduced their real estate exposure. According to the report, the average HNW portfolio allocation to real estate dropped to 13% in 2004 from 17% the year before.

These findings are confirmed by a number of informal conversations I’ve had with my own clients and other professionals who work with HNW individuals. Experienced real estate investors seem to be taking the opportunity to lock in gains and sell a portion of their holdings.

That presents you, the advisor to the wealthy, with an exciting opportunity. Even though real estate transactions may not be your traditional area of expertise, your clients expect you to be involved with the sale — if only to tell them what to do with the proceeds. The wisdom and advice you provide will have a tremendous impact on your relationship with the client and, by extension, on your ability to attract new business.

What should you do when a client tells you he or she is thinking of selling some real estate? Here are some suggestions:

REVIEW THE BIG PICTURE The sale of real estate provides a natural opportunity to review a client’s overall portfolio allocation and confirm that it remains aligned with their personal wealth objectives. Use this conversation to reinforce some of your core investment beliefs: discuss the importance of diversification, as well as the danger of concentration risk. Congratulate your clients on their gains, but take the opportunity to tell them how preserving wealth is just as important as building it. Whatever you do, try to avoid the standard “real estate: bad/equities: good” approach. However well founded it may be, it is largely unconvincing to real estate investors, and can erode a client’s perception of you as an unbiased, objective steward of their wealth.

CORRECT “PROBLEMS”AND INTRODUCE NEW IDEAS I’ve found that a liquidity event is an excellent opportunity to correct “problems” in the portfolio: clients see it as an opportunity to start fresh, and are more open to new products and strategies. Alternative assets are a good example. A hedge fund or private equity position can be an excellent diversifier for the HNW portfolio, and can offer some of the same non-correlated performance that real estate is known for. Principal-protected notes are another possible discussion, providing the client with a way to secure the wealth they’ve just built through real estate. If the client still believes strongly in real estate, and is looking to reinvest the proceeds in additional properties, ask whether they’ve considered diversifying, perhaps by purchasing a commercial or industrial property, or by investing in a pooled asset, such as a REIT, rather than individual properties.

DEVELOP AN INCOME REPLACEMENT STRATEGY One of the most attractive features about real estate is its income potential; replacing that income will almost certainly be an important goal for your client. Demonstrate your proactive approach by working up some income investment recommendations and cash-flow projections for your client. Introduce these recommendations in a follow-up meeting after the client tells you about the sale. Show the client how it’s possible to replace the income they enjoyed with little impact to their day-to-day lifestyle. You’ll be sending a clear message to the client: you are their partner in achieving their life goals, someone who understands their financial needs implicitly an intuitively.

TALK ABOUT TAXES Some owners think about the tax consequences of selling real estate only after the sale. This almost always results in an unnecessary payment of capital gains taxes. Don’t allow your HNW clients to make this mistake. If you know your clients have significant real estate holdings, ask them whether they have a plan for dealing with the tax bill. Whether the client intends to sell doesn’t matter — just bringing up the topic demonstrates how you’re thinking ahead and looking out for the client’s interests. If the client is considering a sale, have an associate review the relevant tax regulations and prepare a rough calculation of the potential tax bill. If appropriate, refer your client to a qualified tax professional with experience in real estate transactions. This proactive approach is an excellent way to strengthen your role as a financial “quarterback” — a skillful coordinator who can take care of the details and simplify the client’s financial life.

CONSIDER CHARITABLE STRUCTURES Finally, a real estate disposition can be a catalyst for charitable giving. The proceeds of a real estate sale make a logical starting point for a charitable endowment, a private foundation, or other giving structure. This is a particularly attractive option to established clients, who likely have little need for additional funds, and elderly clients who may have already earmarked the proceeds for such a purpose. In either situation, a proactive discussion will show how you’re in sync with your clients’ goals, and thinking about their legacy in the community.

Always remember: as an advisor to the wealthy, you are more than a stock picker — you are a steward of client wealth. Even though real estate transactions aren’t your primary area of specialization, getting involved in a real estate disposition strengthens your role as a trusted member of the client’s financial team.

Thane Stenner, CIM, FCSI, is a first vice-president and investment advisor with the T. Stenner Group of CIBC Wood Gundy. The views of the author do not necessarily reflect those of CIBC World Markets Inc. This article is for information only. CIBC Wood Gundy is a division of CIBC World Markets Inc., a subsidiary of Canadian Imperial Bank of Commerce and member CIPF.

thane.stenner@cibc.ca www.thestennergroup.ca

(01/05/06)

This article originally appeared in the December 2005 issue of Advisor’s Edge Report.