A continuation of our discussion on how to preserve wealth – investment, risk thresholds, and how commercial real estate fits in.
Property values remain at an all-time high, so those investors whose confidence in the US and Global economies has been shaken up of late are still in a position to safely exit industrial property investments with huge gains. This may be the best strategy for long term owners whose current plan is to exit their investments in the next 2 to 3 years, as a market correction could claim a chunk of their current equity.
With that in mind, we thought this would be a good time to continue with our second look at the three phases of The Wealth Cycle, which we first sent your way back in 2016. Here’s Part 4 of the six part series.
First we earn our wealth, then we maintain it (and hopefully, enjoy it) and finally we pass our wealth along to others. Today we continue with wealth preservation, that time in our lives when we balance what we have, what we do with it and how we keep it safe.
Each of us has his or her own reasons and methods of acquiring wealth. The term “wealth” in itself, has many definitions. Some measure it mainly in dollars as a gauge of success, others by the opportunity to pursue personal interests and help others.
Wealth is relative and unique to every person who pursues it.
For our purposes, we look at the accumulation of monetary wealth through savvy real estate investing.
In Part 3, we told the story of Rob, who is still in the process of creating wealth and his elderly father who is content with his accumulated wealth and prefers a lower risk approach that emphasizes steady cash flow. Rob wants to leverage the properties they hold in an effort to buy more properties that can appreciate in value and generate more cash flow. Because they carry very low debt on the property, they will be able to withstand vacancy and avoid losing the building due to foreclosure in extreme market conditions.
If they were very conservative investors who anticipated a change in the market cycle, they would be more inclined to sell, suffer the heavy tax burden and convert their equity to cash in insured accounts, annuities or other liquid investment instruments. Cash flow might decrease, as in these days of low interest rates, yields on invested dollars have decreased accordingly.
This amounts to making the decision to “pay” for a higher level of safety. By selling, the tax consequence of the gain is done with and Rob and his dad would have free and clear ownership of the sale proceeds. For some, it’s okay to leave some money on the table, knowing that what they walk away with is truly theirs to keep.
You may be in a similar situation and find yourself becoming more willing to trade maximum returns for greater safety. You may also be invested in multiple properties, along with your investments in other asset classes like stocks, bonds and residential real estate. As such, an important aspect of successful wealth preservation is portfolio balance, both in terms of the real estate own and your other investments.
As far as your real estate is concerned, diversifying into other property types might be a good move. Let’s say you own an industrial building that is leased to a local business that doesn’t have the financial clout of a big corporation. You may be getting your rent on time now, but that income stream might be at significant risk in tougher economic times.
To preserve your equity, it may be wise to exchange your highly-appreciated asset into a rental income stream backed by stronger credit. In recent years, this strategy has become very popular with investors in the wealth preservation phase of their investment lives. The single-tenant net-lease (STNL) market has been booming during this economic recovery. These properties are leased are leased on a long-term basis (usually 15 to 20 years) by major corporations who use retail, office and industrial properties.
Returns are lower, but the integrity of future cash flows is at a much higher level.
So, if you exchange your industrial building leased at today’s market lease rates into one of these investments, your return may lower, but so will be your risk of losing equity due to a correction.
Some investors believe that even STNL deals are too risky because they focus on what the underlying property will be worth when the lease ends and the tenant decides to move on. This is a legitimate concern and should be taken into consideration. Given the popularity of these transactions, there are not enough of them to go around, and buyers are forced into small markets that bring another type of risk into the conversation.
There are many other examples we could give you as to how investors are managing their risks, and we would welcome the opportunity to share them with you. However, only you know what your tolerance for risk is, and it will be up to you how to manage it. We favor balance even if it means slightly lower returns, as we’ve seen what can happen to fortunes when markets head south.
We encourage all of our clients to be in a constant state of portfolio evaluation, and to always be ready to make a move when the situation calls for decisive action.
What should you do to preserve your wealth? There are many questions that need to be answered first. Among them: What do you need to pursue and maintain your lifestyle of choice? How are your assets allocated? Do your investments produce the cash flow you need to live that life style? Does the income from any single asset you own produce a disproportionate share of your total income.
Is income from your investments likely to keep up with rising operational costs? How liquid are your assets should you need to access your wealth in the event of an emergency or new opportunity? The list goes on, but you see the point. To safely navigate the wealth preservation phase of your life, these and other questions need answers that support your objectives.
Next week we will begin our discussion on wealth distribution, our plan for passing along that which we worked so hard to acquire. Interestingly, preparing for the inevitable can be the toughest challenge of our lives.
More from Our Wealth Cycle Series