In our last several posts, we have been revisiting the 3 phases of the Wealth Cycle: Creation, Preservation & Distribution. First we earn our wealth, then we maintain it (and hopefully, enjoy it) and finally we pass along with what’s left of our wealth to others.
Today we continue with wealth preservation, that time in our lives when we strike a balance between spending what we have accumulated and dialing down our risk profile to keep enough dry powder on hand for retirement.
Read the Previous Posts in This Series:
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 degree of opportunity to pursue personal interests and help others. So, wealth is relative and unique to every person who pursues it. For our purposes here, we look at the accumulation of monetary wealth through savvy real estate investing.
Earlier in this series, 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 debt free up to 50% in an effort to buy more properties that can appreciate in value and generate more cash flow. He is firm in the belief that with debt level that low they will be able to withstand substantial vacancy and avoid losing the building due to foreclosure in extreme market conditions.
If they were very conservative investors who anticipated a near term 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 or other liquid investment instruments. Cash flow might decrease from current levels, but the risk of a substantial loss in equity in a correcting market would go away. This amounts to making the decision to “pay” for a higher level of safety. By selling, the tax consequence of the gain would be realized, painful as that would be, and Rob and his dad would have free and clear possession 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 you own and your other investments.
As far as your real estate is concerned, diversifying into other property types might also 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 and your cash flow, 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, in large part due to “Boomers” transitioning into or prepping for retirement. These properties are leased on a long-term basis (usually 15 to 20 years) by major corporations who use retail, office or industrial properties. Returns are lower, but the integrity of future cash flows is much higher. 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 your risk of losing rental income from vacancy.
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 credit 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 smaller or less familiar 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 just in case 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.
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