If family offices were graded on one of the pillars of investing in commercial real estate—due diligence—they might be disappointed with the report card.
While family offices grasp the value of commercial real estate as an investment and continue to include such properties in their portfolios, they’re not always undertaking thorough due diligence, The Family Office Real Estate Magazine says in a report based on findings from its recent survey of family offices.
The survey of 102 family offices in the U.S. found that 79 percent of them conduct due diligence internally vs. outsourcing it (9 percent). Twelve percent reported relying on trusted advisers for due diligence.
For family offices that didn’t create wealth through commercial real estate, most don’t rely on in-house specialists or platforms to conduct due diligence for real estate deals, according to the report.
The survey shows 56 percent of family offices turn to research resources or software for due diligence, but the remaining 44 percent don’t incorporate those tools. Among family offices that do lean on software and research tools, CoStar was cited most often, followed by LoopNet, Reonomy and Reis.
When it comes to family offices that engage in tech-rooted due diligence, one-third also consult real estate brokers, the survey says. However, according to the report, that input from typically “optimistic” brokers might be skewed in favor of the deal rather than the investor.
Family-office professional DJ Van Keuren, publisher of The Family Office Real Estate Magazine, says family offices aren’t neglecting due diligence altogether. Rather, many of them drew their wealth from industries other than commercial real estate and, therefore, lack full understanding of the depth of due diligence required for property investments. Unfortunately, that knowledge gap can lead to sizeable financial losses, according to Van Keuren.
Among the questions that Van Keuren recommends family offices ask during due diligence for direct real estate investments include:
- What is the sponsor’s track record?
- How long has the sponsor been in business? How long have members of the investment team been working together? Have they ever had to weather an economic downturn?
- How much of its own money is the sponsor investing in the deal?
- What are some examples of deals that went south? How did you handle those situations?
- What is the market demand for this type of property? How many similar projects are in the local development pipeline?
- Has the sponsor run the numbers based on best-case and worst-case scenarios, such as fluctuations in occupancy rates and projections regarding cap rates?
- Do you like and trust the people associated with the sponsor?
Wil Ward, partner and managing director of direct investments at TwinFocus Capital Partners LLC, a multi-family office based in Boston, says a number of advisory firms can help family offices carry out due diligence. But at the bare minimum, he says, a family office should develop separate due diligence checklists for sponsors, individual investments and real estate markets.
“These checklists are the first step, and due diligence should not stop there,” Ward says.
Aside from being short of staff and expertise to perform proper due diligence, family offices “tend to be overly trusting and perhaps more naïve than institutional investors. Oftentimes, investing in real estate requires a shift in mindset—it’s not like investing in a fund,” says Kenneth Munkacy, senior managing director of Boston-based Kingbird Investment Management LLC, the newly-rebranded real estate arm of Puerto Rican family office Grupo Ferré Rangel.
Additionally, Munkacy says, family offices often don’t take a big picture view of their real estate portfolios, such as whether their objectives are guided by tax benefits or asset appreciation.
For those reasons, it’s important for family offices—at least those with little experience in real estate or without full-time staff or trusted outside advisers—to gather perspectives from accountants, tax attorneys, wealth managers, financial planners and other experts, Munkacy says.
Due diligence for family offices has grown in complexity as they’ve jumped into more direct deals (in place of REITs or investment funds, for instance), concentrated more on due diligence-driven opportunistic and value-add development deals, and gravitated toward higher risk investments in secondary and tertiary markets, says John Pantekidis, managing partner, chief investment officer and general counsel with TwinFocus.
The robust economy might have lulled some family offices into a false sense of security, he notes, meaning inadequate due diligence might go unnoticed until the real estate cycle takes a turn for the worse.
“This is where inadequate due diligence becomes obvious and family office practices will either catch up with their investments or their investment approach to real estate will change once again,” Pantekidis says.
Real estate investments spurred by the Opportunity Zone program can also cause a lapse in due diligence, as some family offices zero in on a deal’s tax advantages at the expense of overlooking the underlying fundamentals, Pantekidis says. The Family Office Real Estate Magazine survey indicates 18 percent of family offices plan to invest in Opportunity Zone funds.
Whatever type of real estate investment a family office is pursuing, Munkacy says, “you need to do the homework and dig deep to understand the risks and returns.”