The Hangover: Recovering From the Damaging Effects of the Real Estate Crisis

Comparing real estate to wealth management.

By Peter J. Haack, Jr., CFP, CIMA
The Chicago North Group, Morgan Stanley Smith Barney

The recent blockbuster movie The Hangover is a Las Vegas-set comedy centered around three groomsmen who lose their about-to-be-wed buddy during their drunken misadventures, then must retrace their steps in order to find him. In a similar manner, many in real estate today are trying to figure out what got them into the current real estate crisis and how to pick up the pieces. The goal is to emerge stronger and better prepared with new business models and strategies to succeed in this new environment.

Over 20 leaders representing centers of influence in Chicago real estate were interviewed during the second half of 2010. As a group, they covered just about every sector of real estate, in addition to industry advisors and consultants. Obviously, there are varying ideas from different sectors of the broader Chicago real estate industry, yet similar themes emerged as the conversations proceeded. My own experience was two-fold; first, as an owner/operator of apartment buildings in Chicago, and second, as a financial advisor and provider of wealth management services specifically addressing the needs of senior executives in real estate and construction. While I prepared this white paper, one thing that hits me over and over again is how similar the real estate world is to the world of wealth management and financial service. As a participant in both markets, I have a good perspective on the current state of our industries.

The changes to the investment industry have been significant since the stock market peak of 2007. Affluent investors have become risk-adverse and cautious about making any investment moves. Many marginal producers have been flushed out of the industry and the traditional transaction broker has become a dinosaur. Furthermore, profit margins and return on assets have declined, and investors demand more service and holistic wealth management strategies. The investment industry may never return to the old business model, yet those financial advisors that modify their business models and respond to this new environment have the potential to flourish at the expense of the ones who buried their heads in the sand.

One has to wonder if the real estate business will chart a similar path. The single family home, once a staple of initial entry into real estate investing and net worth enhancement continues to suffer from excess supply, increased foreclosure and declining value. The traditional source for financing of properties has drastically declined and that which is available has more stringent lending requirements. Unemployment levels remain stubbornly high in the 9 percent range, well above the 6 percent average for the past fifty years (Bureau of Labor Statistics, Jan. 1, 2011). A slow economic recovery with high unemployment will impact the absorption of all types of leasing space within commercial, office, industrial and retail properties.

Just as in the investment industry, many marginal players will be swept out of the industry. Yet, new opportunities will be presented for those willing to go beyond their comfort zone and chart a new path and business model.

One: Responding while others are waiting

David Tropp, senior vice president at CB Richard Ellis remarks that, “many people make promises or set expectations that are not realistic or accurate. Some make statements to win business, others when delivering service, but the promises were not true or achievable.” We see similar tactics in the wealth management industry, especially when serving real estate professionals, who are often heavily (and sometimes inappropriately) overcommitted to real estate in their personal investments.

Many financial advisors claim to be wealth managers, but actually lack the credentials and delivery. Studies completed by CEG Worldwide in 2007 indicate that, for affluent clients, “wealth management” means having their financial challenges solved and their financial situation enhanced. Although 46.3 percent of financial advisors describe themselves as wealth managers, only 6.6 percent actually meet the full definition of wealth management. Many, in fact, merely provide investment consulting.

Furthermore, the studies by Prince and Gerocioti show that affluent investors have specific key concerns including the following:

• Preserving wealth (including having enough money for retirement)
• Mitigating taxes
• Taking care of heirs (parents, children and grandchildren)
• Protecting wealth (from being sued)

Within my practice, I am “responding to client wealth management needs” while others may be waiting to figure out how to embrace the models of true wealth management.

Two: Formulating new strategies

Another area where our real estate analysis dovetails with the financial industry is around service and the “6 C’s.” For wealth management financial advisors, nothing is more basic, more fundamental, and more mission-critical than personal, high-touch service.

Top financial advisors believe in and implement a consultative process to uncover each client’s unique concerns and allow them to work towards formulating a comprehensive set of customized strategies. In fact, the 6 C’s (character, chemistry, caring, competent, cost effective and consultative) are at the heart of a successful relationship between financial advisor and client.

This consultative approach stands in stark contrast to the transactional approach, which is steadily losing favor with both clients and financial advisors. With the transactional approach, a financial advisor may make recommendations for specific products to address a specific question. But the client’s larger financial life is rarely, if ever, even discussed.

A true consultative approach requires a systematic process that you can implement and then replicate together. I utilize a five-step consulting process, with five scheduled meetings to evaluate all aspects of a client’s financial, business and family life. (See figure 1 for an overview of this process.)

Mind mapping was first developed in the 1960’s by Tony Buzan, an expert on the brain and learning, to help students take notes using only key words and images. Mind mapping allows us to capture information quickly, yet in a highly organized format that helps drill down to the client’s key issues faster and more accurately. It makes it easy to link and cross-reference the very different (yet connected) pieces of the client’s financial picture. On a side note, this mind mapping process can be very helpful to the real estate industry for enhancing client-service models (See figure 2).

Finally, and only after the initial discovery meeting is completed, I start to look at the whole wealth management process. To organize my thinking and approach to wealth management, I use a single all-encompassing formula:

Wealth Management = Investment Consulting + Advanced Planning +Relationship Management

Investment Consulting is the core investment offering for many wealth management financial advisors and the foundation upon which they begin to build the client relationship.

Advanced Planning addresses the range of financial needs beyond investment consulting . It consists of four areas: wealth enhancement, wealth utilization, wealth protection and wealth transfer (See figure 3).

Finally, Relationship Management involves three key tasks: 1) fully understanding a client’s critical needs to those needs over time through a consultative process; 2) assembling and managing a network of financial services; and 3) working effectively with the clients’ other professional advisors such as accountants and attorneys.

Three: Create new ideas and models

We saw how new approaches were essential for success in today’s economy in the real estate industry. The same thinking is important for wealth management. For example, to reflect our clients’ needs, a different methodology is used to underpin our asset allocation strategies. It is based on a series of “buckets” from which your lifetime financial needs are addressed and met:

Bucket #1: Your needs now (essentials)
Bucket #2: Your future lifestyle needs
Bucket #3: Your goals, dreams, and legacy

We then look at the purposes of the investments from each bucket:

Essential needs: Emergency and short term income, short term cash requirements, comfort level of liquid cash

Future lifestyle: Intermediate term cash requirements, retirement income funding, conservative growth

Goals, dreams, and legacy: Long term cash requirements, dream/legacy funding, longer term growth focus

Once I understand the client’s needs and goals, and the purpose of each investment, I can effectively match an investment strategy appropriate for the client’s circumstances. It’s a highly disciplined approach that combines experience and knowledge with the specific desires of each client.

This column is excerpted and adapted from the white paper, “The Hangover: Recovering from the Damaging Effects of the Real Estate Crisis.”

Peter J. Haack, Jr., CFP®, CIMA® is a first vice president, financial advisor in the Morgan Stanley Smith Barney Deerfield, Ill. office. In that role he serves as a financial advisor to high level executives in the construction and real estate industry to help them to achieve financial independence. He utilizes a customized five-step process that looks at all areas of their finances, business and family, using the resources of his wealth management team and other professionals. Peter brings together a rare combination of skills in the capital markets and wealth management combined with his knowledge and proficiency in real estate and construction. Peter is the leader of the Chicago North Group at Morgan Stanley Smith Barney, which is a wealth management team in the Deerfield, Ill. office. He has extensive experience as a financial advisor in the development, execution, and maintenance of investment strategies for endowments, foundations, wealthy families and fiduciary investors.