Family offices are wielding more and more wealth these days with current estimates for the size of the global market at about $10 trillion. Despite those vast resources, some see an investor pool saddled with inefficiencies that, in some cases, are weighing on performance and eroding the transfer of wealth to future generations.
One new effort that aims to bring more professionalism and resources to the family office sector is the Stanford University Global Family Office Initiative. The platform will offer educational programs on topics such as direct investing, co-investing and succession planning, as well as promote collaboration, networking and sharing of best practices. Its first virtual conference is being planned for late spring.
WMRE recently spoke with Ronald Diamond, the first named advisory board member of the Stanford Family Office Initiative, to hear about the mission of the new program as well as some of the latest views from family offices specific to real estate investing strategies. Diamond is founder and chairman of Diamond Wealth, an advisory firm that currently serves about 100 single family offices ranging in size between $250 million and $30 billion.
This Q&A has been edited for style, length and clarity.
WMRE: Why do you think a structured platform is needed for the family office industry?
Ronald Diamond: Right now, family offices are very inefficient, fragmented and siloed. They are sitting on about $10 trillion in capital. You have another $65 trillion that is going to be transferred from the baby boomers to the next generation over the next 10 years. So, this market is only going to get bigger.
Most of the people who are in the space have had a liquidity event where they have sold their company, but it is a different skillset to sell widgets than it is to take $1 billion, do some wealth transfer, not spoil the children, do some philanthropy and grow the asset base. The reason that I am creating this at Stanford is that it is my belief that just as private equity and venture capital disrupted the public markets in the 1980s, that family offices will disrupt private equity and venture capital going forward.
WMRE: The announcement for the Family Office Initiative mentioned co-investing with other family offices. Is there an interest in family offices co-investing on real estate investments specifically?
Ronald Diamond: Roughly 20 percent of family office portfolios is dedicated to real estate. It is the second highest behind private equity, which is about 23 percent, and it is probably going to increase because commitments to hedge funds are going down. Hedge fund allocations are at about 3 percent now and are continuing to decline, while real estate and private equity are going to continue to go up.
The family offices in real estate do want to invest with other family offices, and we’re going to provide the community to do that. The reason they want to co-invest is that a lot of the funds that are in real estate are making their money from AUM–assets under management. They’re incented differently than family offices.
The biggest advantage that family offices have over the private equity and venture capital firms is patient capital. That’s why real estate is such a great play for family offices. If a real estate deal is backed by a private equity or venture capital firm, they are incented to flip the investment every three to five years, because that’s how they’re compensated. Family offices are not compensated that way. So, if a deal is doing really well, they can hold the investment for 15, 20 or 30 years.
WMRE: You said family office allocations to real estate are expected to go up. What’s driving that increase?
Ronald Diamond: It’s been performing very well, and it will continue to perform very well. The two assets that have performed the best for family offices are private equity and real estate. Real estate has been a mainstay, and it will continue to grow.
WMRE: There are a lot of different ways to invest in real estate, including direct investment, funds and REIT stocks. Where are family offices focusing their capital?
Ronald Diamond: The biggest growth right now is in single-family rentals. It is the hottest asset class, and it will continue to be attractive for the next five to 10 years as far as real estate is concerned.
A lot of the family offices are doing direct investing. If they don’t have expertise in real estate, which many do and many don’t, they are going to have a partner that is an expert. What has happened is that many of the family offices over the last five to 10 years wanted to invest direct, but the rationale was they didn’t want to pay the (asset management) fee. That’s not a reason to invest in something.
Up until COVID, everything went up for every asset class, private equity, real estate, hedge funds. Now that we are in a bit of recession and don’t know how deep it’s going to go, those deals aren’t all going to work. Those families that invested in direct real estate deals are going to be way over their skis. They are going to need to partner. There’s a reason that real estate professionals are paid what they’re paid. At the end of the day, families that did invest directly will start either investing with people who fully understand real estate, or more likely with those family offices that are experts in real estate. Family offices do want to invest, network and partner with other family offices.
WMRE: Single-family rentals surprises me a little, because the top two property types we hear about from everyone these days are apartments and industrial. What is driving the interest in single-family rentals?
Ronald Diamond: Demographics number one. Two, it used to be that if you could afford to, of course you would buy a home. That was when you would buy a home and the value would always go up, until 2008 when we realized it didn’t. And now people are moving more. Millennials are expected to have an average of five different jobs by the time they are 30 years old, and they are going to be moving more and more. So, why not rent versus own? The Jaggi family office really pioneered this. They have been investing in single family rentals for 10 years. Now all of a sudden because of COVID and the demographics everyone is jumping into the space.
WMRE: Do you see any other trends from family offices related to real estate investment strategy?
Ronald Diamond: There will be tremendous opportunities for families who have patient capital to make money as a result of what has happened in the market from COVID with hotels in particular. We are social animals. When this ends, we’re probably going to travel even more. It might even be like the roaring ‘20s. There are going to be huge opportunities in hotels, as long as you are partnering with the right operator.
There has always been opportunity in multifamily and that will continue to grow. You can make money in it, but multifamily pricing is very high and a lot of it is expensive right now. Industrial has done really well and will continue to grow. Self-storage and student housing both have had their heyday and done very well, but that market is saturated right now.
The predictions that the office is dead are absolutely wrong and there are definitely investment opportunities, particularly in secondary markets where you see a lot of the population going. I do believe that we can work remotely, but we are social animals, and we need to be together. Somebody who is 50 years old can take Thursday and Friday and work remotely, but the 20- to 25-year-olds need culture and companies need culture. It is not going to be exactly where it was previously, but it is going to come back.
WMRE: Do you think family offices have realistic expectations on returns for real estate, especially with some of the recent changes we have seen due to the pandemic?
Ronald Diamond: No, because the whole model doesn’t work. Only 25 percent of family offices make it to the second generation, 10 percent make it to the third and 5 percent to the fourth. The whole model is flawed. What I’m trying to do at Stanford is create a way to have this model work. The reason is that the first thing people do when they have a liquidity event–they sell their company for $1 billion–they want to start investing. That is not the first thing you need to do. The first thing you need to do is talk to an estate planning attorney and structure everything. You need to build the foundation of the house.
You have all of these people with all of this money and have done extraordinarily well in various different fields, but now they don’t have customers or a board of directors. They have a pile of cash, and that is their business. The whole point of the Stanford Family Office Initiative is to professionalize, network, collaborate and invest in one another’s deals.
WMRE: Is there anything else that you would like to add about family offices?
Ronald Diamond: As I said previously, as private equity and venture capital disrupted the public markets, I do believe that family offices will disrupt the private equity and venture capital in the real estate market. Having said that, we’re only in the second inning of family offices. It’s going to grow exponentially. In order to professionalize it, we’re going to have to address things like how to compensate people. If a family office pays someone $500,000, many of them will look at that as a cost whereas the big firms will look at it from the perspective that they are paying $500,000 to someone who can make them $10 million.
As family offices start to become more professional and institutionalized in the way they incent these people and hire best-in-class, you’re going to see more and more family offices continue to grow and continue to disrupt these private equity firms. Family offices are going to be a huge force both in the for-profit real estate sector and a big force in the non-profit sector as well. I think family offices can solve a lot of the problems that society might not necessarily be able to do—as Michael Milken did supporting prostate cancer research and Bill Gates has done with the vaccine. So, I believe these offices are going to be able to do a lot of social good.