Syndicating Private Real Estate Opportunities

Author: Michael Kitces

Team Kitces

Michael Kitces is Head of Planning Strategy at Buckingham Strategic Wealth, a turnkey wealth management services provider supporting thousands of independent financial advisors.

In addition, he is a co-founder of the XY Planning Network, AdvicePay, fpPathfinder, and New Planner Recruiting, the former Practitioner Editor of the Journal of Financial Planning, the host of the Financial Advisor Success podcast, and the publisher of the popular financial planning industry blog Nerd’s Eye View through his website Kitces.com, dedicated to advancing knowledge in financial planning. In 2010, Michael was recognized with one of the FPA’s “Heart of Financial Planning” awards for his dedication and work in advancing the profession.

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Full Transcript:

Michael: Welcome, Matthew Topley, to the Financial Advisor Success podcast.

Matthew: Oh, thanks, Mike. My pleasure. Thank you so much for having me on. It’s a real honor to be on. I’ve been listening to the podcast for a number of years.

Michael: Awesome. Awesome. I appreciate that. And I’m really glad that you’re on the podcast, here to join us today. And I think, like, talking about what, to me, has long been in a really interesting theme, which is, like, how we start incorporating more real estate into client portfolios. You know, it’s, to me, just one of the strange effects of the financial advisor world, I think very much comes from our roots of mostly kind of being in the stock brokering/brokerage business. You know, if you work for a brokerage firm, you sell brokerage products. Like, that’s just kind of how it works. So, we sold stocks for a long time, and then we sold mutual funds. And, you know, now we may sell managed accounts, ETFs, and other stuff. And maybe certain broker dealers do a small subset of, like, you know, private limited partnership deals that come through. We had some non-traded REITs for a while. But most of what we do are essentially the things that get bought and sold on brokerage platforms, you know, stocks, and bonds, and the like.

And we basically don’t live in the real estate world short of publicly traded REITs and maybe, like, a limited partnership thing that got packaged into a brokerage firm for a non-traded REIT structure. And obviously, if you look at, you know, overall wealth in the U.S., just overall dollars that are allocated, real estate is a trillions of dollars segments of the market that most of us as advisors just really don’t participate in. Like, we’re not built for it. We can’t hold it on our platforms. I can’t trade it in Orion. Like, it’s not built for our current systems. And so we tend not to go there. And it’s always, I think, like, an interesting challenge with a lot of us advisors. Like, you know, if you talk to a client who’s fairly affluent, and you ask, well, how they invest their dollars today, and they say, “Well, I own a bunch of, you know, apartment homes and condos that I rent.” It’s just basically, like, a…as an advisor, that’s usually a moment of, “Well, not a prospect for me. Because you’re in real estate, and if you’re in real estate, you usually don’t get out of real estate, and I don’t have any real estate to sell you, and you’re probably not buying my portfolio. So we’re just going to part ways here.”

And I know that you have spent a lot of time in your career and now in an advisory business that you’ve been building, living very directly in this realm of putting together, essentially private real estate deals for clients. And so, like, I truly have spent almost no time living in that world at all in my career. And so just I’m genuinely excited to learn about, like, how do you do direct real estate investing, putting together deals for clients? Like, how does that work?

How Matthew Began Investing In Private Real Estate [05:43]

Matthew: Yeah. Well, I can tell you, I arrived at doing real estate deals with clients like I arrived at a lot of other things in my career and my life, through failure. I was trying to do real estate on my own.

Michael: Fantastic.

Matthew: You’re referring to successful real estate investors when you approach them as advisor, usually aren’t interested. And my experience is the same as yours. And especially, they don’t like the stock market because there’s a lack of control.

Michael: And just, you know, it’s a bunch of ones and zeros. Like, I can go touch my real estate. I can look at it. I know exactly where it is. It kind of reminds me of, like, you know, “The Beverly Hillbillies” when Jed Clampett would go to the bank. He’s like, “Mr. Drysdale, I’d like to see my money.”

Matthew: Yeah, exactly.

Michael: Just kind of want to see it. Like, you can do that with real estate. It’s really cool. Like, I own that, it’s the building over there. People rent it.

Matthew: Exactly. So, when I was in my former career in finance as a trader, I was doing real estate on the side for myself, which was a tremendous experience, but I wasn’t very good at it. And I wasn’t very good landlord, and amongst a laundry list…

Michael: So, what were you doing? Like, just when you say, like, I was doing real estate myself on the side, like, just what kind of stuff were you… I mean, there’s the, like, people who buy homes and flip them, there are the people trying to leverage up big apartment buildings. There are folks that rent multifamily homes. I live in one unit and rent out the other three. Like, what was your real estate experience that you started out with?

Matthew: Yeah, a little of all the above. So, I did some flips, rehabbing homes in Philadelphia in the suburbs and flipping them. The biggest multi-units were a five unit and an eight unit. So mostly duplexes, townhomes, and rehabs and flips. The most properties I ever had at once, I think, was 10. And when I was doing that…

Michael: That’s awesome. That’s nine more than the one I live in. So that feels like a lot, but okay, so getting a sense of it, okay.

Matthew: But at the time, I was getting frustrated with it and met someone who introduced me to the world of investing passively in private real estate, much different than investing in a REIT, or anything like that. It was deal by deal basis, investing in individual private real estate deals. And the explanation was, this isn’t how wealthy people invest in real estate the way that you’re doing it, Matt. They invest in real estate with groups, like the group I use, Capital Solutions, who are equity providers for commercial real estate, and syndicate the money through investors to raise for apartments, senior living, college dorms, or student housing, I should say. So, way back in 2009, I started investing that way personally, before I came to the family wealth world. I started investing personally, through Capital Solutions, in individual real estate deals. They were nice enough…Frank Seidman, the Founder, was nice enough to let me in under the limit bar, just to try it out and invest in some deals. And I brought them in and introduced them to some of my partners when I was a trader in a mutual fund company called Turner Investment Partners. And that was my introduction to investing passively in real estate.

And I quickly discovered that it was a way better emotional and more financially lucrative, and less time spent by me, and much more emotionally healthy, to invest passively in the deals than to manage my properties myself. So, I gradually started to invest more personally in passive deals and started to pare back my real estate that I owned personally. So yeah, that was my introduction to the world.

Michael: So, lots of questions here. First, you had, I guess, a technical piece there that you mentioned. Like, they cut you a break that you got to invest under the limit. So, what does that mean?

Matthew: So traditionally, if you go invest with private real estate syndicators, a lot of them have a 250,000 minimum per deal limit. Not all of them, for sure, but a lot of them. And most others will only go down to $100,000 per deal, per family, per person, whatever it is.

Michael: Okay. Is this from their end, like, I want to raise enough money for a $10 million property. If I’m doing this 250K at a time, I can get this done with 40 people. If I’m going to take smaller checks, all of a sudden, I got to find hundreds of people. And that just gets burdensome when you’re trying to be a real estate investor. So, you tend to try to get fewer checks by having higher minimums?

Matthew: Correct, exactly. And keep in mind, and I’ll just use my deals with Capital Solutions as examples, right? We’re playing in this sweet spot of $2 million to $10 million raises, where $2 million is a little bit too much for mom-and-pop high-net-worth investors that are doing it themselves. Under $10 million is a little too small for institutional. So, there’s this sweet spot in between the millions of people that are doing it mom and pop on their own, or the hundreds of thousands of people, and the big institutional money. There’s this $2 million to $10 million raise sweet spot where we primarily play in.

Michael: So now I’m seeing that, that’s why you’re saying it’s things like senior living residences, a big old college dorm, a midsized apartment building. Like, these are the kinds of things you can buy and build at $2 million to $10 million.

Matthew: Correct. And right now, we’re primarily doing multifamily apartments and senior living. We have not done a student housing deal in a number of years because I’m personally a huge believer, when we get into the investing part of the conversation, that demographics are destiny and demographics are a massive part of all investing, but especially real estate.

Michael: Oh, yeah. The most fundamental driver of what has supply, and more importantly, what’s going to have demand. So, yeah, I get it. Like, I can connect the dots on why senior living might be appealing, something about, like, baby boomers getting a little older. Uh-huh.

Matthew: So, very good point. And that’s where I was going with it. We haven’t done a student housing deal on a number of years, because you see in the dip that’s going on in the college student demographics. And in the meantime, we’re only in the probably fourth inning of the senior living demographics, which you got it, is baby boomers. But not only that, it’s just longevity period. A lot of what we see going on in the present real estate environment was, the market was not ready for the increased longevity that’s happening in the United States, right? I mean, if you look at… You know, in our real estate deck, one of our favorite charts we show people is this Americans and centenarians, the hockey stick spike that is coming in the number of people living to 100. It just explodes like a hockey stick in 2035. I mean, it goes from, you know, 175,000 people a year living to past 100, to 600,000, 700,000, 800,000, to millions eventually. And that’s not even counting all the health care that’s coming that could increase that even more so.

Michael: Okay. So, I kind of get the structure overall, and we’ll get more into just passive structures and how they work. But firstly, take me back a little bit more to the direct real estate investing that you were doing. Or it’s just duplexes and townhomes, got up to 10 properties at one point. So, tell me more about what that looks like. Because you had mentioned your background, and I guess some of the investable dollars you had came from being a trader, and doing trading for a fund. So, if that’s your full-time job, what was direct real estate investing for you? I mean, are you, like, “I trade stocks by day, and I fix up real estate units by nights?” Was that the life you were living?

Matthew: Pretty much. And I was going to graduate school at night too. So, I wouldn’t recommend this for anyone in your audience. I don’t know, I’ve always had an entrepreneurial streak that’s fully playing out now. And I’ve always had businesses going on the side or real estate going on the side. So that’s how that started. I could tell you landlord stories that you would not believe.

So, my wife has helped me, so if we called her on speakerphone now, she would tell you it’s the worst business in the world. So, it’s not easy to do on your own. Some people are great at it, much smarter than me at it, make a fortune at it. But it’s not an easy business. But in saying that, it is the last legal tax shelter left in the U.S. I know I’m probably not using the right language, tax shelter, but it is an extremely tax efficient investment vehicle, especially for building a passive tax efficient income, getting back to the demographics and people living to 100. I mean, a lot of the beginning of my presentation on real estate, I steal one of your partners at Buckingham, Larry Swedroe, the five modern realities, like, high equity valuations, low bond yields, high private equity, and venture valuations, connected to… And at the same time, we have increased longevity and increased healthcare inflation. So how are you going to create this passive tax efficient income? And the best way to do that, in my mind, is through real estate.

Michael: So, what did the economics look like on these? I mean, as you’re doing your direct deals of the duplexes, and townhomes, and the rest, what do the economics look like?

Matthew: So, most of those homes, I would have an equation out of a real estate book, and you would put 20%, 25% down, and then you would figure out what your cash flow is, what your yield is on the property. And inevitably, when you’re doing small projects, you underestimate vacancies and upkeep. So, you’ll underestimate your cost on the maintenance side, and you’ll underestimate your vacancies, and you’ll underestimate the time it takes to deal with tenants. So, your real estate books are great, but there’s a lot of gray area that does not come out exact.

Michael: So, I don’t know if you remember your numbers at all, but just, like, how did it flow for you? I mean, was it a, I invested hoping to get an 8% yield, but by the time the vacancies came through, I was only making 6[%]? Is it that sort of dynamic or how did it show up for you?

Matthew: Yeah, so I think there’s two types of investments, just like there’s two types of businesses. There’s cash flow businesses, cash flow real estate, and then there’s equity, and equity businesses and equity real estate. Meaning, sometimes, in a faster growing part of Philadelphia suburbs of Philadelphia, you will be buying something betting on the equity play. Your cash flow would not be great, maybe you’re just covering your cost to carry, but you feel great that the area’s going to take off, and you’re going to make your money on the back end in equity.

So that was more than half of my properties. And then the other half, the yields would be more like 5%, 6% instead of betting on double digits, because of the reasons I gave. And at the end of the day, you make your money when the cycle is good, and you have the increase in valuations. That’s really where you make your money. And most of the people I know have done well privately investing in real estate as opposed to the cash flows.

Michael: So, from your end, when you were doing it directly, it was less about, I’m going to buy these things to make my cash-on-cash yield. Well, I guess I don’t know the time period that you’re buying it, but why would I buy bonds at four, when I could do this real estate at six and get a little more yield? For you it’s much more of the, I get my yield, my yield pays my maintenance costs, and covers my vacancy, and handles my upkeep, and covers my mortgage, and hopefully it’s at least cash flow sustaining. Because at the end, in a couple of years, I get to sell this thing for up 20, up 30, up 50, up 100, depending on how much real estate moves in whatever neighborhood it is. And that’s the big payoff moment when you get the exit at a much higher price.

Matthew: Yes. So, a couple of answers to that. I was doing it because my entire career depended on the stock market, right? I’ve never owned a bond in my life. I was a trader at a mutual fund company. So, my career was depending on the stock market. All my personal investments were going into the stock market. So, I did it as a diversifier, and as if anything ever went wrong in my career or anything, could I create a passive income to live off the properties? And secondly, I guess retirement, right? Creating that passive income. And then I would say, there’s all these tax advantages to real estate, one of which you know, is 1031 exchanges. And we did 1031 exchange. I don’t want to act like some of these properties didn’t do really well, they did.

We 1031-exchanged one of our properties into a beach house. So that went extremely well. And we sold some other properties and put it towards the beach house and paying for the beach house, like, in an account to pay the costs on the beach house. So, when the cycle went well at a group of other properties we owned in the city. So, there’s a lot of reasons that we did it, but primarily, in my case when I first got into it, it was to diversify away from my career and all my other investments, A, and then create a retirement passive income. And it was something that you could create on the side as opposed to an operating business or something. That’s really hard to do on the side, right? You can’t really do that on the side.

Michael: But it sounds like you did have some time obligations on the side if you were literally managing the properties yourself, or were you in the world of hiring property managers and subbing out to people who would do a lot of that work?

Matthew: I did not get into hiring property managers till much later in the game. I only own…I have another one for sale now, only own two properties as of a month or so from now. And a property manager runs those two properties.

Michael: So, when you were doing this early on, and you’re 5 to 10 properties in, how much time were you spending just, I guess, being a landlord and all the things from maintenance, to upkeep, to tenant issues, to filling vacancies, and the rest of what it takes to manage real estate?

Matthew: Yeah, I don’t want to say it was more than 10 hours a week, it wasn’t. And on the trading desk, I was locked in during the day. I don’t even remember having a cell phone on back then. It was like 7:00 in the morning till 4:35, we were on lockdown in the investment center, like, portfolio managers, analysts, traders. So, it’s not like I was answering real estate calls in the trading desk. That wasn’t happening. So, I had partners and I had…my wife was helping, and all these other things. So, I wouldn’t say more than 10 hours.

Michael: So ultimately, you kind of frame this as, this didn’t go well. So, what didn’t go well? I mean, did you have some properties that went bust? Did you have a disaster event? What made it not go well, if this did ultimately turn into a beach house at least?

Matthew: And there’s going to be some properties that ended up sold, one that’ll be a paid off and everything, that will go well too. So, I don’t want to overplay that it was terrible. And I’ve heard this on your podcast many times from other advisors. It took me later in life to fully understand this, but I needed to focus 100% on one thing, and not two, three, four, five different things, right? So right now, my firm, from the day I started two years ago, I do nothing on the side. I don’t touch my personal portfolio. I don’t trade any of my own money, because I don’t want to be distracted from the clients and growing the business in any way shape or form. So, it became not a big enough side business to make… It was distracting me from what I should concentrate on, which was being the best advisor I can humanly be, being the best investment person, I can humanly be. It became a distraction.

And when you have tenants, you invite these people in their lives, if you’re running the property. So, you have new crazy uncles, and new crazy aunts, and new crazy friends, because they’re in your life. You know, unfortunately, if they have a lot of personal issues or addictions or anything else… You got it…

Michael: Now their personal issues are your personal issues.

Matthew: Correct. That’s exactly right. And again, we don’t have enough time for me to tell landlord stories, but every landlord out there could tell you stories that you wouldn’t believe.

Offering Private Real Estate Syndication Deals As A Differentiator For High-Net-Worth Clients [22:27]

Michael: So now, help me understand how is the investing dynamics different as you’re doing this in this private real estate syndicated deals structure?

Matthew: Yeah, massively different. So, we do deal by deal basis real estate structure, it’s called series structure LLC. It’s the similar way to the way the sub-advisor has it set up for his direct investors. We’re just a sleeve of his investors. Right? So, series structure LLC is, there is subscription agreements to join. You have to be accredited or a qualified investor, depending on whose agreement you’re using.

Michael: Okay. So, there is a significant financial wherewithal, because just at the end of the day, right, literally from an investment business end, when you bring together a group of people to invest in a business like this, you are literally selling a security, an unregistered security, or… Which means, that’s when the SEC has requirements about who’s allowed to invest into this thing.

Matthew: Correct. So, there is significant legal costs, there is significant compliance costs, no question about it, due to SEC rules, and state rules, and everything else.

Michael: Okay. So, I guess I’m just wondering what the economics of these deals look like for you as an investor? I mean, just literally, like, for you. You said you started with Capital Solutions Group, they let you do one under the standard deal limit, to let you get involved and see what it’s like. So, what was it like? What returns were you seeing, or how did cash flow… Was it still an equity style deal as you’d framed sort of cash flow deals versus equity? So just, how did the economics work once you were in this private real estate investing world as you were literally doing it yourself initially?

Matthew: Sure. So, the first thing I would say is, getting back to series structure LLC. The way the deals come out after you join through subscription agreement, there’s no blind pool fund, there’s no committed capital. They come out deal by deal basis, and you get to elect to be in or out of the deal. So, you get a 2-page summary of a deal, and you get a 200-page full PPM like any other private investment. Our PPMs are extremely detailed, and very professionally done by our sub-advisor. So, you get a 2-page summary, 200-page PPM, then you get to elect to be in or out of that deal. Now, to your point, I can’t advertise or anything performance, but prior to me syndicating deals, my returns were high teen IRRs, net of fees.

Michael: Yeah, and again, this is not a solicitation for investments, a promise of returns, or earnings you can get with any particular person. Again, just introduce appropriate compliance disclaimers. Again, I’m just trying to understand just real-world experience of what happened for you as you started doing this, particularly since you were contrasting it with what it was like when you were doing it. One tenant at a time. I was going to say, hand to hand with your tenants. I know that’s dangerous, hopefully. So, this, like, getting deals where at the end, you’d set a high teens IRR, so internal rate of return over the whole time period. So, I’m presuming then that that is some combination of, I got a cash yield as I went, we did a sale at the end, and then got some appreciation off the sale at the end. And so, then I can do the math of the whole thing. My cash flow as I went, my sale value at the end, over a time period, to calculate an internal rate of return. So, I guess I’m wondering, like, how much of this was the equity side of deals versus the cash flow side of deals? And how long do they take to play out for you?

Matthew: Yep. So, good question. So, about half our deals traditionally are cash flow deals, or what we call value add deals, where you’re taking over apartment buildings that are already 95% occupied. You’re upgrading all the units, you’re raising all the rents. Those deals tend to cash flow pretty early. In the first 6, to 9, to 12 months of taking over the building, you start getting quarterly cash on cash returns, I.e., dividend yields or distributions in real estate’s case. This gets back to why it’s such a tax efficient investment. The way real estate works, as you know, you’ll be getting that cash on cash and showing losses on your K1. Keep in mind, every one of these deals is going to kick off a K1, which adds another layer of complexity, right? So, half the deals are cash on cash deals, with the goal of upgrading all the units, raising all the rents, and either refi’ing the building or exiting the building altogether, selling it.

The second type of deal is new construction, which we’re doing a lot of in the last 18 months coming out of COVID. New construction, as you would guess, takes 18 months to 24 months just to build and start to lease up. So, you’re seeing no cash flow for the first 18 to 24 months at least, if not longer, in some cases like senior living. So new construction, no cash flow for the first couple years. At the end of getting it to a certain lease level after the construction is done and everything, then a decision is made whether to refinance right away or exit right away. We have flipped a number of new construction projects. If not, that will also start kicking off cash flow, right, if the building’s 80%, 90%, 100% leased. And then we’ll make a decision on…or the sub-advisor will make a decision on whether to refinance the property, exit the property at the proper time.

I will tell you, on top of a huge differentiator on our end, there’s a couple of huge differentiators that fit into your question. One is, we are geographically located all over the country. So, we have deals all over the country, huge geographic diversity. As you would guess, we’re especially in fast growing demographic areas now. The second big differentiator is, we do a lot of deals, like, 10 deals, 12 deals per year. So, you can get a lot of diversity by spreading your money out into 10-plus deals rather than investing with a local developer in 1 or 2 deals. The next big differentiator is, it’s not buy and hold real estate, call it a race to get your principal back. So, in three to five years, the goal is always to refinance the property or exit the property. We call it a race to get the investors principal back. So, deal by deal basis is a big differentiator, geographic diversity is a big differentiator, number of deals, which is a lot, is a big differentiator. And then it’s not buy and hold real estate, three to five years looking to refi or exit.

Why is that so important on the tax side, if you can picture this, Michael. If you’re in 10 deals, Michael is in 10 deals. He has $50,000 in every deal. You have cash flow coming out of five of them, three of them are under construction. The fourth one’s close, maybe halfway leased, and the first one you invested in, there’s an exit. So, you have a sale, you end up getting an 18 IRR over the course of three or four years. So, you almost double your money, if my math is correct. You exit, you get an event, you have $50,000 in, let’s say you get almost $100,000 back. There has been no income tax paid, in most cases, not all cases, on any of your cash flow, because you’re offsetting it with depreciation, and construction costs, and all these other things. So, it’s long-term capital gains when you exit that deal. Most of the gains are long-term capital gains. Actually, all the gains in most cases are long-term capital gains. But you have nine other deals going that are kicking off losses that offset that gain. Does that make sense?

Michael: Yes, yes. Because you’re getting enough depreciation flowing through from all the rest of the deals, particularly since you’ve specifically put some dollars into build style deals. So, they have huge negative losses in the first few years, because you’re doing the build, and you’ve got all the construction cost and the rest. So, you’re kicking off enough losses from those to net against the sale that has the gain. And then I’m presuming, and then you come back and say, “That went so well. Would you like to double down? Would you like to take your 100K and put it into the next deal?” And now you end out with a continuous rolling series of deals after you’ve been doing this for a while.

Matthew: Absolutely. Couldn’t have said it better myself. And that is what virtually 80%, 90% of my clients roll every piece of cash flow, and every refinance, and every exit into more deals. Because they’re all in an age range where they’re still working. Not all of them, but most of them, they’re all creating this future passive tax efficient income from building up their real estate portfolios as a portion of their overall investment portfolio. But that’s exactly right, what you just said.

Michael: Okay. So, I kind of get the flow and the gist now, and I guess just thinking mechanically down to the real estate level, just these kinds of IRR opportunities. It sounds like you’re essentially in a world of, like, look, I may be getting some high single digit cash flow yield from cash flow flowing properties. I’m doing a bunch of either building or upgrading of properties, which is going to boost the value of the property. I probably have a little bit of leverage on this as well, which, we take a moderate return and make it a bit bigger with leverage, because my return on assets is one thing, but my return on equity is higher because I debt financed this. And so, you package all that together, and I get some yield from the cash flow, I get some return from the appreciation, I get some juice as it were from the leverage. And now, all of a sudden, I can get into the teens on an IRR pretty quickly.

Matthew: Yeah, absolutely. And let’s just take that, park that in your mind, and then think about like Vanguard, or Blackrock, or anybody’s capital asset pricing models on projected returns the next 10 years. And that was prior to this correction, no doubt. But if you look at the fixed income side of the equation… Now, it’s gotten better since bonds have had such a correction. But prior to this recent correction, Vanguard, or Blackrock, or any of the big firms’ capital asset pricing models, projected 10-year returns. I mean, the ag, they were talking 1 ½% to 2 ½%. So, you’re losing money versus inflation. So, for families that can afford a portion of their portfolio to be illiquid, right, because that’s the trade, the illiquidity is the trade or is the tradeoff. If we were doing half the IRRs that we’ve been doing, it’s still going to look really, really good versus bonds. And if you look at projected equity returns the next 10 years, as we revert to the mean, after having this massive 10-year run in the S&P of 14.5% compound returns. Real estate looks like a very viable option. Now, as you know better than anyone, being the planning guru for all advisors, that it’s all about risk versus return.

Michael: I was going to say, so my brain’s just risking this thing up now, I have learned, like, IRR is in the teens come with a wee bit of risk. I mean, you’re doing this. And you’ve lived trading desks. So, I’m sure you’ve lived not only your fair share of risk, but you can’t live on a trading desk very long without really learning the mantra of protect your capital and protect your capital, or you don’t get to keep playing the game. So, how do you look at and think about the risk in this? So, I guess, like, first of all, just where is my risk at the end of the day? How does this go sideways on me? And then how do you think about it as someone who’s lived trading desk level of risk?

Matthew: Yeah, so I’ll start at the high level and get granular on our particular deal. So, if you look at a 20-year risk return chart and standard deviation on the bottom annualized return, going up the side, you’ll find private real estate in most cases is slightly higher standard deviation than bonds, with a much higher return. And it’s more tax efficient, which doesn’t show up on the chart, but it’s very true. And then if you look at publicly held REITs versus private real estate, the correlation chart, you’ll find that publicly held REITs right now, today, have 80% correlation to the S&P. I think over the long-term, it’s like maybe 60, 70. But it’s at right now, in the last 12 to 24 months. If you look at private real estate, it has a negative 0.20 correlation to public markets. So, diversifier, the historical textbook standard deviation, annualized returns works.

Now let’s get into picking the right sub-advisor is the only way this works because, like anything, real estate can get really speculative. Right? You can make an argument that my investors missed the warehouse boom, right, that has happened, especially exploded during COVID. So, we don’t do speculative real estate really. We don’t do rural land. We don’t do any industrial. I think we did one industrial deal. We don’t do any warehouse. And I know people have made a lot of money doing this, but none of our real estate is really speculative, let me start with that. And then secondly, our sub-advisor Capital Solutions is, number one, is protection of principal. Protection of principal, protection of principal, protection of principal, reasonable rate of return, second, growth is third. So, you’d have to refer to them and reach out for their long-term historical returns, but they do not have a history of losing any principal through 25-year track record.

Michael: I was just going to say, overall, this to me is starting to very much feel in the realm of, by just its core, if you’re doing this privately, and ultimately, you’re routing dollars to a real estate investment firm… You’ve been doing this with Capital Solutions. That this just really quickly comes down to, like… Or have you found someone who’s any good at actually managing real estate, right? Just, like, they do or do not do it well. And it seems like in essence, that means you’re going to have a really significant burden on yourself, either as an investor or particularly as an advisor doing this for your clients, of basically the vetting and due diligence of the firm that’s going to manage the deals for you.

Matthew: One hundred percent. That is exactly where I was going with that. And I know now, because of those cap asset pricing models, I know a lot of people have chased real estate, not through advisors so much. But I can’t speak in an educated manner on some of these firms that are really heavily advertised on social media, and where you can invest in private real estate deals through some kind of fund structure, very, very small amounts. I would be leery of them. I don’t know the returns or anything. But in my 20-year history now of private real estate, you really have to get the right sub-advisor. And we do use a couple other sub-advisors outside of Capital Solutions, but the large majority of our deals are Capital Solutions.

Michael: And it’s like, how did you find, or vet, or choose them? How did you get to, these are the guys we’re willing to we’ll hook our wagon to?

Matthew: Well, I had a great testing stage, because when I got introduced to them, right, I was not in the private wealth world, I was not in the family wealth world. So, I personally, with my own money, started investing with them. And then I introduced them to partners in my old firm who started investing with them. So, before I got into the private wealth world, I had six, seven years of experience investing with them. And then in that timeframe, where I personally was investing with them, I got to know them really, really well. I got to know the process really, really well. And then I got to know a lot of other people who had had success investing with them and their history and… Philadelphia, we can get into it, but I mean, it’s very small town for a big city, to say the least. It was probably the most parochial city in the country. Everybody kind of knows each other and stays here. So, it’s a very small-town feel.

How Lansing Street Structures Their Private Real Estate Syndication Deals [38:43]

Michael: Okay. So now help us understand further how this works with clients. My understanding is, yeah, this started with, you did it personally. But then ultimately, you’ve been building an advisory firm, and this is part of the offering for clients. So, literally, how does this come together to do this with clients?

Matthew: Yep. So, very good question. When I got into the private wealth world, there was heavy alternative use from super high-net-worth clients. So, even over [$]10 million, but especially over [$]20, [$]30 million, coming out of ’08. I entered the private family wealth world in 2014, after 17, 18 years in the institutional world, and there is heavy investments from those families in alts. When I say alts, it’s traditional private equity, venture, hedge funds, private lending, all those things. My due diligence when I decided to make the move out of trading to the private wealth world was, I was inside the sausage factory on Wall Street. The trading desk I was on, greatest experience in the world, generated $100 million in commissions a year. We were like top 50 commission generators for a lot of big U.S. equity trading desks on Wall Street. So, we were the buy side Wall Street to sell side, we were the client. We were generating $100 million in commissions.

My thought process when I entered the family wealth world is, these families are paying a lot of money in fees for these alts, and they’re not getting the returns that were promised. And most importantly, and you know this better than anyone for the planning side, all of our bills in the high-net-worth world, but especially the super high-net-worth world, the biggest bill is your tax bill. And all these alternative investments were super tax inefficient. So, when I did my due diligence, I’m like, “Wait a minute, these family offices have these families on these products that are high fee, poor tax efficiency, so net of fees, net of taxes, not getting what was promised, and not having a lot of success.” There’s a lot of good PE firms out there, a lot of good venture firms, a lot of good hedge funds. But in my experience with the families that I was getting introduced to, they were not having a lot of success in alts at all.

Now, keep in mind, we were also going through the biggest long only 60, 40 S&P 500 run ever. We were at the beginning of one of the biggest runs ever. That’s true, too. But I just could not, side by side, knowing how my sub-advisor executed deals on an after fee, after tax, and risk adjusted basis, and I still do it to this day, comparing it to other alternatives. I could not come up with a reason to not choose real estate over those other alternatives. And I’m well aware that real estate goes through cycles like anything else, that the IRRs of the last 10 years will not be the IRRs of the next 10 years. I don’t want to sell this as some kind of no risk home run. But when I side by side, because we know in our business, all returns are relative, when I side by side versus all the other alts out there, after fee, after tax, risk adjusted. I’ve done it a million times, I can’t come up with a reason to not choose real estate. And it gets back to, more than anything else for wealthy families, to tax efficiency.

Michael: So how does this work? I know how it works for clients in brokerage accounts. You transfer a million dollars, and then I enter my trades for my portfolio, and custodial systems make these things happen, and your positions are in your account. So, how does this work as an advisory firm when you’re doing this with clients?

Matthew: Yeah, it’s not easy. It’s quite the administrative task and it’s quite the legal and compliance task to put that out there right away. But here’s how it works. So, number one, you need to set up a series structure LLC. Call your law firm on that one. And then how does it work mechanically for the clients? So, again, it’s not a blind pool fund, it’s not I commit a million dollars and you draw the money whenever you want. We did not want any parts of that. We wanted deal by deal basis, especially coming out of ’08 when people were getting…you know, the world was ending and people were getting capital calls in private equity and real estate. We didn’t want any parts of that. So, it’s deal by deal basis. So, a deal comes out, again, two-pager and a PPM. So now you sign the subscription agreement, you’re in the group that’s able to do the deals. You now get every PPM that comes out. It goes out to the clients, they get 7 to 10 days before settlement.

They’ll have questions for us that will get answered. They’ll do their own due diligence, especially new clients who are getting used to the process. And then we will have a closing just like a closing on a house, where we will syndicate the money. So, I get an allocation from the sub-advisor, I’m sorry, I should have said that first. So, I get an allocation from the sub-advisor. For the sake of argument to use a round number, let’s say it’s a million dollars. Our PPMs go out to all our clients. And then the clients get an election form, it’s called, from us, where they elect to be in or out of the deal and for how much. And they have to send that back in order to participate in the deal. And that also allows us to see how much money we’re raising for the deal. So, we raise the money through the clients, syndicate the money. Again, to keep it simple, let’s say we raise a million dollars. That, they wire into our real estate account and we come over to the sub-advisor as one ticket under Lansing Street Advisors.

Now it gets difficult on the back end, right? Now, we use Juniper Square software on the back end. So private equity, real estate software, well known growing firm. Juniper Square handles a lot of the back end. 24/7 transparency, by the way. If you go to our website, there’s a drop down. You click on real estate and the clients go into Juniper Square, and everything they ever signed is there, every piece of cash flow is there, any exits to the IRR is on there. Like, it’s really a transparent process for private investing.

Michael: Okay. So, I just want to make sure I kind of understand, just the flow and the mechanics again. So, your advisory firm sets up an initial LLC structure that sounds like is essentially going to be sort of the conduit and the holder of the deals. There’s no money in the thing yet. It’s an empty investing vehicle so far. Clients sign up a subscription agreement that says, “I want to be an investor, or at least eligible to be able to be an investor through the LLC into these real estate deals.” And I’m presuming that’s essentially the point that you determine if they’re accredited or a qualified investor to be able to do it. So, you can only do it with your more affluent clients. So, once they’ve signed that, then they’re ready and eligible to do a deal whenever it is that a deal comes along. So, then we just hang out a while until eventually, the investment firm says, we got an opportunity to take down this big old apartment building. It costs $10 million. We’re going to raise this from a whole bunch of advisors, or investors, or wherever they get their dollars. So, you get some phone call, like, “Matthew, we’re raising 10 million in total, you can have up to a million of this piece of the action if your clients want in. so, here’s some paperwork about it.”

So, you get the private placement memorandum, you get the deal summary. You are now, I guess, I was going to say racing, maybe that’s too harsh. But now the clock is running for you to get this out to clients and say, “Hey, guys, we’ve got a deal. Here’s what it is from the firm. Here’s what we’d be buying and where we’d be buying it, and what the investment opportunity is.” As you said, a 200-page PPM. So, you can go really far down the due diligence, depending how much clients want to go down that due diligence route. The clients then decide, do I want to do this? And if so, how much? So are you giving them some parameters of, like, “Mr. or Mrs. Client, it’s a minimum of $50,000 contribution, if you want to participate in this thing. And you can do up to $200,000, but not more than that, because we want to make sure more of our clients have room.” So, are there limits like that for you?

Matthew: Yeah. So, here’s how we handle it with clients because there’s two types of clients in the real estate deals. There is my full advisory clients, full family office/advisory clients, where we’re managing their whole life, right? And we have a specific financial plan with a specific goal on how much real estate fits into their portfolio. So that’s one type of client. And then we have another subset of clients, a group that just does real estate deals with us. So, we have a fair amount of people that just do real estate deals with us. That’s a different conversation, because we are not doing all their financial planning, insurance, and investment portfolios, and the public markets, etc. They’re just doing real estate deals with us. So that’s a different animal. And they have different personal goals. A lot of them have a set number of dollar amount that they want to get to work in real estate. Some of them exited a business and want to put X amount in real estate, or some of them get distributions once a year out of their business or a bonus from their corporate life, and they want to put X amount every year in real estate deals. So, they’re the two subgroups of real estate investors.

Michael: Okay. How do you just allocate the dollars? If you’ve got a good number of clients that want to do this, just I’m presuming you can easily have an environment where they want to put in more than a million dollars, or you got one big client who just got a giant bonus and is, like, “I’ll just take down the whole thing.”

Matthew: Right. So that conversation… Well, two parts to that answer. So, the giant client that takes down the whole thing, that conversation happens before they ever become a client. Meaning, if it’s a big enough investor, you have to fairly allocate. So, the real estate deal goes out. You’re on point there, Michael, that we could very easily end up what’s called oversubscribed on the deal, right? So, I’m raising a million dollars, we get all the election forms back, and $1.5 million comes back. We cannot favor any one investor. We have to prorate the deal evenly through… It’s a longer conversation on the subscription agreement. But we have to prorate the deal. Luckily for us, we just started two years ago, we don’t run into that situation a lot. But that is mechanically, compliance-wise, how that would go down. If I had a huge client call me and say, I want to do $500,000 a deal, it would be really difficult for us to do that. And not that we wouldn’t try to talk them to do less money per deal and doing more deals…

Michael: Nice problem to have from a business opportunity end. But like, “Yo, you’re kind of crowding out the rest of our clients in a not cool way.”

Matthew: Which compliance actually does a really good job of handling that through the rules that are in place that you can’t crowd out the other clients. But again, we’re so early in the ballgame…

Michael: Because if you end out oversubscribed, your obligation as a firm is to prorate everybody down until you get to whatever your allocation was.

Matthew: Correct.

Michael: So, who gets notified of the deals, though? I mean, I’ve imagined filling anything else, like, “Oh, it turns out my big client is the only one who signed up, which may be because they’re the only one I told about the deal.” Do you have a firm obligation that literally, every client who is part of the subscription agreement has to be notified about every single deal, so they always get their opportunity to thumbs up or thumbs down on it?

Matthew: Yes, to 95% of that. And the reason I’m hedging myself is because we did do a few small opportunity zone deals that really don’t work for smaller investors. If you know the opportunity zone deal… Just if I’m doing $50,000 or $25,000 a deal, I’m just using that as an example, your money’s tied up for 10 years. They don’t make any sense for small investors in our professional opinion, and in the sub-advisor’s professional opinion, and in our accountant’s professional opinion. Everybody’s professional opinion. They don’t make sense, except for the family wealthy enough that was having an exit and things like that. Yes.

Michael: Okay. So short of just, like, this deal is partly not a good fit for you in the first place, you essentially have an obligation of everybody who signed the subscription agreement to be able to do the deals has to get notified of the deal opportunity and get the paperwork. And then either says they want it or not. And if they do, they fill out their election form. And then you do or not find out that you have undersubscribed, fully subscribed, or oversubscribed. So, I get, like, if you get the full million, you get the million. If they sign up for one and a half million, well, everybody’s getting two thirds of their allocation, because we’re capped at a million.

Matthew: Correct.

Michael: What happens if you don’t have a million dollars’ worth of interest coming in?

Matthew: I’ve been working with the sub-advisor so long that we kind of…I let them know. Because they always have plenty of investors. That hasn’t happened though, like, knock on wood. So, there’s enough communication with the sub-advisor and myself where we don’t get into a situation where we’re crazy over, undersubscribed? But it could happen in the future.

Michael: Are there literally adverse consequences for you, if you don’t subscribe fully? Or does this just basically come down to, well, if y’all can’t raise the dollars when you get an opportunity, we’re just going to go work with someone else who is more reliable at bringing investor dollars when we have an opportunity? For advisors who are doing this, like, that’s part of your risk. If you’re not filling the deals, there’s a risk that they might not want to work with you anymore. That’s the risk you’re going to run as an advisor if you do this?

Matthew: Totally, I would say yes. And getting back to the due diligence for the advisors is the key. But the other hard thing for advisors doing this is, I think, in their case, they’d have to find multiple sub-advisors to get enough diversity and to get into enough deals. There’s not a ton of sub-advisors out there doing 10, 12 deals a year, there’s just not. I mean, traditionally, how advisors get themselves…I don’t want to say get themselves into trouble or lends itself to more risk, is they have investors who want to get into real estate, and they end up doing one or two deals with a concentrated local sub-advisor. And then you’re stuck in one or two deals, right? And if one doesn’t go doing well…

Michael: If they made a bad call on one, you’ve quickly got a problem. And if you want to diversify, all of a sudden, now you got a whole bunch of sub-advisors to manage, and a whole bunch of different people, and systems, and paperwork, whatever else. Just I can sort of mentally envision how this gets inefficient relatively quickly if you have to do this across a whole bunch of different investment firms at once.

Matthew: Yeah, and I would say this, Michael, our sub-advisor, just to give you a good feel on the complexities of this, our sub-advisor was approached by advisors a number of times over their 20-year-plus existence, and no advisors, were able to take it across the finish line and form something like this. Now, in saying that, I think like everything else in the world, it’s getting more institutionalized, meaning, look at single family rentals, look at industrial properties, look at private equity, creating products like Hamilton Lane that you can go directly to family offices, and high-net-worth RIAs, where you can see your quarterly performance in Schwab. Everything’s becoming more institutionalized. So, I think this is going to become more institutionalized too, meaning, you’re going to have to participate in it sooner or later, because it’s an asset class that is kind of hard to avoid.

Michael: So then continuing just the flow of the mechanics. So, I’ve got my subscription agreement with my folks, we get an opportunity from the real estate firm for 1 million, or whatever my allocation is. So, all the clients get the paperwork about the opportunity, everybody has to reply in 7 or 10 days, or whatever it is, to say, here’s how much I’m electing, and you find out if you’re fully subscribed or a little over or under. And so that sounds like then, some period of time later, I don’t know if this is just a few more days or longer, you have a closing event. So okay, you said you were in, turns out we were a little oversubscribed, you can’t do your whole 100K, but you can do 80K, or whatever it comes out to be. So, here’s the directions. Like, you need to move $80,000 into our LLC structure by this date. You gather all that together, and then you’ve got now a million-dollar balance in your LLC. And you call up Capital Solutions and say, “okay, we got our million-dollar check. We’re sending you over our million-dollar allocation.”

Matthew: Yep, we’re in the same bank, we ledger it right over.

Michael: Oh, that makes it easier.

Matthew: Yeah. So, I did that on purpose to make it as simple as possible.

Michael: I was going to say, I’m assuming that’s not a coincidence.

Matthew: Yeah. So that’s exactly how it happens, like, settlement on a house.

Michael: And what’s the timeline for that? Deal paperwork comes out, you get 7 to 10 days for the election form. And how long until my client has to wire the money? How long until then I’ve got to move the money from my LLC over to the real estate firm?

Matthew: Seven to 10 days also. It’s a small window to close.

Michael: So, 7 to 10 days for clients to do the election paperwork, then you tell them how much of it they got to take down, and then you got basically one more week to get all this done?

Matthew: Correct. Now, there’s clients who are first starting out that, like, I would be the same way, actually, I was the same way when I was doing it personally. They want to talk about every deal and understand it and everything, just anything else. And then you have clients who have done literally 25-plus deals and they’re just rolling into as many deals as possible.

How Lansing Street Manages Private Real Estate Syndication Deals [56:44]

Michael: So, help me understand just how this works then from the firm end. Because maybe this is just my bias of being comfortable and the way I’m used to doing things. But I’m just envisioning a world where I thought I was going to have a light month coming up here in August, but it turns out, Capitol Solutions calls me on August 2nd, says, like, “Got a great deal queuing up,” so you’re going to be spending the next two weeks going out to all your clients and telling them about the deal, and then fielding all their phone calls, and all their questions, and all the stuff. And then the second week of August, you’re going to be getting all this money and doing all these wires and movements. And you don’t get to control that because you only find out when they’re sending the deal. And that there’s just these flurries of conversations, and activity, and paperwork. And then it’s done and you don’t even necessarily know when it’s coming. That just feels like some activity bordering on chaos to me. It’s like, am I unfairly projecting this? Or is this like, this is what you get when you move in the territory? How does this show up for the firm as deals just appear?

Matthew: Yeah. So, the flurry of activity is real. I’ve been doing it for a number of years. A lot of my clients, 80% of my clients are so used to the process now that it’s not this massive flurry of calls. It’s always 20%, 25% of clients, there’s calls, there’s discussions. I quite frankly enjoy talking about it. My Malcolm Gladwell 10,000 hours is not on the planning side like a lot of people in the business. And, like, yours, mine’s, the investment side. It’s such a huge differentiator for the firm, if you asked our three differentiators, this would absolutely be one of them. It’s well worth the time. The harder part’s the back office, which my partner, Mike Topley, my nephew, takes care of that, because you don’t want me running the back office. That would be not good.

Michael: And the back office is just the paperwork, and the filing, and the tracking. And, like, did the right people sign the right forms? And then complete them on the right timeline, and then put the money in the right place by the right deadline. So, is that what Juniper Square essentially manages for you? Like, this, I am imagining, the Orion of the real estate side? This is the software that tracks and reports, and make sure all the stuff is done?

Matthew: Yes. Now, in saying that, I mean, there’s still a fair amount of input and on our end, but Juniper Square is still a massive… It’s like everything else. Right? Software’s apparently replacing people, software’s eating the world, whatever language you want to use for it. It’s a lot of input on our side, a lot of work from Mike. And we’ll eventually be hiring someone in the very near future and part of their job would be taking over some of this. But again, it’s a big differentiator. It’s been a huge plus for the firm. I want advisors to understand, it is a lot of work. It is a lot of compliance. It is a lot of legal documents. It is a lot of administrative work. So, that I want to be clear about.

Michael: So then, how do you get paid on this? How does this work for you, as the firm, aside from cool to be putting together deals? How does the compensation, the revenue work for your advisory firm in this?

Matthew: Yeah. So total transparency, there is two layers of fees. So, when I say net of fees, IRRs, I mean two layers of fees, two net layers of fees. So, you have the sub-advisor, who their fees are all waterfalls. So, for example, this is not exact, but over an 8 IRR, the split might be 80-20, over a 15 IRR, it might go 60-40, over a 20 IRR, it might go 50-50. So, they’re all waterfall splits on the…

Michael: Wait, say that again. Just how do they work? Just even for your example, I’m just processing numbers and splits.

Matthew: Sure. So, the sub-advisor is all waterfalls. So, as an example, the investor has to get an eight IRR net before they make any money, right? So, the split might be after an eight IRR, 80% to the investor, 20% to the sub-advisor. And then there’s another split at a 15%, let’s call it waterfall, that might go 60% to the investor, 40% to the sub-advisor. And then you get over a 20 IRR and it might be a 50-50 split. So, unlike a lot of other investment vehicles, the sub-advisor does not get paid until they go over their hurdle rate, if you’re familiar with hurdle rates in private investing. There are sub-advisors hurdle rates, are 8% plus, so they do not get paid unless they go over the hurdle rate.

Michael: So, I guess, in all the classic dynamics of those sorts of performance-based fees, I don’t pay until I’m getting a good return, you’re very incentivized to grow it well because you’re participating in the upside. And you also potentially have an incentive to take more risk, because one of the greatest ways to get to the top split is just to leverage the genius out of it.

Matthew: Bingo. And a great point that I was going to hit on, this is why advisors who go down this road really have to dig in and do their due diligence on the real estate sub-advisor, because the commercial real estate world… Now, we do not do any retail, well, very little retail or office even prior to COVID. Literally, 1 out of every 50, 1 out of every 100 deals might be retail or office. But that’s very economically, it’s tied to the economic cycle, obviously, office and retail, even putting COVID aside. But you have to do your due diligence. Yes, because most real estate deals are waterfalls, and you get younger people in the real estate world who’ve not made a lot of money already. And they’re going to be shooting for the big hit. And you got to be really careful of it.

Michael: So, one layer of fees is the sub-advisor, that’s essentially their hands-on management of find the deals, and put them together, and invest the thing, and just literally execute the process and make sure this comes out well. So then I’m assuming the second layer of fee is your layer?

Matthew: Yep.

Michael: So how does that work?

Matthew: So, 1% AUM fee.

Michael: Okay.

Matthew: And then we have one waterfall. After the deal closes, everything over a net 8% to the client, goes 90% to the client, 10% to Lansing. So let me just be very clear about something. There is no double charge for our full advisor clients, right? We’re not charging them an advisor AUM fee and charging them 1% on this real estate fund. It’s just a separate vehicle, totally. They don’t get charged an AUM fee under the firm structure and then a fund fee. But again, getting into my Wall Street background, my former firm, I took all the clients out of most of the stuff that has two layers of fees. And the only thing that I believe in, because we were saying we want this as a bond replacement. Yes, it’s illiquid, yes, it has more risk. But we’re in a super unique bond environment where the math, not predictions, not analysts, the math on bonds was telling us seven years ago, that you are not going to be able to keep up with inflation, you’re not going to be able to get these returns. And if we do half the returns that the sub-advisor has done in the past, literally, if we cut their RIAs in half, we felt really good about the returns. And we still feel that way for the next decade.

And then the second thing I would say, just to so many advisors listening is, you can’t do this. There’s too much cost on your end. And there’s too much work on your end. And there’s too much compliance work and everything else on your end to not charge a fee. I mean, that’s the honest answer, is, that it’s a win-win because the client has done extremely well. And we hope to do well with it. But my startup costs and everything else… I mean, obviously the first couple years, there’s a ton of startup costs.

Michael: So, how do you blend this with the rest of investing for clients? So, you said you’re also doing broader investment management for clients as well. Not only the real estate. So, if I’m a multimillion-dollar client coming to you, do you put 90% of my dollars into your, I’ll call it, “traditional” brokerage account traded investment portfolio and 10% to real estate? Is it 80-20? Is it much more specific to the clients? How does this work in the split and allocation of dollars? I’m thinking at least in terms of clients that are working with you on a full advisory basis. You said some clients literally just come to you for the real estate deal. So obviously they’re just doing real estate deals. But, like, full advisory clients where this is part of your investment offering, and you have to figure out how they’re getting allocated.

Matthew: Yeah, and I want to be crystal clear at the beginning of this answer, is, we are an independent RIA fiduciary first and we’re a virtual family office, we call ourselves, first. We’re not a real estate firm. So, real estate is a sleeve of our investment process, but our primary business is virtual family office independent RIA fiduciary. Right? So, it depends on the client’s discovery meeting, it depends on their risk profile, it depends on, most importantly, probably on their ability to be illiquid. So, a lot of boxes to check before we decide how much of an allocation should go towards real estate.

Michael: And is there a typical domain of where it ends out? Is it 10-ish percent for most clients? Is it 40-ish percent for most clients? Where does it tend to land?

Matthew: Forty, definitely no. It tends to land between 10 and 20. Ten is the more likely number, but it tends to land between 10 and 20. Keep in mind, again, picture five, six, seven years ago, cap asset pricing models two, three years ago, some of the more aggressive clients that would be 80-20, traditionally, 80% stock market, 20% bonds, would much rather… Once we lay out and go through the whole real estate process or a pitch book and everything. I don’t want to call it the pitch book. The explanation of the fund, and they know they’re going to work another 20 years. They have plenty in the emergency fund, they’re aggressive, score a 90 in Riskalyze. They’re more likely to say, what the heck do I want to be in bonds for? Why wouldn’t I be 80% stocks and 20% real estate? Now, so our fiduciary responsibility…

Michael: Functionally, for you, this is… You seem to frame this more of functionally a bond alternative, even though by classic return profiles, this is a higher return than traditional equities, which at least I’m putting on my traditional financial planner hat, means more risky than equities. So, it tends to appear as almost a bond alternative, even though functionally, it’s got a risk return profile that looks more like equity, aggressive equity, even beyond that.

Matthew: Yeah. And it depends on the client, when you say we’re framing it as bond alternative.

Michael: I don’t mean to actually imply how we’re making investment pitches. But I mean, just functionally, you’re kind of talking about it, clients are sort of carving it from a fixed income-y sort of bucket, even though we’re ending out with what are classically, equity or even high equity returns, not what we usually associate with fixed income returns.

Matthew: Correct. And we talked down the returns. We think the last 10 years was extremely good. Just like the S&P, there’ll be somewhat a reversion to the mean. We still think returns will be good, not as good as the last 10 years. But there’s a lot of data, right? I mean, if you look at during COVID, the Vanguard REIT index was down 30% from March to May of 2020. I want to say that was close to double the S&P. Don’t quote me on that. Everybody check their data there. But maybe the S&P had bounced back somewhat, but it kind of makes sense, right, with the REITs, with the retail and office.

Michael: All of a sudden, it was like, oh my gosh, we’re all leaving offices. If we don’t come back, all this commercial real estate is going to blow up. So yeah, I remember the discussion quite clearly in real time.

Matthew: So, not my particular Lansing fund, but our sub-advisor who has a ton of properties, at the same exact time, keep in mind, they have barely any office, barely any retail, they had collected 91% of their rents in March, 87% of their rents in April, and 89% of their rents in May. So, this was at the height of the COVID crisis. So, the usual clichés about real estate, about all real estate being local, and then the different risk profiles around the different types of real estate. I mean, we are in the middle income, multifamily apartment space, and the middle income senior living space right now on all our deals, because it’s the risk profile of our sub-advisor’s clients, including myself, including Lansing Street advisors. We are protection of principal first.

Why Lansing Street Takes A ‘Virtual Family Office’ Approach And Where The Firm Stands Today [1:09:42]

Michael: So now help us understand just the overall offering to clients. I mean, you had said, ultimately, this real estate investing is a sleeve of the overall portfolios, may only be about 10% or 20% allocations. But it’s a material differentiator for you because most other advisory firms don’t show up this way at all. But overall, as you framed it, the core of what we do is we’re an independent RIA functioning as a virtual family office. So, what is that offering? I mean, just what does that mean to you? What does it mean to be a virtual family office?

Matthew: Yeah. So, the first thing I would say, as much as I mentioned that my background is all on the investment side. It’s stunning how you can change people’s lives through the financial planning. I just got back from Chicago, from taking the CPWA classes. I haven’t taken the exam yet. Mike Topley, who works here full time as a partner is a CFP. And then we use Delegated Planners, for planners with 30 years experience with all our clients. So, the really life changing stuff happens on the planning side. Like, tax planning can save hundreds of thousands, in some families’ cases, millions of dollars. But trust and estate planning and legacy planning as you know, can save fortunes. So, that’s where we start as a firm. The “Journal” made it public four or five months ago on an article, that the average advisor right now spends less than 10% of their time on investments.

Now, that really worked for the last 10 years, right? And I’m a buy and hold person. I am a low fee, tax efficiency, check those boxes first, total believer. But if you have a client who just exited their business 6, 12 months ago… We’ve closed three $10 million clients in the last four months. So, if you have a client who exited a business, or has an event, $10,000,000 12 months ago, and you’re looking at Vanguard’s cap asset pricing model, it’s really hard to just put them into a model. They’re just a different level of investor, different thought process, different situation. Maybe they were never liquid in their lives until this exit. Maybe they just have retirement, 401(k) money, they had paying for the kids’ education, 529s. And this is their only liquidity event. I think, and I could be wrong, Michael, but the next 10 years are not going to be as easy as the last 10 years on the investment side.

So, I do a lot of investment work. I do not remotely want people to think I’m trading stocks or anything like that. To answer your question, virtual family office, what do we do? It’s the investment consulting, advanced planning, all your cash flow planning, your insurance planning, all your trust and estate and legacy planning, exit planning for business owners, planning your charitable giving. We basically become your outsourced CFO or CEO of your family’s financial life, right?

So, protect your wealth, increase your cash flow, secure your legacy, make sure nothing sneaks up on you. Discovery meetings, solidifying goals and values. Consult on large purchases, behavioral coaching where I personally am a huge believer in investing is a psychology game, it’s not an IQ game. And then flag issues where we need outside pros, right? That’s where the virtual family office comes in. We’re partnering with great CPA firms. We’re partnering with great law firms on the trust and estate side. Quite frankly, a lot of our clients need corporate advice and everything else. So, we really become the one-stop shop for their financial lives.

Michael: I think you said, like, so you have your or are working on your CPCWA designation, your partner’s a CFP, but I think you said you also use Delegated Planning, which is outsourced financial planning support for them. So, what did they do? How do they fit into this picture?

Matthew: Yeah, so, they’ve been a huge partner of ours. Carrie Beasley Jones is our representative there. They are heavily involved in all of our clients’ financial planning. Mike Topley here works hand in hand with them on all the financial plans. We deliver the plans and are face to face with the clients. Obviously, Delegated Planners is not. They’re doing all the behind the scenes planning with us in eMoney, we use eMoney. I do want to say, I mean, I’m getting my CPWA to be fluid, and understand, to be able to speak to clients in the language of planning. But that is not my strong point. We’ll be hiring more planners. I want to be conversant in it, I want to understand it as much as possible. But I’m not going to be the person executing, you know, doing all the due diligence, and loading up eMoney, and doing the plans myself. But I think I have an obligation to my clients, a fiduciary obligation to really understand it as well as possible. But everyone else is doing the nitty gritty of the planning.

Michael: So functionally, they’re essentially like an outsourced para-planning. Like, we’ll gather the data and then we’ll give it to you, and you can input the data into eMoney, build up the scenarios, produce the plan. And then we get back a fully prepped plan in eMoney, and then we can go and do the delivery with clients.

Matthew: They’re loading in the eMoney. Mike and Carrie are doing the projections and the scenario planning. And then we’ll have a prep meeting before the client meeting, and we’ll all go over it together.

Michael: Because I was going to say, at least for a lot of us that have spent maybe an irrationally large number of hours in financial planning software over the years, there is this effect of, when you build the plan in the planning software yourself, you really know the client situation, the details, because you’re immersed into the data and the details as you’re building the plan. So, I was kind of wondering, how do you make sure you’ve got confidence that you know all the details of what’s in the plan if you’re not building it in the software? So, the answer is, you’ve got a separate prep meeting.

Matthew: Oh, yeah. Absolutely.

Michael: How does that work?

Matthew: Sure. So, Mike Topley here is working hand in hand with Delegated on the plans from the beginning. Right? So, we’ll have a discovery meeting. We’ll get the checklist of all the data. We’ll get all the data loaded into eMoney. And then Mike is involved in the plans with the families from beginning to end. It’s more me coming in midway through or back in to really understand where we’re going with this as a firm. And then I’ll layer on the investment part of it as my job, as CIO.

Michael: Okay. Who are your typical clientele?

Matthew: Seventy-five percent small business owners, 25% corporate.

Michael: Corporate, meaning, like, executive types?

Matthew: Correct, yeah. Mostly stock holding executives. And we don’t have any hard cast limits.

Michael: And is there a typical income net worth? Or I guess, even overall, what’s the asset base of the firm? And how many clients are at the firm?

Matthew: Yep. So, we have $160 million in fee paying AUM. I think a little over $100 million in assets under advisement. And I think we just closed a very nice account today. So, I’ll say $160 million AUM, $180 million assets under advisement, and it’s about 60 families, 60 households.

Michael: Okay. So, it’s like a typical household is a multimillion-dollar household.

Matthew: Correct. I think 2 to [$]10 million is like 97% of high-net-worth in the U.S., if my numbers are correct. And we’re in the $2 million to $25 million market primarily.

The Surprises Matthew Encountered On His Journey [1:17:24]

Michael: Okay. So, what surprised you the most about building an advisory business as you’ve been going down this road?

Matthew: Yeah, so, like any small business owner, but especially the advisor business, and maybe it’s because we have the real estate product and everything, but certainly, the legal bills surprised me and the amount of legal work we needed. It’s not like I was naive to legal bills and the way law firms bill. And we have really good law firms, all positive things to say about the law firms we use. But that was certainly a surprise, the amount of legal bills. And accounting bills, to be honest, are by far our biggest bills. And then still just a lot of work on the compliance end. Even though we started out with RIA in a Box, and then we layered on side by side with RIA in Box outside legal teams, right? So, just a lot of compliance…

Michael: For the real estate side in particular?

Matthew: Correct, yeah. That’s all handled by the law firm.

Michael: How much cost is getting added to the firm with just all the legal and accounting work to be able to do this real estate sleeve?

Matthew: Oh, the startup costs on the real estate fund, legal costs, compliance costs, everything is six figures.

Michael: Does the six figures at least start with a one?

Matthew: Yes, it absolutely starts with a one, yeah.

Michael: Feels a little bit better.

Matthew: Yeah. Yes. It’s a good thing there’s a lot of compliance in our business because anything where there’s this amount of money at risk… Look at what’s going on in the crypto world right now. Anything where there’s this amount of money at risk, it’s a good thing. But it’s a burden on the advisor side. Even though you have outsourced compliance, even though you have outsourced legal, there’s a fair amount of stuff that we have to do to stay ahead of it. But we’re really happy with it so far.

Michael: But I guess the flip side is, you know, I mean, relative to most firms, like, let’s have a six-figure bill to be able to offer real estate for clients is like a really big number and a big pill to swallow. But the flip side is, this is part of how you manage to differentiate working with multimillion-dollar households. This is literally how you’ve been able to help differentiate with very affluent clients, is you are offering a thing that most other advisory firms don’t.

Matthew: Yeah, well said, Michael. And my experience… And again, we’ve been very lucky, we’ve had a lot of referrals. We had three 10 million-plus families close in the last three or four months. My experience is, yes, you need those differentiators. And my clients that I brought on, on the higher net worth side, want to hear more creative stuff. They want to hear more ideas. They want to see differentiators. They’re not going to be satisfied just being plugged into a model, especially in the current market environment we’re in now. Maybe Philadelphia is different, but it would not fly with the large majority of our clients. And I want to reiterate again, we’re not trading stocks, we’re not doing anything crazy. We’re just trying to find small ways to differentiate and add alpha over the long-term.

The Low Point Matthew Encountered On His Journey [1:20:23]

Michael: So, what was the low point for you on this journey?

Matthew: The low point for me in this journey? I guess I did have a portfolio that was pretty specialized, that was just a one-year portfolio. And we did really well. And there are still clients in the real estate side, someone who’s been tremendous to me and a mentor and everything. But we didn’t hit the homerun that we were trying to hit. It was a very specialized client, very specialized portfolio. We did really well, we beat the S&P handily. But we were kind of going for the homerun. They came to me and…

Michael: So just like, what was the thing? I mean, what was the deal? What was the investment?

Matthew: Yeah, it was a long-short equity portfolio. So, we were short a lot of the stuff that you see imploding now, things that were trading for above 20 times sales, and we were long the cheapest stuff in the world. And we did well, but it was an ask from a large client for a specialized portfolio due to the extremely unique environment we were in coming out of COVID. And I want to be clear, I don’t do this for a living. I don’t do this for anyone else. This is someone who is in the investment business, and has executed and exited three large businesses. So, one regret is, we didn’t do a better job on that. But great relationship, still a client. Other regrets, we really don’t have any. And that’s not a huge regret, by the way, because we did a lot of due diligence. And we decided, myself and the client, we avoided crypto, we avoided a volatility bed, we avoided all these things that wouldn’t have worked. So, it wasn’t all negative. It was a tremendous, educational process for both of us. We did a lot of calls together, or once a week, not a lot, and really picked each other’s brains and intellectual capital.

But believe it or not, no real regrets outside of that. Maybe I should have not been overly conservative, and I should have hired someone else already to give us more time for business development. But like any other advisor, I think you got to learn that as you go. But it’s easy to say in hindsight, but maybe we should have hired somebody already to do some of the management on the back end of the real estate and management on the back end with clients.

The Advice Matthew Would Give His Former Self [1:22:39]

Michael: What do you know now about serving the high-net-worth marketplace that you wish you knew six or seven years ago when you were coming out of the trading world and into this environment?

Matthew: I guess I was surprised that there’s still a lot of bad product out there. I guess I was naive with the world going ETFs and indexes, and really things getting much more efficient for the retail investor. Really, just cost of trading is free, indexes, there’s an ETF for everything. At the end of the day, there’s still a lot of product that’s sold for, sometimes, conflicted commissions and everything. I did not have knowledge, even though I was from the institutional world, how much of that was still a large part of high-net-worth investors’ portfolios. And I think we make a huge differentiator there. It was just I learned that at my previous firm that there’s still a lot of bad products sold out there. And high-net-worth investors really are… You know, again, we’re huge behavioral finance believers, and storytelling is still a massive part of the business. And they want a story, they want something different than everybody else they see at a club, or in their social lives, or in their work lives. And these stories continue to get told, and unfortunately, a lot of times it is a poor investment over the long-term.

Michael: So, were there particular investment types or investment vehicles, or structures, or offerings that were showing up for you as surprisingly bad product in your experience?

Matthew: Hedge funds for sure. It’s less prevalent now even though hedge fund assets are still growing, but coming out of ’08, the super high-net-worth world got completely sucked into the hedge fund sale, right? And I don’t blame them, they were scared to death coming out of ’08. No one in our generation has ever been through their business valuation going down, their portfolios going down 50%, their business valuation going down, and even as an illiquid investment to begin with. It was unsellable. Their real estate, their personal property being down 20%, 30% all at once. So the storytelling of, hey, we have this great new vehicle that protects your downside and gives you upside capture. And you never have to go through something like ’08 again. And again, I want to say this again, there’s a lot of good hedge fund managers out there. Unfortunately, we went from couple of hundred hedge fund managers to over 10,000, and the alpha has kind of disappeared. So that would be one, for sure.

And then there’s a lot of good private equity managers out there, but there’s also the tenure lockups, and the fees, and how transparent the fees are, and everything else, makes some of those… If you don’t get the right manager there, just like if you don’t get the right manager in real estate, it gets really complex on the reporting. It gets really complex on trying to figure out the fees. I mean, Michael, I’ve been in the business for 25 years, I’ve reviewed private equity funds and private equity individual deals, and I cannot figure out the true IRR or their true fees for the life of me. But same caveat with real estate, there’s some awesome private equity managers out there that have phenomenal returns and phenomenal transparency. You just got to partner with the right ones.

The Advice Matthew Would Give Newer, Younger Advisors [1:26:02]

Michael: So, what advice would you give newer advisors looking to come into the business today?

Matthew: Yeah, so, the first thing I would say is, yes, you have to learn a lot about the business. And yes, you have to learn a lot about planning. But I would pair that with general world knowledge. Like, reading the “Journal,” and “Barron’s,” and “The Times,” and reading, personally as widely as possible books, not just articles. Because as you go up the high-net-worth scale, you’re going to have to be conversant in what’s going on in the world. You’re going to be conversing in investments. You’re going to have to be conversant in private equity, and how exits happen, and the capital stack, and all these other things. And the best way to do that, in my experience, I had great mentors, is read as much as humanly possible. And I’m a huge believer in that. The second thing, that most new people, period, not just advisors, but I think advisors even more so, you need to really get self-awareness.

You need to understand your personality types. You need to understand your personal investment biases, your personal investment personality type, on top of your general personality type. You really need to know yourself in order to be a great financial advisor. You need a master’s degree in self awareness to be a really good adviser. You need great listening skills, and you need to know yourself and know your biases. And then I would say, build the relationship first. We help as many people as humanly possible, not trying to just get them as clients. We have a great network in the Philadelphia area. Anybody who calls me for anything, I would try to help them out. I mean, just build the relationships first, rather than self first. And then your life’s going to be decided by the books you read and the people you meet. And a lot of it’s going to be the five people you spend the most time with. I know I’m stealing that off somebody, I forget who. But in my life, that’s turned out to be very true. So it’s the people you meet, the people you spend your time with, the books you read. So do it well.

What Success Means To Matthew [1:28:05]

Michael: I love that. I love that. So, Matthew, as we wrap up, this is a podcast about success. And one of the themes that always comes up, just the word success means different things to different people. So, you built this wonderful career through the industry. And now you’ve grown very rapidly and launching your firm and building up to a great base of high-net-worth clients. And so, the business is certainly successful and going well. But how do you define success for yourself at this point?

Matthew: Yeah. So, I think I listen to enough of your podcast that I did think about this question a lot. So, the first part of it, it’s kind of the easy part is, my family first, right? My wife and two children. Are they happy, stable, etc., etc. That’s by far the most important thing. And they would probably vote three to zero that the only one who’s a little crazy in the house is me and everybody else is fine. So, my family, I want to make sure I take care of first, and my extended family. I have a huge family. I’m the youngest of six children. And I have a lot of nieces and nephews and everything. But the second part of the answer is, a lot of what I view as success is personal freedom. And having your own firm, especially an advisor firm with recurring revenue, and quarterly fees, gives you a lot of freedom. I love what I do.

I’m doing research all weekend, reading about the markets all weekend, things like that. Everyone I interview about retirement, it’s never the work, they get burned out by the people. So, when you have your own firm like this, you can kind of eliminate having to deal with passive aggressive or manipulative, duplicitous people like narcissists and anything that are out there in the corporate world. So, it’s kind of a little bit of maybe too much of a psychological answer for your question. But that allows you to be personally happy, right? That you don’t have to have all these passive aggressive, duplicitous people in your life that are doing underhanded things to advance themselves. Because you now have this freedom of owning your own firm and making your own decisions.

And that leads to physical health too, right? A best seller right now is “The Body Tells the Story,” or “The Body Keeps Score.” And our mental health and physical health are so tied to each other. And I’m 52 years old now, and I believe in that philosophy and freedom that this business allows is great for that part of it. And then last, just impact on society, right? For me, it’s all about education. And I’m a first-generation college student. So, we have a major crisis in this country on the education side. So, that’s my passion on leaving a long-term impact. But lastly, I would just say, what’s your impact on society going to be is a huge definition of success for me. And I would encourage all the other advisors out there. I know you’re huge on financial education. And I know everybody has a passion on the charity side. But I think all of us as advisors should embrace somewhere in your community, education, because we’re going a little bit backwards in some regards.

Michael: Well, I love it. I love it. Thank you so much, Matthew, for joining us on the Financial Advisor Success podcast.

Matthew: Thanks for having me, Michael. I’m a huge fan of the show, so it was quite the honor to get the call to be on. I’m here for any questions, any other advisor or anything, want to reach out to me. My blog is www.matttopley.com. And you can contact me through there or through the website, lansingadv.com.

Michael: Awesome, awesome. We’ll have links out to that in the show notes as well. So, this is episode 292. And if you go to kitces.com/292, we’ll have links out to Matt’s site and Matthew’s blog. So, thank you, again, Matthew, for joining us on the podcast.

Matthew: All right. Thank you very much, Michael.