Q74 – How Can I Reduce Or Eliminate My Real Estate Office Expense As An RIA?

Also available as podcast (Episode #74)

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How Can I Reduce Or Eliminate My Real Estate Office Expense As An RIA?

The two largest expenses of running an advisory practice are your real estate expense and your staff expense. Finding a way to reduce or eliminate your office expense will have a meaningful impact on your bottom line profitability.  The most important factor in reducing this expense is to make sure you are paying for it directly as a fixed cost, not as a variable cost via your payout.  There are then further strategies you can utilize to reduce, and in some cases eliminate, the expense altogether.

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Full Transcript:

How can I reduce or eliminate my real estate office expense as a Registered Investment Advisor (“RIA?”) That is today’s question on the Transition To RIA question and answer series. It is episode #74.

Hi, I’m Brad Wales with Transition To RIA, where I help you understand everything there is to know about why and how to Transition to the RIA model.

If you’re not already there, head to TransitionToRIA.com, you’ll find all the resources I make available from this entire series in video format, podcast format. I have articles, I have whitepapers. All kinds of things to help you better understand the RIA model. Again, TransitionToRIA.com.

I previously did an episode on how to have the highest income as an RIA. If you haven’t checked out that episode, take a look. In part of that, I talked about real estate costs. But I wanted to do a deeper dive on the topic with this episode.

There are two macro points I want to start with here at the top of this episode.

First, the two largest expenses of running an advisory practice are your real estate expense and your staff expense.  I’m not going to get into staff expense on this episode, but I have discussed it broadly prior, and might do a future standalone episode on it.

Because real estate, and staff costs are the two biggest expenses of running an advisor practice, if you can find a way to reduce, if not eliminate, your real estate expenses, it going to improve the P/L of your practice. Hence why we’re talking about it here.

The other macro point is that COVID has changed everything.

I am recording this episode in late 2022. Had I made the episode three, four years ago, things would have been looked at differently. But COVID has fundamentally changed how we as a country view virtual collaborations, remote work, etc.

Whatever your preconceptions were pre-COVID, the world has changed. You must look at it through a new lens. The examples I will give on this episode are based on the COVID (post-COVID) world we live in, as opposed to what it was like 5 years ago, 10 years ago, 15 years ago. Everything has changed. You must have an open mind about it.

Ok, the first step in all this is the dirty little secret of real estate expense.  That is, you need to find a way to pay for real estate (office) as a fixed expense, not a variable expense.

If you are in a W2 environment, maybe you are at a wirehouse brokerage firm, you receive a payout for your services. You provide a service to clients, you charge a fee, you get a payout on that.

As I talk about often in these episodes and different articles I write, I strongly encourage you to think of not just your payout, but the inverse of your payout. Let’s say you’re at one of the wirehouse firms. I’m going to use very simple numbers here. I know some of you have higher payouts or lower payouts. But for the sake of simple math, we’ll use simple numbers.

Let’s assume you’re getting a 40% payout. Now, I would argue, and I’ve ranted about before, if the payout table in the compensation plan says you’re at 40%, you’re not really getting 40%. The other 20-plus pages of the comp plan are meant to whittle that down in different ways. Not to mention some of that is likely deferred comp.

So, you’re not actually getting the 40%. I want to acknowledge that because I have talked a lot about that. But for the sake of simplicity on this episode, we’ll say somehow you’re magically getting that 40%. Again, you’re not, but for this example, we’ll use it.

If you’re in that wirehouse world, and your payout is 40%, the inverse of that means you are paying your firm 60%. You are the one that finds the clients, you are the one that retains the clients, you are providing services, you’re charging a fee for that. Mentally think 100% of that fee comes to you, you then pay your firm for the value and services they provide you, so that you can provide those services for your client.

That’s where the inverse of the payout is. If you’re getting a 40% payout, the inverse of that is you’re paying 60% to your firm. Now, they are providing you value. They are likely providing you an office. They’re possibly providing you a sales assistant. They’re providing you technology. Those sorts of things. There are hard costs associated with that. They’re for-profit companies, they deserve to be able to generate a profit. But the question is, are you getting enough value for what that inverse is?

Again, using very simple numbers, let’s say you’re a million-dollar producer, and you’re in that 40% payout bucket. That means you’re paying 60% to the firm, or $600,000. Are you getting enough value from your firm, that real estate, that sales assistant, that technology, for 600,000?

Imagine if you’re a $2 million producer, your payout would be a little higher, but that would be over a million dollars you are paying to your firm, getting certain value and services in return.

Part of what you are paying for in that – in this example 60% –  is your office, maybe also a conference room. So, you are paying for real estate now. Even if you’re not writing a check each month, you are paying for real estate. In a W2 situation where you have a payout, you are paying for it via the inverse of your payout.

Here’s the problem. You are paying for it in on a variable basis. The more fees and commissions you generate from your clients, that 60% in dollar terms keeps going up. Maybe your payout % will increase a bit as you grow, but the more you grow, the more you are paying as the inverse of your payout, and the more you are paying for office space. The problem is your office doesn’t grow in proportion to what you are paying for it.

Assume you’re a million-dollar advisor. You’re paying 600,000 to the house. Let’s say you double to a $2 million dollar advisor or a $4 million advisor, your office space is not going to double, or not going to quadruple. You’re not going to have access to a conference room twice as big, or a conference room four times as big. Yet, you are going to pay close to two times as much, four times as much. The reason I say close is your payout percentage will vary some, but it’s still going to be close to that.

Real estate in reality has a fixed cost. Your firm either owns the building, or they lease it. There could be some variation over time from things like increases in property taxes, but for the most part, it’s a fixed expense for your firm. But as you grow your practice, you are paying for it on a variable basis. If you increase your practice 50%, or double it, or quadruple, whatever the case is, you keep paying more for the exact same office space you’re getting.

That is turning your P&L (Profit & Loss statement) upside down from an ability to manage one of the two biggest expenses of running an advisory practice. I encourage you to consider how you can pay for real estate on a fixed basis, not variable basis.

The easiest path to achieve this is via an independent path, whether that’s the RIA model, or with an independent broker-dealer, where you are responsible for paying your own local expenses.

You might think paying for real estate directly is expensive, but the reality is, you’re likely paying a lot right now for real estate. If you’re producing $2 million, $3 million, $4 million, think about the inverse of what you’re paying to your firm. A big chunk of that is for the real estate they provide you. That can be a very large number that some of you are paying for real estate, and is far higher than the cost if you were paying for it directly yourself.

So, again, the main goal is find a way that you can pay for real estate as the fixed cost it truly is, and not pay for it on a variable basis.

Next, we’ll discuss some ways to reduce your real estate expense or in some cases, maybe even eliminate it. Even if you’re paying for it as a fixed expense.

First, and this is kind of more on the extreme side, is to go completely virtual, to not have an office at all. You might think you can’t do that, but COVID has changed everything. Pre-COVID, that argument is a tougher sell. I don’t know how many clients would go for that. COVID has changed all of that. Meeting virtually, via tools like Zoom is commonplace now.

There are advisors and teams that are fully virtual. They do not have an office presence at all. And you might say, “Is that just for new advisors, startup RIAs?” Many of them are virtual but I’ll give an example where it works for established practices as well.

Consider a niche practice. Perhaps you are positioning yourself as the absolute expert on optometrists. You are the go-to person, you put out all kinds of content, all kind of resources, and you position yourself as the expert financial advisor for the needs and demands of optometrists.

You are likely working to attract optometrists no matter where they are in the country, not just optometrists in your town. If you’re creating content, demonstrating your expertise, you’re trying to attract optometrists, in general.

Many of those prospective clients will likely not be in your town, just by the fact that there’s much more space in the country outside of your town than in your town. If you’re going to attract clients from all over the country, most of those clients are never going to set foot in your office, even if you did have an office. They’re not going to travel across the country to see you. They’re going to do everything virtual.

This scenario is doable. We’re seeing it happen. If you can demonstrate expertise, trustworthiness, that you are the go-to person, you will likely work with clients beyond your local area. If most, if not all, of your clients are not local, you don’t necessarily need a local real estate office. You can fundamentally change your P&L, and dramatically reduce or eliminate that part of the expense pie.

So, the first example is to go virtual. It’s not for everyone, but for many advisors and teams it is becoming more and more feasible. To the degree it works for you, that is a massive cost savings.

The next strategy I want to discuss is to use a hybrid approach.

If 100% virtual gives you pause, consider a hybrid approach.  Maybe most of your client interactions on a day-to-day basis will be virtual, will be on the phone, will be Zoom, maybe you go to them, maybe they’re not even located in your city. But maybe you have some clients that insist on coming in and seeing you in person, or maybe you prefer always initially meeting with prospective clients in person. That’s part of your value proposition.

A strategy is to use a hybrid approach.  You’ll do a lot of interactions virtually, and some in person. To do this, you arguably no longer need the same footprint of office space that you would have needed pre-COVID. Maybe you only need half the space. Maybe you can get away with just a conference room, and one or two offices.

For example, maybe you have a team of four or five advisors.  Most of them might choose to work remotely on any given day and not come into the office.  As a result, maybe you only need two offices. Each set up with a docking station, monitor, keyboard, etc.  Whichever advisors needs to be in the office that day, all they must do is bring in their laptop, sit down, and they’re up and functional. You can schedule amongst yourselves who is going to use what office on what day.

If you’re not all showing up every day, maybe you don’t need a standalone office for everyone. You can potentially reduce your office footprint quite a bit. Pre-COVID the mindset was generally that every advisor needed their own office. With the quasi-virtual world we now live in, that is no longer the case.

And then the final strategy I wanted to note is to simply get creative.

I’ll give you an example. There’s a wirehouse team I’m working with. As I described earlier, they are currently paying for their office as a variable expense, via their payout.

They are members of a high-end social club in their town. The club has pricey membership fees, and likewise has nice clubhouse facilities to match. It has a restaurant in it, it has a bar area, and it has meeting space. As opposed to clients coming to their office, they often offer to meet their clients at the social club.  Many of their clients not only enjoy doing that, but prefer it.

It has these advisors pondering that if they were to breakaway, do they need their own office? They meet with a lot of their clients virtually, and for the ones that like to meet in person, they often want to meet at the club. And when more privacy is needed, the club has meeting facilities they can reserve by the hour.  So why even have an office?

The best part is they are already members of the club.  This would not be a new expense for them.  If anything, they could convert it from a personal expense to a business expense.  So again, think creatively.

Another example relates to geography.  I’m in Florida. A lot of northeastern financial advisors have clients that end up migrating south as they get older. For some advisors, a large portion of their clients are now living in (for example) Florida, and the other half are still in the northeast.

These advisors are realizing that if they are wanting to have an office footprint, and they’ll travel to see the other half of their clients, it’s cheaper to have the office in Florida.  It’s a geographic arbitrage of sorts.

So, again, the main point is to think creatively. Covid has changed everything. How you can implement virtual, how you can implement a hybrid approach. The world has changed. Whatever you thought the answer was 5 years ago, 10 years ago has fundamentally changed. Rethink how you could do it.

I was discussing the variable expense approach to real estate with someone once.  How wirehouse advisors are paying such a huge amount for the office space they are provided to use.  The person responded by noting that for what advisors are effectively paying via this variable approach, they could instead be outright buying a property to use as their office (had they instead gone the independent route, and paid for real estate directly.)

That could provide another meaningful wealth building pillar to an advisor’s career.  Perhaps adding millions $ to their net worth by the time they retire.

I hope this has helped you think through some of the variables of running your own P&L. This flexibility is one of the benefits of being in an RIA model where you’re responsible for your local expenses. You can manage these costs, thinking creatively about ways to reduce or eliminate them. Hopefully, this has got you thinking about how you might do it if you were to transition into the RIA model yourself.

This is the type of thing I have conversations with advisors about all the time. If you’d like to chat about this topic, I’m happy to do so. As I said at the top of the show, if you’re not already there, head to TransitionToRIA.com. You’ll find all the resources I provide. The videos, the podcasts, the articles, whitepapers.

For those of you watching this on video, it is in podcast form as well if you’d prefer.  Just search for the “Transition To RIA Podcast” on all major podcasting platforms.

If you’d like to talk about today’s topic or anything else RIA related, there is a contact link at the top of every page of the website. Click on that and you can instantly and easily schedule time to have a one-on-one conversation with me. I’m happy to chat with you about today’s topic or anything else RIA-related. Again, head to TransitionToRIA.com.

With that, I hope you found value on today’s episode, and I’ll see you on the next one.

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