Q106 – What Is The Real Estate Advantage Of The RIA Model?

Also available as podcast (Episode #106)

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What is the real estate advantage of the RIA model?

Do you own or rent your home? If you own, why is that?  For the tax advantages?  The certainty on not being forced to move?  To build equity?  You probably have the same conversation with your clients, as they ponder buying vs renting.  If you own your home, and advise clients to do the same, why are you not taking your own advice when it comes to the office you use for your practice?  The advantages of owning your office can dramatically impact your long term satisfaction and net worth as an advisor.

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Want to learn even more by better understanding what a transition to the RIA model might look like for your own practice?  I encourage you to schedule a Discovery call, and I’d be happy to begin that conversation with you.

Full Transcript:

What is the real estate advantage of the RIA model? That is today’s question on the Transition To RIA question & answer series. It is episode #106.

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 your practice to the RIA model.

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

Again, TransitionToRIA.com.

On today’s episode, we’re going to talk about the real estate advantage that comes with moving your practice into the RIA model.

You might have listened or watched many of my episodes, and maybe there’s certain things you agree with or don’t agree with that I say, particularly when it comes to comparing the RIA model to the W2 wirehouse model. But even if there is something along the way you might not have agreed with, it is indisputable that today’s topic is more advantageous in the RIA model than it is in the W2 wirehouse model.

This topic applies to almost any independent model in the marketplace. That includes the independent broker dealer model where you are 1099 where you are responsible for your local P&L expenses. And so, it’s not just the RIA model, but it applies in most pathways into the RIA model.

And to be clear, this advice applies to almost any type of service industry. Whether a dentist, an attorney, a CPA, or whatever the case is, today’s topic will still apply. But to be sure, if you are in the W2 wirehouse world and you’re thinking about going to the RIA model, you will want to understand what this advantage is and how it can benefit you.

So specifically, in most pathways into the RIA model, you can own the real estate that you have your office in. Easier said than done, I get that, we’re going to get into the details. But the advantage of being able to get to that point – and it might not be on your initial transition, it might be a phase two – the advantages are significant over the W2 model. That’s what we’re going to talk through here.

Over the balance of your career at a wirehouse, regional W2 firm – for the sake of simplicity, I’m just going to refer to wirehouse firms – over your career working for those firms, you are paying for real estate. That is part of the value your firm is providing you in return for them retaining part of your fees and commissions that you generate, the payout.

You’ve heard me say in several episodes, if you are in the W2 world where you have a payout, you need to calculate the inverse of that payout.

To use very simple numbers, if your payout is 40%, the inverse is 60%. Meaning you should mentally think of, because you are the one generating your fees and commissions from your clients, that 100% of that comes to you. Don’t think of it as, “I get 40% of that.” Think of it as, “I pay 60% of that to my firm in return for certain value that they provide for me.”

To be fair, they provide you some value. They provide you an office. They provide you technology. They provide you, for better or worse, compliance support. They might provide you some sort of sales assistant. They are providing you value.

Now, not to get off on a tangent, because I’ve talked about it often, the big question is, are you getting enough value for that inverse of your payout for whatever that is in dollar terms? Add that up and say, “Am I getting that much value every year?” That’s the exercise you want to do.

If you’re getting a 40% payout – and it’s not that simple because some of that’s probably deferred, so arguably you’re not even getting 40% – but of that inverse, that 60%, part of that is to pay for the real estate, the office that they are providing for you.

They don’t give you any sort of itemized bill that says, “Of that 60%, here’s how much goes towards technology. Here’s how much goes towards compliance. Here’s what goes to the office.” But make no mistake, you are paying for real estate regardless.

The question is, at the end of your career, if you ride out the next 5, 10, 15, 20, 30 years, however much longer you have in your career, and all along that way you are utilizing real estate by having an office, you are paying for that. You are paying for that in your payout. They are not just giving it to you. You are paying for it.

To use an analogy of buying or renting a house, you’re effectively renting that office from them because at the end of the day, after maybe decades of paying into that, you have no equity in that location, in that building, in that office, for all those years of paying into the pot.

Compare that with the RIA model where you control your local P&L, where you can buy the real estate. There are advantages to that. We’re going to go through some of those.

When you own the property, you’re paying into it, which you’re doing anyways on the wirehouse side, now you’re building equity. You’re paying down a note or whatever the case is, and you’re building an asset over 5, 10, 15, 20 plus years.

The simplest analogy when I talk to advisors about this is, in your own personal life, and perhaps advice you give to clients, do you choose to buy or rent the house that you live in?

Most of you, there’s always exceptions, I would venture to say most of you watching this episode own the house you’re in. And likewise, if your clients come to you and say, “Should I buy or rent a house that I’m going to stay in for quite some time, or maybe at some point move, but I still need another house, should I buy or rent?”

Over the long term, most people would say you’re better off buying. I get there are some people who say “rent” and we’ll get into that. But the idea being, for all the reasons you have personally chosen to buy a house and the reasons you likely tell your clients to buy a house, apply to this same real estate situation we’re talking about here.

One of the reasons you buy a house is because as opposed to just paying rent every month, you want build equity every month as you make that mortgage payment, as you pay down that note.

Yes, there are embedded costs in there. There’s taxes, there’s interest. But if you’re paying rent, those embedded costs are still there. You’re just not paying them directly, you’re paying it to someone else.

The reason you want to buy from a home equity standpoint, versus renting, is so over those years you are building that asset for yourself, not for someone else.

If you buy into that theory for your own personal house, why are you not considering that for the office that you are spending years, if not decades, in over the balance of your career? Build equity in something versus just paying rent to someone else the whole time.

The next item as it applies to the buy-vs-rent argument is operating leverage.

With your home, what that’s referring to is if you buy a house and perhaps you get a mortgage on it, a fixed rate mortgage, over the balance of the mortgage, yes, insurance might tick up each year and taxes might tick up each year, but the cost of your fixed rate mortgage does not go up over perhaps 10, 20, 30 years.

However, if nothing else because of inflation, the world keeps going up where incomes or you just grow your practice, grow your firm, then as your income goes up, yet your mortgage payment – again, except for taxes, insurance slowly creeping up – but the main bulk of the mortgage payment essentially stays flat. You are gaining operating leverage the longer you stay in your house. The better deal the original purchase was.

It’s the same with your office. If you are at a W2 firm now, again, you’re paying for real estate as part of the inverse of your payout, you have no operating leverage.

As you increase your production 10%, 50%, 100%….yes, you might slowly creep up a little bit in the payout grid, but at some point you max that out. And yet, as you continue to grow the firm, you’re still paying the inverse of your payout.

An extreme example, if you’ve doubled or tripled your practice, let’s say you grew to the highest payout level – for simplicity, so no one tries to point back at this, assume you’re at the highest payout level. Let’s say you double your production over several years. Now you’re twice as big. Well, they’re not giving you twice as big of an office. But you are now paying twice as much for that same office because the payout retention piece is now twice as big as it was before, for the exact same office you’ve had all along.

Instead, if you owned the building you’re in… and yes, if you build your practice large enough and you expand the team, at some point maybe you have to expand the office. I get there could be costs involved in that.

But as a simple example….if you grew your practice 50%, that doesn’t necessarily necessitate that you grow the office bigger at all. So you have this fixed cost, yet your revenue keeps going up. That’s the operating leverage you get to gain from if you own the office.

If you’re W2 and you’re renting the office, that’s effectively what you’re doing, and it’s based on your payout and the more revenue you generate the more the inverse goes into the pot for someone else, you’re not experiencing that operating leverage at all.

As you grow your practice, it becomes exponentially more lucrative if you own the office. You have none of that operating leverage in the W2 environment.

Another reason people often want to own a home versus renting is the certainty of not having to move.

If you rent a home or rent a condo or rent an apartment, you have the certainty for the term of your lease. And yes, in many instances, a landlord would want you to re-up, but there’s no guarantee that is an option.

Maybe you’ve rented in a neighborhood and your kids, your family, has made friends in the neighborhood and all of a sudden the owner of that property decides to do something else with it at the end of your lease, you have no certainty.

The pro-renter crowd often says, “Renting gives me more flexibility in life and I’m not tied down.” Yeah, but you also could be kicked out of your neighborhood that perhaps you love, and love your neighbors, and you have no vote in that. One of the challenges of renting is no certainty of not having to move.

If you are in that wirehouse environment, you have no say over what office that firm chooses to provide for you. Maybe over time for cost savings, or they’ve expanded that branch or maybe the branch has shrunk, they decide to move office locations. Maybe that’s farther from where you live. Maybe farther and less convenient for your clients. You have no say in that. There’s no certainty when you are essentially renting that office they are providing for you.

If you own the building, that’s your decision. If you’ve made a poor decision of where to buy the property, obviously that’s going to be your responsibility to maybe sell that and find another property.

But if you decide, “This location in this part of town, that’s good proximity for me where I want to live with my family. It’s good proximity for the bulk of my clients.” If you buy it, you have the certainty that you’re never going to be called into the branch manager’s office, or the branch manager comes and visits your office, and says, “By the way, at the end of the year, we’re moving six miles to the east. I hope that’s still convenient for you.”

The same certainty of being able to stay in your place for a home purchase applies to real estate with your practice as well.

Another example of why people like buying a home versus renting a home is because they can remodel.

If you want to paint the walls a different color, you can do that. If you want to remodel the bathroom, you can do that. You can decorate it however you want. Perhaps over time your circumstances change, either your personal taste changes, maybe you’ve expanded your family and now you have kids involved. You have full flexibility when you own a house to remodel it, redesign it, redecorate it.

If you’re essentially renting from a W-2 firm, they make all the decisions, you don’t get any say.

The comparable would be imagine new technology comes along. We saw that recently with Zoom, and Zoom rooms. Being able to set up more automated ways to do video calls with clients. Maybe that’s important to you or maybe there’s other things that your clients now want to be able to access.

Maybe it’s a financial planning tool, and you want to be able to put a big TV up on the conference room wall, and be able to sit and collaborate with your client and look up at that wall together and go over the financial plan.

Guess what? If you’re essentially renting from the W2 wirehouse firm, you can suggest those things, but you don’t have any vote. It’s theirs to decide what they do or don’t do with it. If you own your own real estate, you can do whatever you want to it. So again, a big difference between buying and renting.

The final example, this is not an all-inclusive list, is the tax advantages.

Buying a home often comes with tax advantages. The ability to perhaps write off interest on the mortgage, the opportunity to possibly have your property taxes set and then only increase at some incremental amount above that. It can be advantageous to buy versus rent.

When you own an office, you get all kinds of tax advantages. Whether it’s the depreciation of the office, deducting the interest on the note you have for it, the cost of remodeling you can write off as an expense. Things you don’t get to take advantage of when you are merely along for the ride, renting from your W2 firm.

I suggest you think hard about why you are probably passionate about owning a home versus renting a home, and yet you’re probably not applying that same methodology if you’re at a wirehouse. Why aren’t you trying to do that with your office as well that you’re going to be at for a very long time to come?

A couple takeaways to wrap up. I could go on and on with different examples, but I think you get the point.

First what I’m describing applies to whether you start your own RIA or you join an RIA. I’ve done several episodes on joining an RIA. What’s important, though, this applies to joining an RIA that’s a 1099 model, where you control your local P&L expenses. That’s the key. If you control the P&L, you control the office you’re in. There’s multiple ways you could go into the RIA model and benefit from today’s conversation.

To be clear, though, there are some W2 RIA firms where it’s going to be the same real estate scenario as the wirehouse firm. So I don’t want to blanket say any pathway into the RIA model gets these advantages because that’s not the case. But if you own the RIA, or you’re joining one where you 1099 control your local expenses, you absolutely can utilize these benefits and advantages.

The next takeaway, don’t feel like, “A transition is already a big enough step. I don’t know if I can manage trying to buy a property all at once, whether that’s for cash flow reasons or there’s so many moving parts related to transition, or it’s just too much all at once to do.”

That’s fine. I know several advisors that have started by renting an office, but who have a plan of, “Maybe we’re going to lease first. We’re going to sign a three-year lease or a five-year lease or whatever the case is. That’s going to be an easier path. But I do want the long-term benefits of owning a property. First, let me make the transition. Let me get my new world figured out, clients moved over. Then when the lease expires, if it makes sense, in a more measured pace I can start looking for properties.” There’s no reason you can’t do it as a two-step process.

The final takeaway I’d give you, which I’m sure there are a lot of these stories, relates to a conversation I had a year or so ago with an advisor.

This advisor was near the end of his career and was working through his succession plan. We were talking about the valuation he’s getting for his practice for his life’s work, this business he’s built. It’s a big part of his net worth.

Long prior he had bought the building that he has his office in. As he was entering retirement, he planned to sell the building as well. Turns out, he was set to make just as much from selling the building as he was from selling his business.

If instead, through all those years he had leased an office, and not acquired the building, he still had a very nice business to sell, but because all those years prior he made the decision to buy (and was able to), he’s now going to see essentially double the takeaway, double the assets he has at the end of his career. Because he had taken those steps so much earlier.

I encourage you to think about that. There are reasons the RIA model may be for you, or it may not be for you. That’s what I help advisors think through is how that works. But make no mistake, the advantages of the RIA space when it comes to your ability to own and control real estate is one of the significant benefits. From flexibility, satisfaction, economics, net worth, however you want to position it, it’s worth thinking about as you consider your long-term plans for your practice.

As I said at the start, my name is Brad Wales with Transition To RIA. This is the sort of thing I help advisors think through all day long of, “Is the RIA model right for me? Would it be a fit for my practice? What are the advantages of the model? What are the responsibilities that go with those advantages?” Real estate being one of those advantages.

That is a typical conversation I have with advisors. I’d love to have that conversation with you as well if you’d like to learn more about how the RIA model would look for your specific practice.

First things first though, head to TransitionToRIA.com where 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 model.

At the top of every page is a Contact link. Click on that and you can instantly and easily schedule time to have a one-on-one conversation with me.

Again, TransitionToRIA.com.

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

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