The Legacy Trap

however, all is not lost. From their different perspectives, eric and rick will discuss the challenges successful entrepreneurs face when trying to leave a legacy, the consequences if estate planning and succession issues are ignored, and the ways successful families have addressed these challenges.

When is trying to leave a legacy a problem?

eric von berg: When you mix money and children you face potential problems. Let’s look at a typical profile. A successful developer or deal maker created a fortune in his lifetime. he wants to leave a legacy in property but he also wants to see his family business carry on. his daughter is in the business but the patriarch is currently making all important decisions. Let’s say he has three other children. One daughter is a stay-at-home mom, the other daughter is a doctor, and the only boy runs kayaking trips and has never been able to save or earn a dime.

What brings a successful real estate entrepreneur to the realization they need a plan for succession?

rick raybin: I would like to say my persuasive arguments motivate a desire for planning and change, but the desire to craft a succession plan usually comes from a combination of two things: (1) an attachment to a real estate portfolio with a desire to see it maintained as a family legacy, and (2) some outside event; a health problem, an economic setback, or the death of a spouse or partner.

e: Most real estate entrepreneurs take care of estate tax issues but don’t really put together a proper succession plan. I agree many owners are very attached to their portfolios and these properties are their babies. So, maintaining the portfolio is the priority.

What Would be the goals of such a client?

r: Succession planning is just one element of effective estate and legacy planning. The true work of estate and succession planning is often subtle, and can be summarized as overcoming the age-old pattern of “from shirtsleeves to shirtsleeves in three generations.” It

The Legacy Traperic Von Berg, a commercial property mortgage banker, and rick raybin, a wealth management expert, have several clients in common. Over the years, they both have seen, too often, the acrimonious and costly lawsuits that sometimes follow a developer-dad’s passing. These lawsuits dismantle and divide the family trust containing the parents’ commercial real estate portfolio, and, at resolution (and after $1 or $4 million in legal fees), none of the children are happy and they are no longer speaking to each other. a suit to reach family estate settlement is akin to a messy divorce. But in these cases, it is often the surviving parent who is caught in the middle and has to hear the vitriol, mistrust and accusations between her children.

below are comments on this subject from two of eric’s mortgage banking clients, both survivors of sibling divorce—messy law suits to break up the family trust and divide assets among siblings. their comments are below, with names changed.

bill: “complex estate planning originates from the fear of paying estate taxes.”

michael: “real estate entrepreneurs have been given many tax advantages. under irs status 6166 if at least 35% of the assets are in family real estate holdings you can pay the estate tax liability over 15 years at a favorable interest rate. you can structure the ownership of the property to significantly reduce the value used for calculating the estate tax. these are huge advantages.”

m: “most people wait until their kids are out of college to do any succession planning. that is too late to impart family values.”

m: “transferring control is complex as the business leader’s self esteem is connected to his success and position in the community.”

b: “you have to be careful in letting experts craft an estate plan. complex estate planning is sometimes so complex that no one really understands it. and because mom and dad don’t really understand it they do not explain it to their kids.”

m: “to begin to shift control, you need to shift focus away from wealth creation. there are far more people who can manage wealth than can create wealth.”

involves considering a host of issues involving your family’s relationships, values and goals, including:

• Imparting your values to offspring and descendants

• Building an enduring family culture

• Keeping family―and family values―intact

• Easing business succession and establishing the role of the next and future generations

• Transitioning from a role as creator and deal maker to a position as executive/patriarch

Why is a planned succession so important?

e: If your legacy is to survive, you need to make sure your portfolio can be run without you. hopefully, you can see it running well under a new chief when you are around to give advice.

If you have brought a son or daughter into the business, you need to work on handing over first the operations and later the deal-making role. This is always hard, but there are ways to ease the transition, including creating a board of directors, bringing in consultants, defining roles, and setting a time line for shifting duties and decision making to the next generation.

If you intend for your children to rely on third-party management, this process is easier. But, remember that asset management is a separate role from property management. asset management can never be fully contracted out unless you convert your holdings to stock in a well-managed reIT through an up-reIT process.

r: as a successful entrepreneur, you’ll want to leave a real, lasting legacy―not just your assets―to your children and their descendants. To do this, you need to think through your family’s unique issues and the potential consequences of your decisions. you’ll need to be honest with yourself about your family dynamics and your children’s interests, skills and shortcomings. This kind of comprehensive planning will help guide the outcome to what you think will be best for your family.

While a succession without planning is possible, it is unlikely to be successful. Instead, it’s critical to take concrete steps, including considering how to provide for different needs among offspring and descendants and avoid strife; strategies for protecting the estate from creditors (including divorce); and whether to continue to focus on real estate or pursue a broader diversification of your wealth.

We both agree, waiting too long to think through and plan for a smooth transfer.

What is the biggest mistake?

e: Most successful real estate developers and investors love deal-making. The hunt for the next

b: “siblings want to ask questions about their parents plans for succession, but don’t because they fear the answers.”

m: “parents avoid discussing succession plans with their children because they do not want to air family secrets nor to they want to point to a child and say; ‘i don’t trust you or i don’t trust your spouse.’”

m: “When you bring a child into the family real estate business you need to give him or her a way to make it their own.”

m: “the patriarch needs to embrace this need for change. he needs to put as much effort into developing a sustainable legacy as was invested into creating the wealth in the first place. the patriarch also needs to embrace having a child central to the business. finding ways to change gracefully opens an exciting opportunity to work together and develop skills. if the founder cannot teach his techniques and inspire with the vision that started and grew the company, he will never be comfortable letting the successor find his own way.”

deal, negotiating leases and creating value keeps them young. But, too often I see my clients transfer the reins of their empire when they are on the way to the hospital for the last time. The assets collected during their real estate career are often not a fit for the next generation and the “child” taking over the business is in his or her 50s or 60s. at this point, it’s a bit late to start to command the respect of employees, vendors, investors and lenders. Unfortunately, it is also too late for the new boss-child to gain the trust of the siblings who are not in the family real estate business.

r: Successfully transferring the business you’ve worked so hard to build to the next generation doesn’t happen overnight. If you envision your children taking over the management of your company, you need to start planning for that long before the actual transfer of control occurs. even if your children won’t be actively involved in day-to-day business operations, you still need to address concerns about how your wealth will be distributed and how your legacy will be maintained. This isn’t always easy to do, and the process can bring old resentments or previously unrealized feelings to the surface―both in yourself and in other family members. But, in my experience, avoiding these sometimes difficult planning issues is a recipe for legacy planning failure.

hoW do you bring the children or a child into the business?

r: you can’t assume that sharing your passion for your business will be enough. Instead, your children should learn by working in the family business. For a successful transition to happen, you must prepare your business for a time when you will no longer be making the key decisions.

First, one must realize that creating a successful real estate firm is very different from sustaining one. The roll-up-your-sleeves approach to making sure everything gets done―your way―does not work well in a larger organization with employees. Instead of being dominated by one individual who made certain what needed to get done was done now, a sustaining firm will rely on people who are well organized and have good attention to detail. Most will not tolerate the “drop what you’re doing now” approach.

Second, what you needed to do when you started your firm may no longer be sufficient. During the last 30 years the competitive landscape has changed. The sophistication, breadth and scope of issues facing real estate owners and developers have increased dramatically. What one person could handle before often requires two or more today.

Third, many successful families have learned that they don’t have all the answers and send their children to work in other successful real estate organizations before returning to run the family’s firm. I have worked with families without that experience and found significant shortcomings in one or more of their approaches.

but i love deal making. do i need to give this up?

e: No. But do not get wedded to your specific assets. It is time to begin making changes. recognize that assets that take effort (i.e. assets that need renovation or ongoing value-creation) usually do not fit with the goals of everyone in the next generation. It only takes one disgruntled child to throw a monkey wrench into the workings of the estate. Once the value has been created in an asset, think about trading it for one that does not need as high a level of effort and expertise.

If you have a child in the business who is a good deal maker, able to take risks and able to create value, try to set that child up to do deals when you are gone, without risking the assets of his or her brothers and sisters who may not be risk-takers. This often requires separating assets and creating two or more trusts.

r: My advice to the next generation taking control: One of your great strengths is doing what you love to do and doing it well. rather than trying to learn a new skill set, especially if it means doing less of what you do well, I recommend that you hire the talent, whether it’s an employee or contractor, to handle the other duties.

but my kids love each other. Why should i plan my affairs as if they Will fight over my Wealth?

Money issues are the biggest threat to family unity.

e: The objective is to head off strife. If I tell you the horror stories I’ve witnessed, you will claim that such fights could never happen in your family. But ask yourself: My kids get along now, but will they in 10 years time? Will their spouses trust the child I left in charge of my portfolio?

r: If you have taken one or more of your children into the real estate business, that son or daughter has a special status due to their knowledge, responsibilities and their own contribution to value creation. Unfortunately, that status may not be trusted or understood when you’re gone. you should anticipate that the child with special status will not get the respect from his siblings that you enjoy as their parent. Planning for conflict now may be unpleasant, but it will make it easier for your family to deal with a disagreement if one does arise after you’re gone.

m: “blood is thicker than water and money is thicker than blood.”

m: “hiring third-party talent when the patriarch is still on the scene is difficult. There is usually a lack of trust and a strong fear of losing control.”

b: “as the patriarch, you need to face your worst fear: that you have created a generation of entitled siblings waiting for the parents to pass so they can cash in their lottery tickets.”

b: “legacy is just another word for ego.”

Shift real estate asset from wealth-creation to income generation in the latter stage of your career.

What changes should i make to my real estate portfolio?

e: If you are like most successful, self-made real estate investors, your focus has been on building wealth. you have been ready

b: “When one sibling is cho-sen to run the business, the big question is always: if mom and dad loved us all equally, how come the sibling in charge of the business is getting more money than the rest of us? it is an uncomfortable subject for both parents and children, so it festers below the surface until the parents are gone.”

m: “preventing family strife is an honorable objective, but it can only be accomplished with insight, cooperation and continuous management that is open to adjustment for life’s changes and eventualities.”

Why does the single entity estate planning solution create so much strife?

e: Most developers have built a real estate portfolio of which they are proud, and they hate the thought of it being dismantled. as a result, they gravitate toward a single entity solution, which is also easier on the estate planner. This expert, usually a cpa or attorney,

Because, rather than solving differences on an asset-by-asset basis, the only solution is a break-up of the single trust. Think of this as a contentious divorce between your children. The lawyers do well but usually no one wins or is satisfied with the outcome.

is primarily focused on minimizing estate taxes. The continuity of your business or avoiding family strife is not usually an area of expertise.

r: To avoid strife, think about creating separate entities for each asset or at least two entities. One might contain the “coupon clipping” real estate and one would contain the assets that will need reinvestment or redevelopment. To do this, it helps to work with a professional who is experienced not only in estate planning, but also has a background in real estate and creating legacy solutions designed to avoid conflict.

Lawsuits over estate issues usually happen when the flow of checks stop. Separating assets out of a single pool will allow for a child who cannot or refuses to make their capital call to sell out or be squeezed down in ownership in that one asset, without jeopardizing that child’s ownership and cash flow from the other assets. Several small problems are easier to solve than one large problem.

to reinvest if it creates value. I have many clients who made tens of millions but lived frugally for most of their lives. assume that one or more of your children or their spouses will be more focused on receiving a steady income from the portfolio than seeing that portfolio managed to maximize the creation of wealth.

r: In my experience, I’ve found that the disruption of steady distributions is one of the most common issues for strife in family-run portfolios. at the risk of spouting heresy, I am a proponent of broad diversification. Although you may have created your wealth through real estate and never enjoyed much success with other types of investments, there are significant benefits that come from diversifying your wealth. Diversification reduces your exposure to an unsuccessful succession or the squabbling over the family fortune. also, it is unrealistic to expect that real estate will continue to outpace other investments. comparing the returns reported in the NcreIF property Index with other asset classes bears this out. I have found the key to successful diversification is avoiding investment programs that favor the sponsor at your expense. Fortunately, there is a growing cadre of financial products and advisors who can help you successfully diversify.

The role of the sibling(s) active in the real estate business is not understood, appreciated and/or compensated.

What else causes the most sibling strife?

e: The parent often splits the estate evenly between the children. an even split is the easy solution.

If some siblings go on to professions or careers and one or more stays behind to help run the real estate business, that sacrifice is seldom understood, appreciated or compensated by the siblings who are not in the real estate business. So where is the reward for the child running the assets for the benefit of his brothers and sisters? A property management fee is usually not enough. even so, a property management or asset management fee paid to the sibling in the business is still often resented by the other siblings.

r: Besides money, control can be a problem. Many trusts vest control proportional to ownership in the trust. Because the siblings outside the business don’t understand the vicissitudes of commercial real estate, they mistrust the advice of the active brother or sister.

Ongoing mistrust too often leads to accusations. and accusations can lead to a messy lawsuit that breaks up the estate. These lawsuits are by design confrontational, and this confrontation too often leads to estrangement among family members. The last thing most successful entrepreneurs want is to see what they’ve built destroyed because their heirs can’t work together in a constructive way to continue the family legacy.

As a financial advisor, my goal is to try to prevent family strife so that the wealth that mom and dad worked so hard so to accumulate allows their kids―and the generations that follow―to be happy and successful.

rick raybin, cpaa principal with the lifetime capital group.

I am a financial advisor specializing in cross-generational wealth transfer. I started my career as a cpa. From 1979 to 1990, I was the cFO of the rreeF Funds (now the real estate investment management business of Deutsche Bank’s Asset Management division) and also served as the first president of NcreIF. as ceO of Lifetime capital group, I help successful individuals and their families build financial security by serving as their personal chief financial officer. My work includes legacy and estate planning for families with significant real estate investments

eric von berg, cmba commercial property mortgage banker with newmark realty capital, inc.

I started my mortgage banking career with clients who were 20 to 40 years older than me. Now I am working with these same families as the assets move to the next generation. I have seen too much family strife that could have been prevented. reworking a real estate portfolio takes planning, time, skill and financial engineering: I enjoy working as part of an estate planning team as the real estate and finance expert. I attended good schools, but my real expertise—both in real estate and estate matters—comes from watching my clients’ mistakes.

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