Structuring the Family Office. Insourcing versus Outsourcing Decisions for Real Estate Investments into Foreign Markets

Term Paper, 2013
34 Pages, Grade: 1,2


Table of Contents

List of Abbreviations

List of Figures and Tables

1 Introduction
1.1 Problem Definition and Research Objective
1.2 Course of the Investigation

2 Family Office Business
2.1 Family Offices
2.2 Scope of Services and Outsourcing Considerations..
2.3 Asset Allocation for Family Offices.
2.4 Synergy Considerations for Real Estate Investments

3 Real Estate Investments by Family Offices
3.1 General Real Estate Investment Strategies
3.2 Real Estate Market Entry Challenges
3.3 Geographical Diversification into Foreign Markets
3.3.1 Macro Perspective - Real Estate and Other Economic Force
3.3.2 Micro Perspective - Market Particularities

4 Case Studies
4.1 Outsourcing Opportunities at Ernst & Young LLP
4.3 Club Deal Structure at Taurus Investment Holdings, LLC

5 Conclusion.
4.1 Summarizing Reflection
4.2 Prospectus and Future Research Possibilities.

Reference List.


List of Abbreviations

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List of Figures and Tables

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1 Introduction

The term family office (FO) is a hot buzzword in the financial services industry today (Bowen Jr., 2004). As their wealth increases, families will at some point likely turn to advisors to assist with the management and protection of their prosperity. These professionals working under one roof are commonly referred to as family office (Cestnick, 2011).

Like any business operating in the capital markets, family offices focus on the achievement of superior performance and investment return maximization. Yet, in a globalized world, markets have turned out to be fairly volatile during the past two decades. In particular as a consequence of the 2008 financial crisis, markets have been turbulent all around the world (Adair, Berry, Haran, Lloyd, & McGreal, 2009). Still today, Europe - as an economic entity - appears to be sensible to the offshoots of the financial and economic depression (Adair et. al., 2009).

During such times, the axiom for a family office may be contrasting: If only few reputable investments turn out to be profitable, the primary objective rather has to be the diversification and securitizing of assets and risks (Basel Committee on Banking Supervision, 2011).

Hedging against inflation and economic disruptions, both gold and real estate, often considered the classical alternative investments, have lately received increasing attention by academic scholars and practitioners (Bond & Seiler, 1998; Enns, 1979; Preston, 2011; Worthington & Pahlavani, 2007). Real estate, in particular, is considered favorable by some as, unlike for gold, capital gains are not the sole source of income and positive cashflows on income properties may be achieved on a reoccurring basis (McKnight, 2010).

1.1 Problem Definition and Research Objectives

May it be real estate or any other investment in the global financial services industry, it all comes down to one essential problem setting: Investors have to rationally analyze the risk-return ratios of their actions. During the economic and financial crisis in Europe, families will find it hard to achieve risk-adjusted returns in their home markets only. Hence, it may be a tempting claim to reallocate some of the assets and risks across borders, where risk and return better match the individual investors’ preferences.

Having this consideration in mind, the research objective of this paper is to examine how family offices can seek real estate investments in foreign markets and if it is profitable. Therefore, it is aimed to obtain insights into the family office business and to understand how FOs can be structured beneficially in this process. Moreover, the strategy for a real estate operation going abroad has to be evaluated. Here, an individual investigation on real estate investment size, structure, and mix of outsourcing and insourcing decisions has to be executed. It is desired to evaluate a practical strategy that family offices can use during the process of entering a foreign real estate market.

1.2. Course of the Investigation

This paper is arranged to consist of three parts.

The first part is dedicated to an analysis of the family office business. Therefore, the term family office is defined and different types of FOs are displayed. Additionally, the family office scope of services will be presented. For that reason, the consideration of outsourcing opportunities is scrutinized. Having allocated their assets, liquidity issues in real estate may arise for family offices. Using sophisticated literature, this is a matter that will be deeply reviewed.

Second, real estate investments by family offices are investigated. As a starting point, an introduction to the relevant real estate considerations is given. Building the basis for further examination, essential real estate market entry barriers are named. Thereafter, geographical diversification into foreign real estate markets is considered. From a family offices corporate strategic point of view, a micro and macro approach for real estate market entries is laid out. Various academic perspectives on the specific matters are evaluated.

During the third and final part, a dedication to the practical approach entering a foreign market will follow. In order to confirm the insights gained in the previous chapters, two case studies are portrayed. First, outsourcing opportunities with a consultancy firm, namely Ernst & Young LLP (EY) are shown. Second, an example of a possible investment vehicle into a foreign market is elaborated on. Here, a case study of a transaction by the real estate private equity firm Taurus Investment Holdings, LLC (Taurus) is given.

The study ends with a summarizing conclusion and prospectus.

2 Family Office Business

2.1 Family Offices

Family offices as we know them today, may have begun in both Europe and the U.S. several centuries ago, when wealthy individuals assembled trusted professionals to oversee and administer their wealth while they were traveling (Gray, 2004). To this day, the conceptual purpose of a family office - to preserve and administer a family's wealth, that is, to centralize the management of a significant family fortune - has not changed (López, López, & Vazquez, 2011). Many wealthy families have created family offices, private trust companies, and similar entities to manage their investments and provide fiduciary and other services (McDermott Will & Emery [MWE], 2011). Yet, the term “family office” lacks a clear definition (Bowen Jr., 2004), because each office has its own goals, preferences and requirements when it comes to business, culture or investment approach (Marsh, 2012, p. 11).

Scholars have come to an agreement to distinguish three different types of FO’s (e.g., Burri & Reymond, 2005; Castro-Balaguer & Fernandez-Moya, 2011; Elliot, 2010; Mathieu, Strassler, & Pearl, 2010). As a distinction, the number of families per office is used as the main criteria.

Single-family offices (SFO) serve just one single family. At least $500M in assets are necessary to profitably run this enterprise (Burri & Reymond, 2005). SFO’s can be very advantageous (Castro-Balaguer & Fernandez-Moya, 2011): by coordinating all functions through one office, the family’s financial life is much easier to manage and control (Bowen Jr., 2004).

In multi-family office s (MFO) multiple families combine their resources. Thereby, they are able to capture a higher level of cost and operating efficiency (Bowen, 2004). However, Castro-Balaguer and Fernandez-Moya (2011) stress, that potential conflicts of interest with other families are disadvantageous and risky. While many exceptions exist, MFOs typically handle families with $25M or more of investable assets. Commercial family offices (CFO) are investment advisers who offer money management and administrative services (Bowen Jr., 2004). The advantage is that these offices provide a professional and experienced team of managers that reduce task monitoring and entail lower costs by not creating a dedicated structure (Castro-Balaguer & Fernandez-Moya, 2011). However, during the transition from a single-family office to the commercial family office, families might find the cultures too different (Soldano & McCarthy, 2005).

As depicted in Figure 1, it becomes increasingly hard to align interests as the number of families in a family office structure rises (Soldano & McCarthy, 2005). Reibling (personal communication, August 15, 2013) characterizes this as the most critical incident in the FOs practice.

Figure 1. Types of Family Offices and the Degree of Complexity in the Alignment of Personal Interests. Own Displaying.

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2.2 Scope of Services and Outsourcing Consideration

Family offices offer a vast scope of services to their clients (i.e. the families, cf. Figure

2): Besides their core competency of financial investment services, FOs nowadays have many more offerings, such as philanthropy, office administration, and personal support. This is because high net worth individuals require tailored and personal solutions (Bowen Jr., 2004). To some extend, that might even be household help or travel arrangements (Johnson, 2011). Educational development of the own family members also became an important component (Castro-Balaguer & Fernandez-Moya, 2011).

Figure 2: Family office scope of services. (Adapted from Johnson, 2011, p. 681).

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Considering the vast scope of services, it is hard for FO’s to develop the expertise to meet or exceed benchmarks (i.e., what competitors such as private banks are able to offer) in all of the respective areas (Mathieu et al., 2010). Properly managing the family's investment portfolio requires insight, allocation of resources, capital outlay, and consistent administration (including managing legal and regulatory requirements), particularly when the investments under management represent portfolios of various family members (Johnson, 2011). Given this high level of complexity, only few advisers are fully qualified to meet all the needs of the wealthy and, thus, high salaries are necessary to appoint capable personnel (Bowen Jr., 2004). Yet, family offices, as any business, require capital to operate office space and infrastructure. Ultimately, profitability becomes a threat (Bowen Jr., 2004):

Interviewed by Marsh (2012), Senior SFO Executive William Chang states that private banks ask for advisory and management fees of 1-2% in assets under management (AUM). Therefore, only few families have the ability to build a financially successful in-house platform that would outperform the competitors (Johnson, 2011). “For example, a $100 million [in AUM] FO may have a $1 million salary budget [i.e. 1% in AUM]. That means, say three or four staff, each on $200,000 or $300,000 a year, depending on how senior they are” (W. Chang, cited in Marsh, 2012).

Concluding, the amount that justifies setting up a FO with full staff and infrastructure needs to be sizable. Regrettably, the sum has not yet been clearly defined (Marsh, 2012). Even with a budget of several hundreds of millions, families will have difficulties to afford a top-notch operation (Reibling, personal communication, August 15, 2013). In the entirety of the observations of this paper, the views range from assets under management (AUM) starting at $100M up to $500M as a beginning point (e.g., Bowen Jr, 2004; Johnson, 2009; Marsh, 2012; Steinberg & Green, 2013; Vorhees Family Office Service, 2013).

The common guidance to increase operating profitability proposes to make use of external advisors rather than permanently hiring in-house staff for every service (Johnson, 2011; Elliott, 2010; Mathieu et al., 2010; Zaret, personal communication, May 27, 2013; Bowen, 2004; Marsh, 2012). Elliott (2010) describes it as the family offices challenge to find the right and unique combination of in- and outsourcing decisions in order to be successful. This view is shared by Mathieu et al. (2010), who express it as the central task for a family office to understand what they require in expertise and trusted advice. To conclude, family offices make it their business to know the best experts in any field (Bowen Jr., 2004)

Regarding the individual “outsourcing culture” of a family office, it is hard to make generalizations. In practice, FOs typically have some in-house staff to provide core services of investment management and administrative services, such as recordkeeping, asset management, aggregated statements, and accounting (Bowen Jr., 2004). However, other tasks like professional due diligence for an investment, valuation, or the creation of a legally secure investment structure (i.e., entity selection and tax structure) are often outsourced (Johnson, 2011; cf. Figure 2). Referring to complex tasks, Zaret (personal communication, May 27, 2013) weights that the use of professional consultancy firms can increase the quality of the operations.

2.3 Asset Allocation for Family Offices

Within the variety of services provided by family offices, the investing of the families’ capital is one of the original core competencies. In order to execute investments, it is important to understand that, first of all, an asset allocation that overlooks the needs and wants of all the family members needs to be designed (Gray, 2006; Mathieu et. al., 2010).

The term asset allocation is generally defined as the diversification of an investor’s portfolio across a number of asset classes (Sharpe, 1992). Family offices can diversify their portfolios by either increasing the types of assets or the geographical location of the assets’ origination (Basel Committee on Banking Supervision, 2011). Professionals endorse making this consideration within the inner circle of the owners of the family office and its most senior management (Reibling, personal communication, August 15, 2013; anonymous SFO-executive in Marsh, 2012). During this process, the specific allocation problem to a family office is to seek the combination of assets and investments that best suit their individual risk-return preference in a market environment (Meucci, 2005). Having confirmed this primary consideration, Reibling (personal communication, August 15, 2013) suggests that feedback should then be assembled from external experts that have the least bias or interest in the assets and investment activities of a family office.

Carefully shifting the focus of this paper, it has to be mentioned that one possible asset to diversify across is real estate. Quan and Quinly (1991) note that a large part of studies conclude that real estate has provided a higher risk-adjusted return compared to other investment instruments; the inclusion of real estate in a portfolio of investments can therefore reduce portfolio risk1.

2.4 Synergy Considerations for Real Estate Investments

Diversifying their funds across different asset classes (one of them being real estate), family offices automatically reduce their financial power for each individual investment (cf. Figure 3). Reibling (personal communication, August 15, 2013) states that the “critical mass” for real estate investments into foreign markets is at $150M-$500M (multiple investments per market possible). Having assigned both their AUM as well as their liquidity to different assets (including real estate), it becomes questionable if family offices remain to have the critical mass to successfully engage into real estate investment activities (Reibling, personal communication, August 15, 2013; Johnson, 2011; Marsh, 2012). In accordance with this argument, Figure 3 displays different asset allocations by billionaire and millionaire SFO’s in both the Americas and Europe on average.

Figure 3. Average Asset Allocation by Wealth. (Own displaying according to Amit et. al., 2008, p. 27)

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As depicted in Figure 3, average allocation to real estate ranges between 4-18%. At the current market environment, Reibling (personal communication, August 15, 2013) suggests that European high net worth individuals and family offices should allocate between 5-10% to foreign real estate investments. For this reason, even if the family office is able to set up a fruitful investment platform with qualified advisory personnel, only a fraction of the original assets are available for real estate investments. Therefore, family offices will find it tough to compete in the international real estate markets that are often dominated by local institutional players (Reibling, personal communication, August 15, 2013).

If they have not themselves the needed funds to profitably engage into a real estate investment - may it be foreign or home markets - family offices, as any investors, will have to learn to innovate and apply different business models (Layak, Punj, & Seetharaman, 2013). In the interest of raising equity and splitting risk, family offices have several options:

First, single family offices can try to merge with other family offices that have aligned interests (Elliott, 2010). This would result in a MFO or CFO structure. Second, family offices of any type (SFO, MFO, CFO) can try to engage alternative forms of cooperation. As for any company in general, these options can be described as networks, (strategic) alliances and especially joint ventures (Moser, 2012). Analyzing this from a more functional perspective, typically, family offices invest into a “club-deal” structure, acquiring shares of Special Purpose Vehicles (SPV) that are set up by the private equity firm in order to invest into selected properties (Schindel & Reid, 2006). Furthermore, the option of setting up joint ventures is the most popular strategy in todays practice. (Layak et al., 2013). Engaging with the existing land or property owner can help ensure quality of the acquisition, as the sell-side suddenly has an interest in the success of an investment (Reibling, personal communication, August 15, 2013).

Nonetheless, co-investing requires careful review in-house (anonymous SFO executive in Hong Kong, cited in Marsh, 2012). For this reason, responsibly managing the families’ undertaking depends critically upon the understanding of real estate investments.

3 Real Estate Investments by Family Offices

3.1 General Real Estate Investment Strategies

For the purpose of a real estate investment, three general possibilities to achieve a positive return have been classified. McKnight (2010) characterizes them as follows:


1 They hereby refer to studies of Fama and Schwert (1977); Webb and Sirmans (1980); Miles and McCue (1982, 1984); Ibbotson and Siegel (1984); and Brueggeman, et al. (1984).

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Structuring the Family Office. Insourcing versus Outsourcing Decisions for Real Estate Investments into Foreign Markets
EBS European Business School gGmbH  (Strascheg Institute for Innovation and Entrepreneurship (SIIE))
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structuring, family, office, insourcing, outsourcing, decisions, real, estate, investments, foreign, markets
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Florian Manz (Author), 2013, Structuring the Family Office. Insourcing versus Outsourcing Decisions for Real Estate Investments into Foreign Markets, Munich, GRIN Verlag,


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