A large chunk of DC’s real estate is held by companies with only a handful of owners or shareholders. So how do companies like Lerner Enterprises and Gould Property Co operate differently?

Baker Tilly partner Dwayne Holt says closely held real estate companies differ from public, institutional or non-closely held entities in several predictable ways, and understanding how and why is integral to engaging these firms, empowering them and maintaining a healthy working relationship with their constituents.

Definition

A closely held real estate company is a family or very small group of active individuals who own or control assets. It is usual for the ownership group to collectively manage, develop, construct and/or lease the properties and buildings in their portfolio.

Advantages

Dwayne tells us that, compared to a publicly traded REIT or other institutional ownership, they are sometimes limited by a lower risk tolerance, cost of or access to capital, and a lower threshold deal size, but benefit from aligned owner and manager interests, speed, deep local market knowledge and strong relationships.

Closely held companies investing only their own capital—instead of other people’s money—usually have a lower risk tolerance. It’s typical for these investors to be somewhat conservative.

Because these firms are owned and managed often by the same people, that reduces, and in many cases eliminates, the potential problem that arises as the manager looks short term and ownership is usually more concerned with the distant future.

Disadvantages

Most closely held companies do not have the same access to capital or accumulated funds to deploy as do REITs and institutional funds. That usually results in a higher cost of capital, taking them out of the marketplace in certain areas—downtown DC, for example—where a significant barrier to entry is cost.

Differentiators

Dwayne says closely held companies usually focus on smaller geographic areas because of their limited resources and in-depth knowledge of their communities.

They tend to focus on one market and a certain product type, but they establish deep relationships, sometimes spanning generations, and develop equally deep market knowledge in the location in which they choose to do business.

Another key advantage stems from the fact they can move more quickly and act opportunistically, because deals are not subject to layers of approval.

Finally, Dwayne says that “deal threshold creates a niche for closely held companies, as an institutional real estate company might not look at a deal under, say, $50M” that a closely held company might jump at.

Dwayne's clients typically have a long-term plan for their acquisitions and are different than institutions, but similar to foreign investors, in that they are “much more focused on cash flow than current values.”

After site selection, development and lease-up, much of a property’s value is dependent upon market forces and not management expertise. Cash flow is more heavily influenced by management decisions.

“All of my clients watch year-over-year cash flow from their investments very closely since that pays the bills and funds owner distributions,” Dwayne says. "High values are usually only important when you need to finance or sell an asset."

Most closely held companies don’t sell often because of transactional costs and income taxes. Transactional costs, including transfer taxes, brokerage fees and professional fees, can be significant.

All of these costs and taxes diminish working capital, which can make it extremely difficult to find a new investment that will generate similar cash flow.

Tax-deferred exchanges and other creative disposition strategies can insulate investors, allowing them to defer or eliminate taxes. But a lot of Dwayne's clients simply buy and hold.

Guidance

Accountants and advisers can assist family-oriented clients with a number of areas: tax advice, entity structuring, wealth transfer and succession, tax and cash flow projections, repair and maintenance analyses, understanding state and local tax incentives, benchmarking data and facilitating access to potential partners in the real estate ecosystem.

Dwayne’s clients rely on him not only for the versatility of his team’s services, but also for the care with which they treat the intimate details of their client’s financial life. Among closely held companies, trust and loyalty are tantamount, and built up over time.

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