Ep 188: Leading With Directly-Held Real Estate Advice To Differentiate Traditional Wealth Management with Rich Arzaga

Summary

Financial Advisor Success Podcast Summary
Episode 188: Leading With Directly-Held Real Estate Advice To Differentiate Traditional Wealth Management with Rich Arzaga
Host: Michael Kitces
Guest: Rich Arzaga, Founder of Cornerstone Wealth Management
Release Date: August 4, 2020

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1. Introduction

In Episode 188 of the Financial Advisor Success podcast, host Michael Kitces welcomes Rich Arzaga, the founder of Cornerstone Wealth Management. Rich distinguishes himself in the financial advisory landscape by integrating directly-held real estate advice into traditional wealth management, leveraging his dual certifications as a Certified Financial Planner (CFP) and a Certified Commercial Investment Member (CCIM).

Notable Quote:

• Rich Arzaga [00:27]: "Rich is one of just a handful of advisors across the country who holds the CCIM designation to advise clients on commercial real estate."

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2. The Importance of Directly-Held Real Estate in Financial Planning

Rich emphasizes that directly-held real estate constitutes approximately 30% of total wealth in America. Despite its significance, many financial advisors lack the expertise to provide comprehensive advice in this asset class, presenting a substantial opportunity for specialization.

Notable Quote:

• Michael Kitces [05:00]: "Real estate is a very big asset class. It represents maybe 30% of this country's wealth."

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3. Rich Arzaga’s Journey into Real Estate-Focused Financial Advising

Rich recounts his transition from the technology sector to financial planning in the early 2000s. Dissatisfied with the generic real estate advice he received from other planners—either being encouraged to sell properties or merely adding their values to financial plans without deeper analysis—Rich saw an unmet need for specialized real estate financial planning.

Notable Quote:

• Rich Arzaga [00:16]: "I became the person that I was looking for back in the early 2000s."

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4. Integrating Real Estate Analysis into Financial Plans

Rich utilizes an Annual Property Operating Data Analysis (APOD) as part of his clients' financial plans. This comprehensive analysis goes beyond basic asset valuation, examining cash flows, taxes, and the performance of each property to provide actionable insights.

Notable Quote:

• Michael Kitces [08:13]: "I just wanted somebody who is smarter than me to say, you know, here's a few things that I see and what you're doing."

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5. Fee Structure for Real Estate Analysis

Rich explains his fee model, where initial financial planning fees include real estate analysis add-ons. For instance, a standard comprehensive plan starts at $4,900, with an additional $500 per property evaluated. Complex cases may require higher fees, but the structure remains scalable based on the number of properties.

Notable Quote:

• Michael Kitces [21:57]: "Our base planning fee is $4,900... we add about $500 if they have one rental property, another $500 for two, and so on."

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6. Tools and Methodologies for Real Estate Analysis

Rich employs APOD spreadsheets to pro forma property cash flows, integrating these analyses into financial planning software like E Money Advisor. These tools account for various expenses, tax implications, and projection scenarios to assess the viability and performance of real estate investments.

Notable Quote:

• Michael Kitces [24:34]: "APOD stands for Annual Property Operating Data. We use it to pro forma the cash flow for the property that the client owns."

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7. Building and Growing a Real Estate-Focused Advisory Firm

Rich details his strategic approach to growing Cornerstone Wealth Management by embedding himself within the real estate community—attending CCIM chapter meetings, partnering with realtors, brokers, and attorneys, and conducting real estate advice workshops. This niche-focused strategy fostered referrals and led to steady business growth.

Notable Quote:

• Michael Kitces [50:29]: "Most of my relationships in the beginning were from that community. Then they broadened when clients had their advisors and I contacted."

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8. Impact of the 2008 Financial Crisis on the Business Model

The financial crisis of 2008 posed significant challenges, particularly for Rich's directly-held real estate clients facing declining property values and increased risks. This period led to a temporary stagnation in business growth, highlighting the vulnerability of specializing in a single asset class during economic downturns.

Notable Quote:

• Michael Kitces [61:00]: "The Crisis was dated 2008 and 9. What happened to us is that we were flat for a while. It did have an impact."

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9. Current Practice Structure and Revenue Streams

Today, Cornerstone Wealth Management oversees nearly $70 million in assets for 65 affluent clients. Approximately 40% of these clients have directly-held real estate investments. The firm's revenue streams include upfront planning fees, ongoing Assets Under Management (AUM) fees, and insurance products. Rich also discusses his ventures into insurance through a separate brand, Insurance Whisperer, to complement financial planning services.

Notable Quote:

• Michael Kitces [66:18]: "We charge a classic 1% fee on AUM from $500,000 to $2 million, with slight variations for larger portfolios."

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10. Insurance Whisperer: Expanding Services

Rich introduces Insurance Whisperer, a brand he developed to provide fiduciary-based insurance services to Registered Investment Advisors (RIAs). This initiative aims to fill the gap in insurance product offerings, ensuring clients receive tailored and trustworthy insurance solutions alongside their financial plans.

Notable Quote:

• Michael Kitces [68:19]: "Insurance Whisperer helps RIAs who want an insurance partner or who might have an insurance license, but they don't want to do it themselves."

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11. Advice for Advisors Specializing in Real Estate

Rich offers valuable guidance for advisors interested in integrating directly-held real estate into their services:

• Passion and Interest: Ensure genuine interest in serving clients with real estate investments.
• Credentialing: Pursue certifications like CCIM to build expertise and credibility.
• Community Engagement: Actively participate in real estate-focused communities and networks.
• Tools and Processes: Develop or utilize reliable tools for property analysis to streamline the advisory process.

Notable Quote:

• Michael Kitces [80:56]: "Make sure that you have an interest in serving that community... Become credentialed, take the best education."

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12. Defining Success in Financial Advising

When discussing success, Rich emphasizes its multifaceted nature, encompassing family, client relationships, and business growth. He highlights that success is dynamic, with metrics evolving as one achieves various milestones.

Notable Quote:

• Michael Kitces [87:16]: "It's all different... When you get to those, the metrics move. They just... So I don't have a definition for that."

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13. Conclusion

In wrapping up, Rich shares his aspirations to further integrate real estate advice and expand Insurance Whisperer, aiming to blend fiduciary-based insurance solutions with comprehensive financial planning. He underscores the importance of continuous growth and adaptation in achieving sustained success.

Notable Quote:

• Rich Arzaga [88:27]: "The growth journey in and of itself is the point."

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Key Takeaways

• Niche Specialization: Focusing on directly-held real estate can differentiate an advisory firm in a crowded market.
• Comprehensive Analysis: Utilizing tools like APOD and integrating real estate into financial planning provides deeper insights for clients.
• Strategic Networking: Building relationships within specialized communities (e.g., CCIM) fosters referrals and business growth.
• Resilience: Specialized business models may face challenges during economic downturns, underscoring the need for adaptability.
• Diversified Revenue Streams: Combining upfront fees, AUM fees, and insurance products ensures multiple income sources.
• Continuous Learning: Pursuing advanced credentials and expanding service offerings (e.g., Insurance Whisperer) can enhance credibility and service quality.

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Resources Mentioned:

• APOD (Annual Property Operating Data) Analysis: A tool for pro forma real estate cash flow analysis.
• CCIM Designation: Certification for professionals specializing in commercial real estate investment.
• E Money Advisor: Financial planning software used for integrating real estate data into comprehensive plans.
• Insurance Whisperer: Rich Arzaga’s brand offering fiduciary-based insurance services to RIAs.

For more insights and resources on building a successful financial advisory practice, visit Nerd’s Eye View.

Transcript

[Michael Kitces]

Welcome to the Financial Advisor Success Podcast.

[Rich Arzaga]

Where you go behind the scenes with financial planner, speaker and consultant Michael Kitces to hear stories of how leading financial advisors navigated the inevitable challenges that arise.

[Michael Kitces]

On the path to success and get.

[Rich Arzaga]

Insight from leading industry consultants about how.

[Michael Kitces]

To break through to the next level.

[Rich Arzaga]

In your advisory business.

[Michael Kitces]

And now, here's your host, Michael Kitces.

[Rich Arzaga]

Welcome everyone. Welcome to the 188th episode of the Financial Advisory Success Podcast. My guest on today's podcast is Rich Arzaga. Rich is the founder of Cornerstone Wealth Management, a hybrid advisory firm based in Northern California that oversees nearly 70 million of assets under management for 65 affluent clients. What's unique about Rich, though, is that he's one of just a handful of visors across the country who, in addition to being a CFP certificate, also holds the CCIM designation to advise clients on commercial real estate and in practice has been able to turn his ability to advise on directly held real estate investments into opportunities to gain clients for his traditional wealth management services as well. In this episode we talk in depth about how Rich incorporates advice on directly held real estate into his practice. The apod, short for Annual Property Operating Data Analysis he prepares to clients as part of their financial plan, the tools that Rich uses from E. Money Advisor to separate Excel spreadsheets to track and analyze directly held real estate for clients and why Rich charges an upfront but not an ongoing financial planning fee for his real estate analyses. We also talk about how Rich was able to turn his directly held real estate advice into a growth engine for his advisory business, the unique networking opportunities he was able to develop through the CCIM organization as a holder of their designation, why Rich used but now stays away from advising clients on REITs as an alternative to directly held real estate and why Rich views advising on directly held real estate is a great way to open the door for clients, but traditional wealth management is a better approach for generating ongoing revenue as an advisor and be certain to listen to the end where Rich shares how he turbocharged his advisory firm in the early years as a career changer coming into the financial advisor world, why he pursued the education for both his CFP and CCIM designations before he launched his firm even though he didn't have the experience to actually use either of the marks, how Rich became an adjunct professor teaching financial planning early in his career as a way to further establish his credibility and why the financial advisory business can be challenging for career changing entrepreneurs because in the end, even for successful advisors, the path to growth is rarely a good sprint and More commonly a very long marathon. And so with that introduction, I hope you enjoy this episode of the Financial Advisor Success podcast with Rich Arzaga. Welcome, Rich Arzaga, to the Financial Advisor Success podcast.

[Michael Kitces]

Thank you, Michael. And thanks for the headset, by the way.

[Rich Arzaga]

Absolutely. I'm glad you could join us in. We try to make sure all of these have good, consistent sound quality. So we always send some headsets out to guests to record with and keep with our compliments. I'm excited about the podcast and the discussion today because I know you have what I think, at least relative to Advisor World, is a somewhat unique practice and, and, and specialization and expertise and that you, you do a lot of work with directly held real estate. And I feel it's like, like it's one of those worlds that we just do very little of in Advisor World. Despite, you know, lots of people have created a lot of significant wealth with real estate investing. You know, I don't know how much of it is maybe even some of the conflicts of our business model. A lot of us work on assets under management, and short of selling or getting paid to manage a reit, I don't, I don't often get paid with direct real estate, so I kind of have an incentive to have clients pick portfolio based investments. You know, we don't really teach it terribly deeply in things like the CFP curriculum. So for some, I think we probably just have an expertise gap in being able to get in deeply. But you, you've done a lot of work around this, you work with clients around it, you actually teach a course on it. And so I just, I'm excited to kind of dive into this intersection of what does it look like to advise clients on directly held real estate as part of a financial advice offering.

[Michael Kitces]

Good. I, I hope it helps.

[Rich Arzaga]

So talk to us a little bit about how you, I guess, came to this place, this journey of having directly held real estate as part of your portfolio of what you do in giving advice to clients.

[Michael Kitces]

Back in 2000, I was coming out of the technology world. It was a startup company and it was sold to a blue chip company. I thought I was retired at that point. So I was looking for a planner and I interviewed a number of them here in the Bay Area, the East Bay in particular, and the mix of things that I needed help with included, you know, estate planning. I was going through stock options, so help with that. So certainly taxes, financial planning, and also real estate, because I had some smaller directly held real estate investments here in the Bay Area. And so when I Interviewed these advisors. I got the same two answers on real estate consistently from them. One group would say good for you on your real estate. And that was the time when the real estate market is, you know, still, you know, doing okay and pre housing crisis decline.

[Rich Arzaga]

Understood.

[Michael Kitces]

Yeah, Congratulations. So that's where that came from. And why don't we sell those and we can put those in bonds. Okay. So that was their real estate alternative. The second group was good for you. Congratulations. Go ahead and just give me the numbers on those and we'll add those to your plan. So it really just became data, but it wasn't really advice. And I know because I had previous dealings in real estate that the real estate is a very big asset class. It represents maybe 30% of this country's wealth. So I thought, you know, with all the advisors out there and all that they do to impact people's lives and this being 30% of the total wealth in America, there's a wide open niche opportunity for an advisor who knew about how to help clients with their directly held real estate investments. So I became the person that I was looking for back in the early 2000s, which I, which I feel like.

[Rich Arzaga]

Is the, like the quintessentialism of most entrepreneurship. Like had problem, couldn't find solutions, said, darn it, I'll make solution, sold it to other people, have business.

[Michael Kitces]

Yeah, exactly, exactly. Plus it was a fun asset class for me. I really enjoyed it. So it was an easy niche or problem to solve.

[Rich Arzaga]

So talk to us more about, I guess I'm wondering even from the, I'll call it from the client side, right, for where you were even then as you're going to advisors saying like, give me, you know, give me the numbers. I guess like, you know, what's your free cash flow? Because I can put that as a cash flow on your, on your, in your plan. What's the property worth? So I can put that as an asset into your plan. What were you hoping the advisor would ask you about or give advice on that? They weren't doing that. You, you would have thought that they would have been doing like what, what was the advice gap?

[Michael Kitces]

Yeah, that's, that's a great question. I guess I was hoping for some sort of collaboration on that. At that time I wasn't really, I knew a lot about the asset class, but I wasn't really the expert. So I thought I made good choices, but I wasn't certain about that. It would be nice to have somebody who is smarter than me to say, you know, here's a Few things that I see and what you're doing. So some sort of assistance around how is it performing? Is it complementary to your existing, you know, set of assets? Is the cash flow really necessary? Is it conflicting with other cash flows and is it causing taxes? I just wanted somebody to put it in perspective of, you know, our entire picture and also just to get some sort of advice. Either way, if it was this is a good idea or this is a bad idea, I'd like to hear that too.

[Rich Arzaga]

But the idea being not just about real estate in the aggregate, like, you wanted this down to like, let's talk about this property. Like, I'm not just looking for real estate advice. I'm looking for, like, advice about this piece of real estate that I have a deed that says I own. I need to know what to do with it.

[Michael Kitces]

Yeah, that's right. A little bit more in depth on that investment as they would a fund that they would choose. Maybe not as detailed because I know they don't. The operating part is out of their hands, but just more of a higher level in terms of the cash flows on property.

[Rich Arzaga]

Interesting. So what did that then take you towards? Like, did you go out immediately and say, okay, I've now realized in my moments of epiphany, not being well served by advisors, that I'm going to go become an advisor and I'm going to do this as my thing. Like, was it, was it that direct and immediate that you said, all right, I'm going off to do this?

[Michael Kitces]

It went in increments. I think I took some time off, actually worked for a company, Prudential Real Estate. They were very. One of the larger brokerages, brokerage companies in the real estate business. And I was working in their new media, trying to start that up for them in house. And while I did that, I decided to go ahead and begin to take courses that took me in the direction of, of this. So I always knew about a year or two I'd be out and doing what I'm doing now. So the two approaches are, one is take CFP courses. And back then in 2001, 2002, I imagine the best way to become a CFP and an advisor, to take CFP courses. And then the other was to take CCIM courses. And what CCIM is, it's a top designation. Like the CFP is for commercial real estate. It stands for Commercial Real Estate Investment Members. It's kind of an awkward name, but it's ccim. So I ended up taking courses for both and got, you know, dually I guess, educated. And then I got. Then I realized after, pretty much after I took the CFP courses, as many of my students do now, or some of them do now, that you don't need to take those courses to get licensed for the business.

[Rich Arzaga]

You were actually coming out, assuming, like, I need the CFP certification to get my license, be an advisor. And then got out, was like, oh, well, I guess that'll still be useful education.

[Michael Kitces]

Yeah, Well, I knew I wanted to be a cfp, but I didn't know I can get started. So I really. And I thought I did, you know, enough work, but I was so focused on the CFP that that's the direction I went. So by 2003, I had my education done for both and I began getting licensed and really started practicing in 2004. So it was a little bit slower because I. I decided to go and take the educational route. But that's how I got to, you know, getting the credentials for. For what we do now.

[Rich Arzaga]

And so how did you, how did you launch and get started? Like, where, where did you go? Like, did you hang your own shingle from the start? Did you join a large firm? What did the entry pathway look like when you. When you decided to come in knowing you were coming with this CCIM designation that not many other advisors at all have?

[Michael Kitces]

Yeah, back then, I think they were. I did a search one time at that point, and I think there was maybe about what, 36,000, 40,000 CFPs, and I think only about 3 or 4 had CCIM designations. And those 3 or 4 actually were selling commercial real estate. So the CFP was probably the first thing they did. Then they decided to go to sell commercial real estate. So I knew it was a thin market there. Mixed blessing. I went to work for sagemark Consulting, meaning I was a contractor with them. Sagemark is a planning arm of Lincoln Financial. Mixed blessing because I got some wonderful training there. I learned a lot in that program, and I'm so grateful for it. And I still use what I learned because it is comprehensive and. And then the mixed part of it is that it's not really the captive environment that I wanted to be in. They really. It's less independent, I should say, than I was hoping for. So within six months after that training, I popped out and joined fsc, which is now known as Advisor Group, I think, and was with them for a while. So that's how I got into that. And I was always mindful about the real estate. So in the compliance process, in the intake for those firms I let them know that, you know, this is my interest. And we looked at a couple of presentations that I did. The compliance department reviewed them. So I knew I was going to be okay being able to serve that community. At least at that point I was.

[Rich Arzaga]

Going to say did, did the firm, I'm thinking particularly in terms of these kinds of, of traditional brokerage firms have, have problems, have concerns with you saying I want to talk about real estate, I want to advise on real estate with clients.

[Michael Kitces]

No, I think they saw it as a market target audience. I wanted to get into the advice side of it. There's no tools out there still isn't really. So I don't think they really saw conflict. The only thing that they were really concerned about was to make sure that the rules around selling outside the broker dealer, that those weren't being violated, which is easy. I just follow the rules and it's not a problem. But they're vigilant around that because I do have this specialization so that, that's.

[Rich Arzaga]

All the selling away securities to rules of not, not selling outside securities which, which I guess ironically means like direct real estate is fine as long as you weren't having clients invest into something that was a syndicated securities offering. Because that would have to go to. Through BD compliance.

[Michael Kitces]

Yeah. And in fact I actually get even further away from that line if there is a discussion on where to go next. I make recommendations to the brokers but I don't get close to endorsing or even reviewing, you know, those other purchases they're about to make. I give them the tools, I give them the coaching, but I'm not there to say this is the one to get. So I, I stay away from that part of it and it keeps me further away from that selling away line. But they are aware of it. I'm at the LPL now and so I probably get a few extra questions but it's never an issue because it really isn't a risk that we take, I guess.

[Rich Arzaga]

And again, sort of speaks to the, I was going to say the irony of just, you know, directly held real estate is so outside of our normal regulatory purview. It's like ah, I don't even have to oversee the advice you're giving because it's, it's, it's not our, it's quote, not our world.

[Michael Kitces]

Yeah.

[Rich Arzaga]

Which feels kind of strange to me. On the one hand, as you said, 30% of wealth in America is in real estate. It's a major driver of wealth for a lot of people. And, and we sort of talk about it as an asset class when it's a reit, but talk about it like it's this alien thing in another world when, when it's directly held real estate to the point that even compliance isn't as concerned about it.

[Michael Kitces]

Yeah, that's, that's absolutely right. I've always felt that there was room for a designation in this industry that focused on real estate investment and real estate planning and that might be able to create the, you know, the corridor for working more in the space, but I don't know what the appetite is for that sort of thing.

[Rich Arzaga]

Yeah, yeah, I guess it would. Well, hopefully there's at least a little bit more overlap now of CFP professionals and CCIMs, but I guess that's, that's your starting market and it doesn't sound like it's a really big one so far. Yeah, I think again, as you said, just we, you know, we come in the industry, at best, we're not trained on real estate, understanding, really understanding real estate, the mechanics of evaluating properties and deals and mechanics and cash flow. And at worst, as I think you experienced from a few of the advisors, we essentially get down to, I don't get paid to give you advice on real estate. It's like, how about you sell those? We put that into some income producing bond funds or REITs that I can actually manage for you because I don't know how to manage that thing you've currently got. It is, I think one of the fundamental business model conflicts that we almost all collectively experience, whether you're on the broker dealer side or the RIA side, almost all of us have models that are fairly tilted towards not just assets but investable assets. And directly held real estate doesn't fall in our investable asset bucket for most of us.

[Michael Kitces]

Yeah, that's right. That's right.

[Rich Arzaga]

So how did you start incorporating this when you said, all right, I want to actually make this part of my business model when at the end of the day you can't sell or collect at least a classic AUM fee on directly held real estate. So how does this work for you? Or I guess how did it evolve as you made some of the initial moves, I guess, you know, went through sagemark, landed at FSC and said, okay, I'm building my business now, I get compensated for certain things through fsc. I want to work with clients who do directly held real estate. That is not one of the things I do through fsc. So like, how did the business model work? Or what were you at Least envisioning when you got started in this direction.

[Michael Kitces]

The way it started and how it is now hasn't changed too much. The advice part is really covered as a planning fee. So for example, a client comes to me and they have $3 million in net worth and maybe about a million dollars is in an investment real estate property and another million is in their liquid assets, another in their home. I would charge a fixed planning fee for the initial plan, as we do right now. That fixed planning fee would also include any sort of additional work or discussion on the directly held real estate investment, any sort of cash flow modeling, that sort of thing, and any advice. So I would simply take our base or whatever the fee is that we would charge them for that plan and add a little bit more in for the real estate discussion. So that's how I covered the initial plan and then after that I don't charge for the aum. I mean, once you have a property and you understand its cash flows, unless there's problems down the road, there's not a lot of variance to that. And it's actually, it can be very predictable except for the risk that comes with owning directly held real estate. So then that's when we get back together and talk about it. We mostly talk about how to, you know, what we do to mitigate the impact of that risk more so than the risk itself. And we talk about the risk itself and I'm mostly, you know, talking with them and, and advising on what sort of attorney or maybe giving some recommendations. So that's how that works.

[Rich Arzaga]

And we're just. When you talk about risks, like are we talking investment risks? We're talking like, you know, tenant gone haywire and destroys your property risks like what, what kind of, what kind of risks are we talking about? When you say just you're, you're discussing and advising on risks.

[Michael Kitces]

Well, it could be that it's a commercial property and the tenant as a long term lease, that was favorable, but demand for that property has gone down. And so once the tenant leaves, it would leave a big hole in their cash flow or in their income and they still have their expenses for that. They might have to bring another tenant in. They might have to actually reduce their price, which would impact their cash flow to their, you know, to their family. It could be a tenant, a smaller property where tenant squats there for a while. It could be one where they're sued. It could be one like one. I owned a commercial property in, in Washington state where for a year the tenant went dark on, on paying Rents. So a variety of different risks could be legislative risk, you know, where in the plan they actually expected a certain amount of increases in terms of rents that was, you know, pro forma that way. And there's now more rent controls in some areas than there was way back in, what, 15 years ago. So there's a lot. It could be operating risk, it could be that the, that the owner, him or herself is not a very good manager of properties or people or of tenants. And so there's that risk where they just don't want to increase the rents because they're afraid to annoy or upset the tenant. So they keep the rents the same, so everyone's at peace. And then five years later they finally make an increase and the tenant is upset. Right, because they didn't expect that. So there's lots of different risks. And those are the things that pop up in that sort of conversation.

[Rich Arzaga]

So I'm struck by just the framing that, hey, once we do an analysis on a property, like, as long as stuff isn't happening, your tenant is stable, the situation is stable. There might not be, in essence, a lot of ongoing advice needs. So you charge upfront for the advice and the analysis. But it's not necessarily a big piece of the, the ongoing fee model and the ongoing service model. It's like, I did my analysis. Let's talk when, when and if something changes.

[Michael Kitces]

It's almost, almost right. It's. It's a discussion point during reviews to make sure that things are largely the same. But yeah, there's not a lot of changes until there's something that happens that requires a discussion and then, and then that discussion. It's, it's just I've had those many times before, so that's to cover that under our AUM model. On the example I mentioned earlier, the million dollars that we get to manage, that's easily covered under that for us. There's not a need to charge another fee for that incident.

[Rich Arzaga]

So talk to us a little bit more about fee structure itself. Like, what's. I don't know if you have like a standardized base planning fee. Like, what do you add on if they do have directly held real estate and want these conversations and want this advice, like how. What do you find is actually tenable in the marketplace?

[Michael Kitces]

Yeah, I don't know that I've explored what clients would pay or take. I'm not testing the high side on that as a policy. We've kept this since I started because I know how long it'll take to pro forma A property using their tax returns and have the discussion, and have the discussion on the second property and the third. So we kind of know what that looks like. But we have a base planning fee. It's a minimum. Today it's $4,900 for a plan that's comprehensive but not too complex, meaning there's not advanced estate planning or real estate issues on there. If they have a piece of property that's, let's say a duplex or a single family home that's a rental property, we'll probably add about $500 to that. That's been the what we charge or what we add consistently. If they have two of them would probably add another $500 to that. If they have four or five, we'll probably keep it just at that thousand dollars. What we find is this. A lot of the time it takes is shared time. So when we collect a tax return and we look at their schedule e to help us do the pro forma on the real estate, the three or four or five properties are in that schedule either. So we're not asking for those documents over and over again. We've got them once and we proforma all the properties because we want to do that, see if there's any weird stuff going on. And then once we take one or two that represent good examples of a discussion we want to have with them, when we cover them and explain to them how it works and then put it into the plan, then we really, even though we have it, perform it, we really don't have to talk about the 3rd, 4th, and 5th and so on. So, you know, I don't know that we maxed it out and said, okay, there you have six properties times $500. That's $3,000 more. We haven't ever done that. Now that said, there are some plans that are more complex and that start maybe at $6,000. And they have two properties and you know, it's $1,000 more. There's a plan we did that was $15,000 plan. It was more of a business exit planning case. And they had commercial property and they had another one they were thinking about buying. So we added some more dollars to that, a little bit more for that commercial property. But the process is the same. So it doesn't take us out of our, our lane when we did that work.

[Rich Arzaga]

And so when you talk about doing these analyses, I mean, how, how long does it take you to do this for, for each property and what are you doing for those who aren't, aren't familiar what it, with what it means to, to pro forma a property projection.

[Michael Kitces]

So pro forma cash flow, those are kind of the same things. In my world, what most people want to know when they have a piece of property, at least those that are advisable, is they would like to know how their property is doing because they think they have a feeling of how it's doing. And their math on that is really about here's my gross income. And by the way, it's gross, not including vacancies or bad debt, that sort of thing. So they use gross income and then they take out the mortgage and take out the taxes and they might remember the insurance. And that's really the, that's really it. And when people give us an idea that you ask about the intake of these other advisors early on, when advisors ask what is your income? Mostly they're given a gross number. They're not giving the net. And then when, if they're given the net, they're not given the net of all actual expenses because there's a lot of other operating expenses that are forgotten that really weigh down performance. So the tool that we use to help us assess performance on a property is called an apod. Apod and it stands for annual property operating data. Again, another awkward term. But if you look up APOD real estate on the web, you'll see a bunch of companies offering these spreadsheets that you can buy. So these spreadsheets are really a way to pro forma the property. And you put one property on every spreadsheet and then you can see how it flows. And the great thing about these, I'm going to go use the word APOD now, the great thing about these APODs, these cash flow tools, is that they also, the good ones, consider the client's tax situation and they count right off on interest. They count the cost recovery. So it really is tax sensitive. And they can give you a performance analysis year to year for, let's say 10 years. They can also give it to you an internal rate of return before and after taxes. So if you put in the right tax, marginal tax rate for the client and make sure to include the state, you're going to have a really good idea what performance looks like. And so when we do these analysis, that's what the end product is. It really is a pro forma or an analysis of the cash flow for the property that the client owns. And it's an eye opener because they don't realize that actually when they thought they were making money, they're break even. And when they're breaking even, they're actually losing money. So that's just one step of getting them to help them decide to either keep it for whatever other reason or to help them make a better choice on that equity. And then you bump that to the plan and it becomes, it just accelerates the drama of, you know, whether it's, especially if it's bad, of a bad property.

[Rich Arzaga]

And so what are you ultimately trying to boil down to like a, a raw dollar cash flow, a like return style metric? Like what is your, you know, what is your free cash flow relative to your equity invested? What's your free cash flow relative to, to the asset value? Like what, what do you look at at the end of the day to say is this a good return or a bad return? I mean, I get if it, if they thought they were making money, it turned out to be zero or negative. Clearly this isn't probably good. But you know, we do the math. I'm making money. Like on what basis are you deciding or giving recommendations to say that's, that's good money or that's not good money. We should redeploy that.

[Michael Kitces]

Right, Right. So the big picture, we use the plan as a way to see if the property contributes to their objectives or if it actually takes away from it. So after the EPOT is done, we use a tool to put some of that data in because at that point we have kind of net information that we can just plug in, make it easy for the tool. The tool we use is E Money and they do have a schedule for real estate. It's not very comprehensive. So we find that using the APOD first and then taking key data and then putting that into E Money's schedule for real estate does the trick. And so by putting that property in there, we can see and the keeping it for the balance of their life, that's really what they, they plan to own real estate and that's really one of their objectives or strategies to get to their objective for financial independence. We'll put that in there and then we'll do a scenario where, well, what if we didn't have this in there and what if we sold it? And by the way, it's not my preference to sell it or not sell it. I just want to know if there's a better use of that equity. So to answer your question, we put the scenario in there. Where do we take the equity? Where do we sell it for a little bit less than we think it's worth? We pay the Taxes, and we really do a number on the net proceeds for that property just to make sure that it's very conservative. And then you put that equity back into the plan. And then what it shows us is it shows us the use of that net equity at their risk tolerance level based on their risk reward, are they better off keeping that property, which would be great. That means it's consistent with their goal to own that property, or whether they're better off using that equity elsewhere or buying a better producing property. We'll put that as another scenario to do a 1031 exchange. So that's what we use to measure how a property is contributing to a financial plan for a family.

[Rich Arzaga]

And so I guess in essence you end out with if the cash return on equity is a better return than whatever your portfolio assumption is, then this is going to model well, if their cash return on equity is worse than whatever your portfolio return assumption is, it's going to look better to make some shifts.

[Michael Kitces]

That's most of it. I think the other part is taxes. So when you put this into a plan and then you consider taxes, if they're already, for example, if they're already earning a large amount of income and then they're generating more income from the real estate, their tax situation is actually worse because they're paying taxes on some of the income that they're getting from the real estate property. So maybe taxes actually play a role in that. But you cannot see that from the.

[Rich Arzaga]

APOD by itself because sometimes your APOD analysis just says, okay, you're not making a ton of free cash flow after depreciation. It's actually negative. But I got to look at the rest of your plan to figure out, does that depreciation offset against somewhere else? Is this actually helpful from a cash flow perspective? What's the net tax impact in the overall scenario?

[Michael Kitces]

Yeah, that's right.

[Rich Arzaga]

And Emoney can handle that level of tax analysis and crossing over depreciation, deductions and the other tax aspects of real estate.

[Michael Kitces]

They can. You just have to use the right cost recovery number and you have to have the right adjusted cost basis when you put it in. And the other thing it can do well is it can also assume appreciation for that property. Appreciation is not a primary driver of value of real estate, but you put an appreciation number in there as well and it'll count that as well for total net worth and, you know, estate planning, that sort of thing.

[Rich Arzaga]

Okay, and is there a particular piece of software that you use for this APOD analysis? Like, is this your Own homegrown spreadsheet. Is there some commercial tool? Is there like the. The E Money advisor of apods out there?

[Michael Kitces]

Yeah, that would be nice. I think E Money is terrific. No, it's a little bit of a wild west out there, but the tools are pretty consistent. I use a free tool actually that CCIEM gave me and it's probably one of the most primitive tools out there. But it's very simple to use and show to clients happy to share that on a link. So everyone can have that tool. Their instructions are on tab number five or six, but that's what we use.

[Rich Arzaga]

It would be great if you can, if you can share out. So for folks who are listening, this is episode 188. So if you go to kitsas.com188 we'll have a link out for the CCIM APOD.

[Michael Kitces]

I think the only thing I would add to that if somebody downloads that and begins to use it, is you're only good as the data that you put into it. So if you put in a high annual rate of inflation of 10%, right. Or you use the wrong cap rate or. So it's maybe a little more complicated than just getting it for free, but just be aware of that. You want to learn how you know what to put in, what to what sells and why. If you don't use enough expenses, it'll just be a house of cards. So that's where the schedule A comes in. So just use it wisely, but use it often if you use it well.

[Rich Arzaga]

And I guess helpful note, for E Money, like an A pod is apparently a spreadsheet. So you could probably code this in the software and make it and output any money.

[Michael Kitces]

You know, that would be so exciting for, for someone like me. But you know, there has to be a demand for that. Right.

[Rich Arzaga]

Well, although on the flip side, create a tool that makes it easier to do real estate analyses and we might find out that advisors do more real estate analyses for clients too. I'm sure for at least some who are, who are listening, who are out there, who maybe do have some interest or some expertise in this. Just getting down to, okay, I want to, I want to analyze for clients, but I don't know what the tools are. I don't have the time or inclination to make my own. And I can't do a, you know, grind it from scratch analysis every time because then it's time consuming. I charge clients a lot more money and then they may not want to pay for that. So it sounds like at the End of the day, once you, like you've got the APOD template from ccim, you're collecting information heavily from Schedule E that it sounds like kind of drops into the, into the spreadsheet, into the calculations. And so how long does it actually take you to do up a property analysis when, when you've got the tool and you just need to collect the information, get it in there, and then obviously do some analyzing of. But what do I actually see? And is this a good deal?

[Michael Kitces]

Normalizing the Schedule E takes some time because we're talking with the client about expenses from one or two schedulees over two years that might be extraordinary. So the discussion around normalizing, and for them, this is the first time they thought about this and they didn't know they had these expenses or they forgot the $24,000 expense on the fence from three years ago. So, you know, that's where most of the time comes from. And it depends on the situation, but maybe that's another hour or so. And then the APOD itself probably takes, once I have good data and I can put it right in there, can take about 15 minutes. For 15 minutes, I like to sit back and just look at it and really appreciate what's going on with that property. It's really kind of fun. And then the, then the advice or the discussion part of it will probably take another hour or so for that one property. And then the second and third will be very quick, if we even do those. Because they'll understand, right?

[Rich Arzaga]

Because once you've taught them, like, you know, as your advisor, as a professional, like, here's how I look at your property, here's how I analyze it. Here's how you properly think about all of these different costs and expenses. Like 50 minutes to teach the first time, you know, one minute to remind them for the second property after you've gone through the first.

[Michael Kitces]

First, yeah. And at the end when they, when they learn that, then there's one part of that APOD that we go to religiously. In fact, we just jump there because they know they can rely on this. Because the key around populating the APOD or any plan is to make sure that you use your own data, you're not using your own stuff. And if they're missing things, you want to point that out too and agree on the assumption on that expense. But the part that we go to is called a T bar or T chart, and that is a simple illustration. It's a T form. And people have, you know, four questions about real estate that they have or that they want to buy. How much money goes into this property and when does it go in? So there's two questions right there and then how much money comes out and when does it come out? And so the T bar does a really good job in one setting, showing this year by year, very simple, concise way. And also shows an internal rate of return. So we jump to that then for the next properties. And it's very quick work around that.

[Rich Arzaga]

And so then you just start, get to see you, you do with an IRR so you can account for timing of cash flows.

[Michael Kitces]

Yeah.

[Rich Arzaga]

And you just start to see like, okay, over the, over the long term, you're getting a 1% IRR or a 3 or a 5 or a 7. And then we can start having a conversation like is this an appealing rate of return? Is this a good number? Could we do better elsewhere with either other real estate estate or, or other available investments? And down we go down that path.

[Michael Kitces]

And yes. And I realize as we're talking about this, it sounds like quite a process, what we've just been talking about the last 15, 20 minutes or so. But you know, once learned, clients don't see the back end of the back office part of this, you know, so it's actually much more enjoyable for them because they're really learning a lot. And for you it's really kind of, if you really like this sort of advanced planning work, it really is kind of fun.

[Rich Arzaga]

Well, and enemies sort of makes the classic point around anything where you form some kind of, of, of niche or specialization. You know, I think for a lot of advisors listening, like we can all say, well, I can, I can take in a bunch of real estate information and put it into an Excel spreadsheet and do some analysis and say, yeah, but if you're not used to looking up on, at them on a regular basis, it's going to take you longer to figure out where to grab the right information and what information you need and make sure the spreadsheet's calculating right and you're doing the math right, that you've got all the pieces there and then it gets built each time and you're not used to exceptions and clients take a while until you've done a whole bunch of these and you just get to a point of yeah, you know, I could do it. Anybody who wants to take the time can probably do it. But you're doing this in a systematized basis in an hour or two, which lets you charge less and do more of it. Everyone else may have to charge $1,000 or $2,000 to cover their time for it. And if you charge enough, you don't get as many people that want the service because it got more expensive and the economics don't hold.

[Michael Kitces]

Yeah, that's right. And I think we've been focused on the technical side of this because, you know, sudden money. I know you had Susan Bradley on your show before, but they talk about two sides of finance. They talk about the technical side and then the emotional side. So we've been covering the technical side, but the emotional side is there's a whole nother discussion around, you know, why they, why they have it, why it's important, what will it do for them, that sort of thing. And so when you talk, when an advisor thinks about this, there is that technical part of it that you just talked about, but then there's also the discussion about, you know, why is this important. And it normally boils down to something about. They're very, it's common, but either about insecurities about the other asset, class A supreme confidence on real estate, you know, some sort of family imprint that, you know, that the family had real estate or some sort of very close friend they trust that was successful in real estate is something like that. And then being having that discussion on a deeper level, then just collecting the data is really important.

[Rich Arzaga]

And how often or I guess, like, do you get into the conversations and dynamics of just, you know, Mr. Mrs. Client, like, do you want to be a landlord? Have you dealt with property managers before? Like, how, how much are you into the, I guess, like the, the execution of buying and selling real estate or the ongoing management of buying and selling real estate or trying to connect clients to those resources. Like. Or are you primarily at just the. The business and economic analysis? Like, we've done the A pod. This is a good deal or not a good deal. You need to find a different property.

[Michael Kitces]

To invest in often. I mean, the area that we don't spend a lot of time on with them is execution of that because there's other people, insurance companies, attorneys, brokers that can. That help them with that. And they get those details. But, you know, we're often the precursor for that sort of activity. So I have a client in Berkeley now who is thinking. He was retiring and thinking about either leasing their commercial building or selling it. So it's quite a discussion. He has a great range of options. He is actually in a good position right now in his case, even with COVID 19. But, you know, it's not an easy decision and it's also a financial decision too, because all of them have different outcomes. Their range of outcomes is considerable. So I'm happy to spend time with him on that discussion because it's interesting. It's important to him and he may not choose the best financial decision, but that's okay because it's really more. It's more, I think, more about comfort level for him and what he'll be okay with in the future. And maybe about risk, maybe he wants to take a little less risk. And so maybe some of the options kind of fall off the table so often.

[Rich Arzaga]

And so does that mean you've ended out with like a, a network of people that you refer to or you just kind of let clients go do their own thing once you've given them advice, you need to find a different property or are you actually trying to give suggestions like, hey, you might want to buy in the city or county or area? Not that county or city or area. How far down that road do you go?

[Michael Kitces]

Yeah, the latter. We don't do. We don't pretend to know which markets because you can actually get a decent real estate investment in a market that is perceived to be not a good market to invest in. So it really is more realty decisions are more by property than they are by market. Although the market is more of an, kind of a global thing. You can still find a good deal somewhere. So. But we don't do that, the tactical stuff, because there's no way we can really know that. But we do have a resource for clients and so especially local here in Northern California. But if I have a client that wants to settle some real estate in Florida, the CCIM network comes in very handy. The advisors can do this too. They don't have to be a ccim. They call the local chapter. They see who the board members are, they work their way through the board members. The advisor will give them profile of the client and what their needs are and what they have. Not the details like address or name, but just kind of a profile. These folks in that position at CCIM will give some names they will be happy to share. Sometimes it's their own name, right. But they'll be able to share some other names. And then that's how you come up with. And then you vet them across and you ask another person, what about this person? So you actually end up with three or four pretty good names as a start for a client. So the network can be as far away as that. There's a process for getting some decent names and getting A good head start.

[Rich Arzaga]

So. So help me understand this from the. The overall business perspective. Just, it sounds like at the end of the day, when you're doing close to $5,000 planning fees and, and $500 property fees, like the real estate is not. Advising is not literally the driver of the business model directly. And so is that still primarily the clients that you work with? Like, is it unique because all your clients or almost all your clients end out with these kinds of real estate analyses as part of the discussion? Because other advisors won't do that level of analysis for them? Like, how's the real estate component fit in in the end when the real estate analysis charge is not necessarily the dominant portion of the client fees?

[Michael Kitces]

Yeah, that's right. First of all, the real estate is a niche that we're interested in, and it serves a community. From a advisory perspective, a business perspective, it's the milk in the grocery store for us. So they put the milk all the way in the back of the store. The customer comes in and they have to go through a bunch of vials and a bunch of other products to get to the milk. And I don't mean to make it sound that way, but it really is kind of our centerpiece. And the reason people, some people come to us in the beginning, from there, and I would guess probably about 40% of our client base, it's a small client base. 40% of our client base has directly held property where we've done some sort of work like this, like we talked about. The other 60% came from referrals or came from our natural market. Or maybe they initially thought they wanted real estate investments. They came to us as being, you know, more knowledgeable. And then maybe they actually did something or maybe they didn't, but they stayed with us as a client. So that's kind of how that breaks down. But you're right, the fee from planning for real estate is not a big driver for our business in terms of gross revenue, but it's the driver for.

[Rich Arzaga]

A lot of new client growth because it's what distinguishes you from all the other advisors that won't do that thing.

[Michael Kitces]

Yeah, we get referrals from CFPs on discussions of people that have real estate, and they just. The CFP's eyes glaze over because the folks, all they want to do is talk about their real estate. So they gladly refer those people on it.

[Rich Arzaga]

Reminds me, I think I had first heard this from Mark Tiberjian, and apologies, Mark, if you're listening, and I bastardized your quote, but some of the effect of, to be effective in the marketplace, you really just have to be similar in capabilities to everyone else in almost everything and materially better in one one thing can create the differentiation for you to say, yeah, a lot of advisors can do a lot of stuff for you, but if you need this one thing, this is where I have expertise that you're not going to be able to find anywhere else or very many with very many other advisors. And you often only need one thing, that you're materially better than everybody else and anyone who has that problem is coming to you and you can grow a business on that basis.

[Michael Kitces]

Yeah, I understand that statement. It makes sense for us. We like to believe, and I think many of your advisors believe this as well, that we're very good at everything that we do and we are special at the real estate advice area. But yeah, you're right. In the land of the blind, the one eyed man is king. I think that's what he's saying.

[Rich Arzaga]

Yeah, yeah. I mean, I don't mean it at all to, to belittle or put down the, the, the rest of the work that you do with clients. But I mean, I think we all have sort of had that collective struggle like, well, you should work with us because we, you know, we do good comprehensive holistic financial planning. It's like, well, okay, but all the other advisors I talked to said that as well. I was like, well, well, we're holistic or incomprehensible or like it gets really awkward really fast just trying to say we're, we're more betterer than everybody else. It's something that relatively is holistic and comprehensive in the first place. But when you can really stand up for this, this one thing, whatever your one thing is. Like when you can stand for this one thing. Oh well, if you have real estate, directly held real estate investments, you're probably going to struggle with other advisors that don't have the depth to do the analyses and aren't fluent in the, in the, the language and the lingo and the relevant evaluations that need to be done. We're really good at this. This is what we, we do. And as you said, it becomes your, your milk in the grocery store. Like if that's the milk you're shopping for, everybody's coming, then you got other opportunities to do business with them over time.

[Michael Kitces]

Yeah, that's, that's right. And people, we sit down with them and that's what they have questions on and they realize how deep we go. Sometimes they don't Even know that's. That's something that we do. They get very excited. They feel like they've met a match. It's nice too.

[Rich Arzaga]

So talk to us about the, the evolution of the advisory firm itself. So you set out in sort of 2003, 2004, with a firm change or two with the idea of doing this model. Like, I'm gonna be an advisor, I'm gonna charge for real estate analysis because I got a passion around it. I'm also building a. An advisory business more broadly. So, like, what did you do when you actually wanted to get started and like, you hung your shingle and you had to start getting clients? Were you like, immediately into the real estate world to market yourself? Are you doing more traditional advisor marketing channels? Like, how did you actually get going when you said, I've got this expertise and a vision of how to do advice, now I actually find someone who's going to pay me.

[Michael Kitces]

Yeah. Yep. So I. And I try to do exactly what you said I want to do. Since that was a focus, I spend my time in that community. So I ended up meeting realtors and commercial brokers, title folks, exchange folks, attorneys who are real estate attorneys. So you just hang around that environment and you attend their programs. CCIM has chapters all over the US I was a committee member on CCIM East Bay for. Or Northern California for a couple of years. So you hang out with those folks and then you find that community, a few folks that you really like. And then we started doing real estate advice workshops and included a cpa, a financial advisor, and, you know, a title person, a broker. And so. And then you take that around, different topics, different over time for a couple of years. And that's how we really started building some traction here is by hanging out with that community and so literally going.

[Rich Arzaga]

Out to things like CCIM chapter meetings, which is that. That's where you found that community was. Was through ccim.

[Michael Kitces]

Yeah, most of my relationships in the beginning were from that community. Then they broadened when clients had their advisors and I contacted. I met a CPA in Fresno who does a wonderful job with land. So now he is my land attorney for California mostly. So, yeah, that's how you go out to that. And then what we did was we then would invite our past and present client base. And at that time, it was. I had virtually nobody to these communities. And so we kind of shared visibility that way. They came to the workshops and we gave the workshops. And then we met new. They met new advisors.

[Rich Arzaga]

And so as you were, as you were Building this way. How long did it take you to find some traction? Start, start actually getting client opportunities to work with. Because I know just anytime you show up in a community and like, hi, I'm the new guy. Yeah, love some clients. Kind of gets awkward out of the gate. How long did it take you to find some, some traction with this?

[Michael Kitces]

Yeah, so at that point, being in my early 40s maybe, you know, I didn't look like a new guy, so. And I was comfortable having conversations and with the CFP and the CCIM work, I really knew a lot more than a lot of other folks did there, so I really didn't have to suffer through the whole new guy effect that way.

[Rich Arzaga]

Interesting. One of the benefits of coming in as a career changer to the, to the industry, just for better or worse, some of the, some of the age bias issues that exist for advisors coming in when they're in their 20s, especially early 20s, it's not the same dynamic if you're coming in a little bit further along in life and the conversations are different.

[Michael Kitces]

Yeah, that's right. That's right. But it was a, it was a grind. I mean, that 2004, I remember, remember this year, a lot of smaller clients, and then over time it just kind of grows and the net worth grows and of the clients that you serve. But you know, I had, I think at 24 plans that year and I believe the average revenue per plan and then that implementation was about 4 or $5,000. So my first full year on a gross basis. So my first full year, you know, was just over $100,000 of revenue in 2004 for this business.

[Rich Arzaga]

You only get to keep a small piece of that in broker dealer world as, as you're going as well. So that's, that's gross minus grid payout, minus business expenses. Now the rest.

[Michael Kitces]

That's right.

[Rich Arzaga]

And these were even at the early stage, like these were planning fees, these were real estate analyses. This was also implementation with, with insurance investments and other brokerage products. Like, what did the, what did the business model look like for you?

[Michael Kitces]

Yeah, the real estate analysis were part of the planning fees. So that's kind of in one bucket there. I think I was charging $2,500 a plan back then. I think most of those 24 plans were paid. So that gives you an idea of what that looks like. And then the balance then came from implementation. So it would be, you know, advisory accounts, it might be some insurance as well. So that was the first year and the second year, then that doubled. I Didn't do as many plans as second year, but the revenue doubled. And then the third year, I think it increased a little bit more as well. So this is what, 4, 5 and 6. So at that point, and it doesn't exist today, but at that point at FSC, we could do 1031 exchanges because they're securitized. They offered them. So I did a couple of one or two of those. Not a whole lot of those, frankly, because directly help real estate mostly they want to control it on their own. So they're not likely to go into a group investment. It's contrary to what their, their objectives are. So we did a few of those and that, that helped a little bit with the revenue.

[Rich Arzaga]

Those were 1031 like kind real estate exchanges into packaged REITs that are still eligible for 1031 exchanges.

[Michael Kitces]

So to be clear on that, actually there's, there's only one way you can go into from a directly a property into a REIT that's through a 721. So they didn't, none of them involved that you would actually go into another commercial property. Or they were all commercial properties at that point for 1031s. So you go from like kind real estate, which couldn't include land, by the way, to another real estate asset that generated cash flow. So these were industrial warehouses. There's only a few of them, but the industrial warehouse, office building, another warehouse. So that's where they went.

[Rich Arzaga]

But they were securitized products or they were limited partnership structures. Like what's the. How did they click into fsc? As a broker dealer, that's making it feasible for you to do these.

[Michael Kitces]

They were reg D partnerships, so they were that, but they're also securitized. So the broker dealer reviewed, approved them, you know, and said our reps can sell them. So that's why they're both okay. Now fast forward a couple years. Then they came up with the DST model and I apologize for being technical here, but that actually allows an exchange, a person who owns a residential, to go and do a commercial exchange just like what I said, except instead of just having one building, you can actually have a pool of assets in there. So it reduces risk, increases diversification. You can have three or four Walgreens, Home Depots, whatever the flavor is for that particular dst.

[Rich Arzaga]

And so for those who aren't familiar, what's DST stand for? What is the structure?

[Michael Kitces]

Thank you for that. That stands for Delaware Statutory Trust. And it's like a tenants of Common 1031, except it allows for more properties in that exchange and also allows for a little bit less agreement from all of the owners of that on certain things that happen during the life of that dst. So you don't have to agree on everything, which was a problem with tics.

[Rich Arzaga]

Which just makes it a little bit easier for whoever is going to manage it or exit if it's time to exit. Because you don't have to. You don't have a whole bunch of different people who all own fractional interest in this real estate and you have to get every single person to sign off on something at the same time.

[Michael Kitces]

That's exactly right.

[Rich Arzaga]

Okay, interesting. And were these also securitized brokerage solutions or was this just something in the consulting advice quiver for people that wanted to go that route?

[Michael Kitces]

No, these were securitized solutions or broker dealer approved. And several broker dealers mostly the to get FSC to approve on these 1031s and later LPL, they did a few of those. You know, they really had to be had to have a good story, good track record, good management. I mean it was really very scrubbed. Stanger and Associates got their hands on it as well, did a review. So several people looked at it before the broker dealer would approve them. Fast forward to today. I know that LPL does not allow 1031s which is, which is fine with me because they're just so much work and they take so long to review and only a few people benefit. So I understand the finances of them.

[Rich Arzaga]

We unfortunately, our whole industry has had challenges with exchanges into a wide range of REITs, particularly private REITs and non traded REITs. Some work fine, some don't work so fine. A few turned out to have fraud in our industry. And so I was going to ask like how do you think about or handle just some of the product due diligence in those sorts of exchanges. And did you have challenges in getting caught up with some of the 1031 programs that turned out not to do so?

[Michael Kitces]

Well, no, I got lucky again. Our broker dealers, the ones I was with, did a good job on making sure that these, as best they can tell, were good. And they turned out. The 1031s turned out fine actually. Yeah, they all had outcomes. Now when something bad happens and there's a hurricane in Houston and there's an office building that takes a hit and they lose part of the roof and they lose a bunch of windows, you know, insurance covers that assuming putting a fraud aside, because there's a lot of properties that don't involve fraud, in fact Most of them don't, right?

[Rich Arzaga]

Yes, mostly don't, fortunately.

[Michael Kitces]

Exactly. But things like that. The question is, what is the risk? And then the next question is, how do we mitigate that risk? And These professionally managed 1031s or operators do a good job considering that. But it's nice to not have those available because frankly, it just took a lot of work and it's still, in my mind is still a lot of ass. A lot of equity in one property. So I'm kind of glad to be diversified away from that 1031s for my own practice.

[Rich Arzaga]

So how do you handle the challenge? The other end of just. Again, you're back to this world of I'm doing a lot of advising on real estate with a specialization in real estate. And I don't have a way to get paid as much on that advice short of the advice fees I do on the real estate analysis up front. But that's not the driver for the business model.

[Michael Kitces]

I'm not really worried about that. I don't think I'm losing any leaving money on the table. It's not really a primary goal of mine. I mean, the primary goal was to be the person that I was looking for way back in the early days. So the. And I'm not, you know, I don't want to. I'd rather keep it on a higher level and be an advisor than, you know, execute on some of those details. So I don't really miss the revenue on that. But I do get it. I do get it back from the assets that we manage, some of the insurance that we offer, like long term care, life insurance, that sort of thing, and from referrals. So I don't think I'm leaving a hole there. I just don't think it's necessary to chase money from that sort of advice long term.

[Rich Arzaga]

You don't literally have to try to get paid on every possible thing that the client's dollars are attached to or involved with.

[Michael Kitces]

No, I think I get paid. Okay.

[Rich Arzaga]

So Rich, you're building this specialization in real estate, getting your firm going, going deep into the CCIM community. And then a couple years in there's this kind of like we. Worse than a century recession in real estate while you're trying to get going. I feel like one of the big fears that a lot of advisors have in picking some sort of niche or specialization is like what happens to. The thing I specialize in has bad stuff that happens to it. So what happened to your business, this model, this, this kind of specialization way of growing when the whole real estate recession financial crisis rolled through.

[Michael Kitces]

Yeah. So the Crisis was dated 2008 and 9. And what happened to us is that we were flat for a while. It did have an impact. So there is truth to the idea that, at least in our case, that you're subject to the risk of that one asset class. So our servicing was probably a little different. And the sort of calls that we got in were different too. We got in calls from people who knew that we. This is what we did. But they're mostly trying to get their clients or their friends out of a partnership or out of a friendship that had that where they invested in a property together. I mean, there's a lot of stuff that happened that was bad during that time. And so we got calls like that. And none of those are really very. Everyone was trying to exit and cut their losses. So there wasn't a lot of great business opportunity there for us. But there was a chance to help a few folks and then get them along to some attorneys who helped them even further. So that's what that was. But it really did impact the growth of the firm for a number of years.

[Rich Arzaga]

But is that like it set you back? You lost assets and clients just kind of knocked you flat because the growth channel thing you had just wasn't growing as much, but you still had clients already that did their normal client things.

[Michael Kitces]

Well, I think if, if 40% of our clients are subject to that risk and probably more than that because it did impact people that didn't have directly held real estate. So there was, you know, it really impacted everyone, but especially our directly held real estate clients. And then they needed money out for reserves. Right. And then we got some money in from somewhere else and then some more money came out. It really was a flattening of our aum, you want to measure that way, as well as revenue. So it did have an impact. We weren't starving, you know, and we were. Okay. I was still sort of retired, you know, from 2000, 2001. But it wasn't fun.

[Rich Arzaga]

Right. So what does the advisory firm look like at this point? Can you paint us a little bit of a picture of the practice as it exists today?

[Michael Kitces]

Sure. So we have a number of clients that we help with plans. Like we have two right now that probably won't be long term clients. We don't count them in our client base, but we are helping them. And they're both real estate cases. So putting folks like that aside who might pop up later on, we have 65 clients where we do comprehensive work, where we handle assets. Some of those clients are really. Some of those 65, not a lot, but a few of them are really small because they're relationships that we have and we want to help them. But they're counted in that 65 and we help them with the overall planning, comprehensive planning. And again, about 40% have directly held real estate. So if you focus on that 65, we manage well nowadays it depends on the market this week. Right. But we're at about $70 million of assets under management. Almost all of it is advisory and we charge a classic, you know, scale. We are at 1% all the way from 500,000 to $2 million for anyone under 500,000. We really don't go after that community. Sometimes we still help them, but that's 1.35. But we end up never charging that. We always charge one all the way to about 2 million even though it's on our schedule. And then it drops down 10 basis points roughly for a few every 10 or $20 million after that. So that's what that looks like in terms of what we charge and where our AUM is and our clients.

[Rich Arzaga]

And so you've got an upfront planning fee of $4900 plus add ons and then an ongoing AUM fee if they want to work with you after initial planning. It's like a step one, step two thing.

[Michael Kitces]

That's right. And then the average plans this year, I think we've been about $6,000 or so. And then on top of the planning fee and the aom, there's also insurance. If there's a gap and there's a need for insurance, then we offer that too.

[Rich Arzaga]

What insurance domains are you typically involved in?

[Michael Kitces]

The three are life insurance, disability insurance and long term care.

[Rich Arzaga]

And in practice, like when you look overall at the revenue mix of the firm, like how much of the revenue is planning fees versus AUM fees versus insurance business, how does that typically break down in practice?

[Michael Kitces]

I should know that. I don't know that. In fact we're a customer of bean counters, so they would know that. But I don't remember what that is. But our insurance revenue is, is not bad. So I'm core to the table every year for the last 11 years or so. That's the MDRT Million Dollar Roundtable. I guess performance level, quarter of the table means that you up there and I don't know, maybe it's the top 10 or 15% of producers for people that belong to MDRT. So it's pretty decent. And then we have another revenue stream with the Insurance Whisperer. But I'd say over $100,000 in revenue from the insurance side, not included in the AUM side. And planning fees. I mean, if you want to spitball it, if you use $5,000 times maybe five, six plans a year, that gives you an idea what that looks like. So maybe piece that together because you're.

[Rich Arzaga]

At this point you're not necessarily trying to add a high volume of clients. You're focused on building the practice around you and your personal capacity.

[Michael Kitces]

Yeah, we have two advisors here to serve the 65 clients and then we have one service advisor. So I think we can serve another 20 people without having to add headcount at this point. And then the next person we bring on is going to be the person that takes over from us, which hopefully will be sometime, will bring somebody in sometime in the next year or two for that.

[Rich Arzaga]

And you mentioned Insurance Whisperer as well. What is, what is Insurance Whisperer?

[Michael Kitces]

So both Dave Winkler, my partner, and myself teach at UC Berkeley Extension. In fact, Dave just, I think he just stopped there recently. The PFP program there offers a variety of classes. I've taught four of them over the years and I would get requests from advisors for help on their RIAs. They know that I do real estate. I've taught the class for many years. They know me and to some extent trust me, I think. And so they say, can you help us with this case? So back in the old days, we would do that. But when we gave people or their customers or clients our business card, it would look like we did the same thing that they did, that we were competing. So I decided a few years ago to create a brand that was separate so that we would be able to help RIAs and other professional advisors with insurance services that were fiduciary based and also planning based. So I created Insurance Whisperer. So that, is that what that's about? We help in our Marketplace. We help RIAs who want an insurance partner or who might have an insurance license, but they don't want to do it themselves anyway. They want to be able to talk about it. They don't want to handle a transaction.

[Rich Arzaga]

So taking your insurance expertise as a partner with other advisors, but being able to put it under a, a separate brand. So as the advisor, when I explain, like Rich or Zaga is coming in to work with us on your, on your insurance needs, they don't feel like I'm putting my client in front of someone else who looks similar to doing What I do, it's. Yeah, Rich is with Insurance Whisper and is going to specifically help with the insurance needs that you've got because I'm working with you on the rest on an ongoing basis.

[Michael Kitces]

Yeah, I think I had more of a concern about that than the advisors because they know me and they know I wouldn't do anything to poach their relationships. But I think it helps, helps both clarify the relationship with their client.

[Rich Arzaga]

Interesting. Okay. And I'm curious as well. You had mentioned growing the business at FSC. You're now at LPL. What was the switch and what led you to LPL?

[Michael Kitces]

Well, so back at FSC, I was with a OSJ, a group that was at FSC and they decided to leave FSC all at once, all 200 advisors plus and move over to ASC Associated Securities Corporation, which was a subsidiary of LPL Financial. So I, I like my relationships back then with this osj and I just, I went with them. And LPL was a big firm at that point, or ASC was. I was a small firm, but it was part of a bigger firm. So I said this is. And their due diligence was comparable and so on. So I, I made the move with my group within a year. Inside of a year, we had another BD change where LPL swallowed up asc. We became lpl. So probably a good move for everybody.

[Rich Arzaga]

Interesting. Part of the reality of the broker dealer world, particularly in the consolidation age, is just sometimes the name of that top changes and you get the news. It's like, okay, I guess we're over here now.

[Michael Kitces]

In that case, back in 2009, I think it was less than that and more that LPO is planning to go public. So let's clean things up and make them consistent. So that's what happened with that. They rolled up, I believe it was three or four different firms into LPL. And now the LPL is about 16,500 or 600 advisors in the group.

[Rich Arzaga]

So as you look back over this journey, what surprised you the most about building your own advisory business?

[Michael Kitces]

How slow it is. So I'm used to things happening very quickly and I guess particularly if you.

[Rich Arzaga]

Originally built in the tech world in the 1990s, boom, like things moved. Things moved real fast then when they.

[Michael Kitces]

Got going, yeah, it was fun. I had so much fun in that industry. But here, not only are do things lag around technology and especially around insurance technology, but also developing a business as a comprehensive planner really is a lot of work. If you really do the work, which, you know, I would argue that probably a lot of your listeners do do the work because of the nature of your content, but a lot of advisors don't do the work and they're growing so much quicker. And so, you know, I kind of look at that and I wish, I wish it was that way because that's what I'm used to. But this has been very slow. So that's what I'm, I guess, most surprised by and even frustrated by.

[Rich Arzaga]

Yeah, it's, it's the comment I make for a lot of younger advisor, just newer advisors coming to the industry like you. You have to view what you do here as much more a marathon than a sprint. Right? We try to come out fast. I'm getting started particularly if you, if you don't start with enough savings or fallback net for yourself, like, there's a lot of pressure to get revenue going very early on. But you know, as, as with running a marathon, like, if you try to sprint right out of the gate, you're, you're much more likely to just tire and burn out. Like you, you, you have to make sure you're set up to pace yourself through it because it's a long run. Like it's a really positively compounding one the longer that you're in it. But it's a really.

[Michael Kitces]

Yep, yep one.

[Rich Arzaga]

And I'm struck as well, I think you still got a, a much faster start than a lot of advisors if, you know, if you got up to a hundred thousand of even of gross revenue in the first year and 200 in the second, which I guess in part to the virtue of either being a career changer coming in and just being able to come at it without some of the age challenges that are there for younger advisors and coming with your, with your designations, your studies, I guess technically when you got started, were you not able to use your CFP certification? Like you couldn't use the letters yet because you didn't have the experience. Experience or did you have enough.

[Michael Kitces]

Correct, correct. So I had the education and I didn't even have my CCIM back then because I didn't have the hours or the portfolio that's required to be able to qualify for that. So I had to wait for both of them for a couple years. And I remember those years. I remember, you know, being there on the weekends, being there late, being there in my T shirt on the weekend when the office cooler was off and sweating. So it was a lot of work. But that's really okay. I mean, that's what I really enjoyed doing. Was building things from scratch. So it wasn't. The hundred thousand dollars was okay. I mean, it was a lot less than I used to make, but, you know, it was worthwhile. And there's a lot of great people I met along the way.

[Rich Arzaga]

And so what was it like coming to the table, I guess with the, with the education, because you'd done the coursework, but not the letters.

[Michael Kitces]

So this is the, I guess if you think of the Colby test and you look at the different four colors and there's a green, which is a quick start, and my green is a 10, which is really, for a lot of admins, unmanageable. It's just, you know, totally focused. So part of that was, was in my 2005. So I was only a year into this business. And this is where I get the street cred that you're asking about. I had a terrible insurance instructor back at Berkeley. Now they're gone. That person's long. They're still with us, but long gone. So. But I realized, you know, the way you learn insurance is by teaching it. So I didn't have very many transactions. I had two at that point, I think two insurance sales in nine months or something like that, or a year. And so I called the program and I said I was a part of that program. I took this class from this instructor. I remember that class because I know it was a common weak link for them. I know it's a problem for them. And I said, I think there's a better way to teach. I said, I think there's a different way to teach that class. So I use the word different. And they said, you think there's a different way? And I said, yes. I said, and this is without. This is back then, this is without. They're trying to solve a problem. I didn't have very much credentials except that I called and I said I could teach the class. So. And this is in the fall of 2005. So they said we were brainstorming. They said, I wonder if you can take over the class midway through. And she realized as she was saying that, that it would be very disruptive to do that. Plus I don't have any curriculum. Plus, you know, she didn't know I only sold two policies. I needed some ramp up time. So she decided she talked herself out of it. And I actually took it over the very next spring fully prepared to teach it still with not a lot of actual experience. So teaching in 2006 at the extension, by the way, I think I'm a pretty Good teacher. I don't know. People think that when they come to class, you know, they're going to get a guy they don't know.

[Rich Arzaga]

You're 15 years in the program. So.

[Michael Kitces]

Yeah, so it's a lot of street cred when you teach that the program. You're an instructor of PFP classes. And that's how I was able to kind of pre use that education. And then I finally got the CFP in 2009 and my CCIM about the same year. Yeah, so.

[Rich Arzaga]

So for you, teaching the program in addition, just. There's nothing like learning it by teaching it. Being an instructor for the program became part of the. The credibility marker that you could use because you didn't have the designations yet.

[Michael Kitces]

Yeah. And I don't know. I think it would have still been okay if I didn't teach, but I learned a lot about insurance. And you have to be smarter than the students, and the students in that program are very smart. So it was really a great idea to take that risk.

[Rich Arzaga]

So what was the low point for you on the journey?

[Michael Kitces]

The thing that comes to mind is I wish we had more of the same clients that we have now. I wish the business was bigger. I would equate that to success, but don't know. So that's really. I wish it was more. I'm not used to slow growth, but I don't know that if you get your hands on everything and family's life and you help them with everything and I don't know how much more. We talked about this a few minutes ago. I don't know how much more you can really stimulate that. So I'd rather have the relationships with my clients that I do now than the growth. But it would sure be nice to have that growth. And I think that's the most. That's the area that I struggle with. It'd be nice to be bigger.

[Rich Arzaga]

So anything you wish you'd done differently in the journey, what do you know now that you could. You wish you could go tell you from 15 years ago.

[Michael Kitces]

You know, I think there's some things that have come up along the way that you think that might work. I remember this program back in the east coast and they were talking about building partnerships with CPAs, and I remember spending some time on that and some money on that, you know, and realized it was just another. It had great potential, especially if I executed, but realized it just wasn't up my alley the way they were structuring that. So I let that go. But I wish I could avoid distractions like that. But I also think that you learn a lot from those distractions. You take pieces here and there. It would be to streamline my focus a little bit better.

[Rich Arzaga]

It's the blessing and the curse of being a Colby 10 quick start. You know, you can, you can get off the line to get started on something in the way that a lot of other advisors, a lot of other people struggle with. You know, one of the biggest challenges, I think for people starting businesses, starting firms, getting launched as advisors, it just like the, the hardest thing about getting started sometimes is getting started usually not a challenge for 10 quick starts. The challenge is that you may have so many different things you want to get started in that it's hard sometimes to pick which one you're going to focus on because another one seems neat and then another one seems neat.

[Michael Kitces]

I think that's well said. Absolutely agree.

[Rich Arzaga]

So what advice would you have for advisors who are interested in making real estate and making directly held real estate more of a focus?

[Michael Kitces]

I think maybe the first layer would be to make sure that you have an interest in serving that community, that audience, and it's not just the marketing niche for yourself. The people that love real estate and that are in it, you know, can tell if you're real or not. Plus, also, if it's not really something you really want to do, the people you want to serve, then it might get exhausting for you. So before you decide to focus a lot of time on this, make sure that you would really enjoy this. I have a feeling there's a subsection of our advisor base out there or industry that would really enjoy this. And then after that, become credentialed, you know, take. The best education I had for this is the CCIM curriculum. And it is expensive and it takes. It takes a while. And then to get your ccim, it takes some work.

[Rich Arzaga]

Can you give us at least a sense like what, what kind of costs are we talking about and what sort of work does it take thereafter to get it done?

[Michael Kitces]

Yeah, if I can summarize it, I'm thinking about my prices back then in 2002 or so. So back then it was about $1,000 a class, and each class lasted a week and they didn't come around very often. So I ended up flying to Denver and Jacksonville to take several of these weeks. But so $1,000 a class, you have to take four classes. So that's 4,000 back then. So it's probably about 6,000 now, if I had to guess. You can go on ccim.com and see and then another elective or two. So there's that. You have to pass them all. There's exams at the very end of them. They're not easy, but for CFPs, they're not. They're doable. Some people there will not pass because they just struggle with concepts and numbers, frankly. Commercial brokers, that's who else is in the audience. Commercial brokers and you as a financial advisor. And then you have to have a portfolio of advice. Now, if you're an attorney or cpa, you get exemptions from that because you're deemed to have given advice on that. And there's a way that they can certify that. For me, I got an exemption because I give advice. So I had to show, I think it was 10 or 20 million dollars worth of advice, a plan I had to show an A pod. I had to show the outcome. I had to show the receipt that I got paid for it. So that was pretty easy because by my first year or two, it was well over that amount of money.

[Rich Arzaga]

Interesting. That's how they measure it. Like, what is the. What is the aggregate amount of real estate that you have given advice and done a pods on for which you were paid?

[Michael Kitces]

Yes, correct. And then they look at this. It's a portfolio you put together. They review it. I suspect they review it and they want to make sure that you're not crazy before they give it. Because once you have the designation, then unfortunately there's not any CE to that. And that said, there's only, I think, probably about 12 or 14,000 ccims out there. I don't know the number recently, but it's not that high.

[Rich Arzaga]

Interesting.

[Michael Kitces]

But that's where I would go for the education. I'd be happy to chat for a few minutes. Wouldn't charge you. But also wouldn't take a lot of time either. But I'd be happy to answer some questions and push along the way. I have a class that I teach that teaches financial advisors at Berkeley, so that's still ongoing. And this next semester it'll be online. I'm sure they'll cap the audience on that. So that way people can get real value from it. So those are. Those are some tools out there. But CCIM, and especially the CCIM 101, where you learn about the APOD and the cash flow analysis. Very valuable.

[Rich Arzaga]

All right, excellent. Again, for folks that are listening, this is episode 188. So if you go to Kitces.com188, we'll have links out for CCIM and Rich's real estate program at Berkeley, if that's your learning style, as some additional resources for anyone who wants to go deeper on this. So, Rich, what, what comes next for you from here?

[Michael Kitces]

Thanks for the question. That's. That's very nice of you to ask. I've thought about that a lot over the last couple of years. I think that I love what we do and I love the clients that we serve. I think the next iteration of this is to go in with another firm somehow. I've been the boss before, so I don't have to be the boss this next time. But I want to play some sort of key role and integrate this real estate advice and this Insurance Whisperer service, integrate those into them. So it'd be an ria actually many firms don't do the two, but idealist an RIA that would want to go ahead and begin to offer more specialization on this thing and these asset classes. Insurance is an asset class, or it can be. So that would be neat. Or maybe there's a smaller version of that. And then making sure that my clients are taken care of. And I really would like to do more with Insurance Whisperer. It's just such a gap out there. It's the next niche and I'm excited about the potential to marry fiduciary thinking and planning. There is RIA friendly products out there and services. There's a few of them out there. No loads, low loads, index funds, but they really don't solve the bigger problem around the fiduciary problem, around selection or planning or suitability. And they're still not fiduciary based. I mean they, they appear to be closer, but there's a big gap there. So I think there's another niche there. So that would be nice to explore that more. So I think I've got another career left, probably a kind of a sub career off of this one here for that. And I'm excited about that. But right now I'm just focuses on growth and bringing somebody in and then we'll go from there for the meantime.

[Rich Arzaga]

Very cool. So. So as we wrap up, this is a podcast about success. And, and one of the themes that always comes up is just even the word success means different things to different people. And so, you know, as you built this successful practice for yourself and, and still going and growing, I'm just wondering, how do you define success for yourself at this point?

[Michael Kitces]

Yeah, I know that you asked this question. It's probably the least best answer I have in this conversation here for me, it's situational. I think it's whatever. Is it family? Is it, you know, is it my clients? Is it my practice? It's. And it's all different. And they all have different metrics. And then when you get to those, when you get there, then the metrics move. They just, you know, so I don't think I'm in the position to, you know, put an umbrella on this and qualify or quantify that. I. I'd be uncomfortable doing that. I mean, I'm grateful that we have great relationships, but I always think we can do more. So I don't have a definition for that. And then when I finally land on a place for one area, it moves up and then there's more to do. And that's. That's the best answer I have. Michael.

[Rich Arzaga]

Well, I love it. I think it speaks to the. The point you made earlier of just always wanting to be growing and moving forward, whatever that means for you and wherever it is that you go, sometimes the growth journey in and of itself is the point.

[Michael Kitces]

Yeah. There we go. It's been fun.

[Rich Arzaga]

Well, thank you so much, Rich, for joining us on the Financial Advisor Success podcast.

[Michael Kitces]

Thank you. Thank you for your questions. I really appreciated this.

[Rich Arzaga]

My pleasure. Thank you. Want even more ideas, tools, and resources on how to break through to the next level of success as a financial advisor? Check out the leading financial planning industry blog, Nerd's eye view at www.kitsis.com, where Michael covers the latest practice management trends and financial planning strategies. And by joining the Members members section, you can earn IMCA and CFP continuing education credits along with exclusive member content. Get it all now at www.kitsis.