This is the latest installment of a regular column to answer questions from advisors who are considering transitioning to an RIA model. To see Brad’s previous articles, click here. To submit your question, please email Brad here.
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Have you ever seen a seemingly successful restaurant go out of business, one you’ve visited multiple times, always finding it busy?
While not always the culprit, a common cause is the restaurant’s lease was up for renewal, and it could not afford the new lease rate demanded by the landlord. An otherwise successful business shut down because it did not own the property.
Or consider my attorney friend who has his own law firm. He has leased the same office space for 20 years. Two decades in, he has not a cent of equity in his office. His landlord, in turn, has done quite well.
These examples remind you of real estate's importance to your business. It is a message so important that it could double the value of your practice.
Here are two lessons to double the value of your practice:
1. Pay for your office expense as a fixed, not a variable cost.
Unless operating under a fully virtual model, every financial advisor pays for office space. You might not see a line-item charge, but you are paying for it.
If you are a W2 employee advisor at a wirehouse (for example), you are paying for the office space provided via your payout. More precisely, it is the inverse of your payout. If you receive a 45% payout, your firm retains 55%. Part of that 55% is paying for your office.
The challenge with this arrangement is as you grow your practice, the dollar amount you pay for the same office increases.
An advisor producing $2 million in annual fees and commissions, who receives a 45% payout, is paying their firm $1.1 million per year for the services they receive ($2 million x 55%.) A portion of that $1.1 million is paying for their office.
If that advisor doubles their production to $4 million per year, and for simplicity, we’ll assume the payout stays the same, that advisor now pays $2.2 million.
Is that advisor given an office twice as big? Do they now have access to a conference room twice as big?
No, they do not. Yet, they are now paying twice as much for the same space.
The advisor is paying for office expenses as a variable cost (via their payout) when the underlying cost of the real estate is a fixed expense. The more the advisor grows their practice, the more they pay in real estate expenses for the same office arrangement.
In the independent model, you pay for real estate directly. Whether you rent space via a lease or own the building, the expense is relativity fixed. As you grow your practice, your real estate expense does not increase in lockstep.
Once your annual revenues exceed your fixed office expenses, every incremental dollar of revenue you produce is more profitable. You can never benefit from this operating leverage when you are paying for office expenses as a variable cost via your payout.
2. Owning is better than leasing
Once/if you’ve taken the step to pay for your office expense as a fixed cost, the next lesson is to do so by owning the property, not leasing it.
Depending on your location, this is not always feasible. But for those in geographies where this is attainable, it will dramatically impact your net worth.
If you will pay for office expenses for the next 10, 20, or more years of your career, consider the equity you could build for yourself versus for a landlord.
Some scoff at the idea of renting a house, insisting you’re better off owning one. Yet some of those same individuals lease an office for their advisory practice.
What impact can owning your office have on the value of your practice?
I was discussing this topic with a recently retired independent advisor. He noted that by the time he sold his practice, the value of the building he was in (which he owned and subsequently sold) was worth about as much as the practice itself. He nearly doubled the value of his practice by owning the real estate he used for it.
Unless you 1) pay for your office as a fixed expense, not a variable expense; or 2) own and build equity in your office, you are potentially leaving millions of dollars on the table by the time you finish your career.
Brad Wales is the founder of Transition To RIA, a consulting firm uniquely focused on helping established financial advisors understand everything there is to know about WHY and HOW to transition their practice to the RIA model. Brad utilizes his nearly 20 years of industry experience, including direct RIA related roles in compliance, finance and business development, to provide independent advice regarding how advisors can benefit from the advantages of the RIA model.
Read more articles by Brad Wales
This is the latest installment of a regular column to answer questions from advisors who are considering transitioning to an RIA model. To see Brad’s previous articles, click here. To submit your question, please email Brad here.
