Desert road leading into the distance

Transitioning ownership of a commercial real estate organization can be a complex process. If you want to build a sustainable business that runs smoothly after you step down, it’s imperative you put time and effort into planning and executing your business succession plan.

"Too many times, failure to properly plan for succession has left family or related shareholders litigating over business interests," said Steve Faulkner, Head of Private Business Advisory for J.P. Morgan Private Bank. "The prior generation could have prevented the fights with effective business and estate planning and conflict mitigation, saving significant dollars and avoiding the emotional toll of family conflict."

Once you start the succession planning process for your real estate organization, think about the qualities, skills and culture you want in the next generation of ownership and how you can develop those traits in your successors.

Key issues to address when succession planning

1. Sudden events

"There should always be a 'what if' plan," Faulkner said. Regularly review and revise contingency plans. They should include a clear vision of the company’s future, plus the roles and responsibilities of all future players. Plans should also include structures connecting the family or other invested parties with the business, as well as dignified and properly compensated exits.

2. Orderly transition

Craft a formal succession strategy with the same elements as your contingency plan. Focus on training and integration that covers business operations and legal documents such as your will, trust, shareholders’ agreement and insurance policies.

3. Liquidity and estate taxes

The current U.S. estate tax rate is 40%, and payment is usually due nine months after a person dies. As you draft your succession plan for the business, make sure you have an estimate of your estate tax and a plan to pay for it. Not having a plan in place may result in forced sales at distressed valuations. You can also consider wealth transfer strategies as a way to lower your tax bill.

4. Concentration

If your properties only appeal to younger renters or rely on a single vendor for management, you could be at increased risk. Diversifying your portfolio over time could reduce your risk during economic uncertainty.

5. Family involvement

It’s critical that you anticipate and defuse potential family discord before it arises by proactively addressing issues and considering implications for a family business.

Finding the right ownership structure

Look at what type of ownership structure—passive or active—best suits you, your successor and the business. Regardless of which you choose, communication and a shared vision are key.

  • Passive ownership involves one or more successors serving on the board or as a managing member in an oversight role. You can also create a board of directors or advisors composed of independent members to advise your successor on the business and management’s performance.
  • Active ownership requires one or more individuals with the training and experience to effectively run and manage the day-to-day business operations. While both types of ownership require training and understanding of the business, active ownership requires more hands-on training and experience.

Commercial real estate owners and operators can group their portfolios into distinct property classes, rather than operating as a single company, making it easier to hire a management team with expertise in specific property types. Doing so could make it easier to hire a management team to run day-to-day operations. However, the more people involved in ownership and operations, the more complicated those structures can be.

The structure can also grow more complex when children are involved. For example, one of your children may want to keep and run the business, while the others do not. Your succession plan should account for this and other scenarios in its buy-sell agreement, which should be a thought-out document drafted by counsel addressing valuation methodology, funding sources, ownership requirements and acquisition procedures.

Choosing the right successor

Often, owners hand down their business to the oldest child without much regard for who is best suited for the position, Faulkner said. Likewise, owners do not necessarily need to require their children to work in the business to receive an ownership interest. "This incentivizes the next generation to come into the business when they may not be interested or even suitable as an employee, let alone a manager or senior leader," Faulkner said. 

Regardless of where you’re looking, think about who will best fill leadership roles at your business and the skills you’d like them to bring, which may include: 

  • The basics of business finance: While your successor doesn’t need to be an economist, they should understand business finance fundamentals. The knowledge can even help them set the tone as the company’s leader. “Developing a strong balance sheet, excellent credit relationship with lenders and trust with contractors and service agents can be as much cultural as it is financial,” Faulkner said. 
  • Real estate or property management knowledge: This experience may not be necessary early on, but it’s still helpful. While there will be on-the-job training, you may want your successor to have general knowledge of commercial real estate or complete related coursework.
  • Professional experience: Some business owners ask their successors to major in a related field or possess several years of work experience. Others require the successor to start in an entry-level position at the organization and work their way up, which can help the successor earn respect from other employees. 

Preparing your successor

Is your real estate business properly organized to handle the transition of a new leader? Your processes, vendor relationships and other key information should be well-documented, rather than reliant on one person’s institutional knowledge that may be lost in a transition or death. 

Training your successor is critical. Make sure you outline regular activities and detail key performance indicators, such as rent prices, occupant turnover, renter credit quality and credit facilities, as well as reporting. Introduce and integrate successors to the team. As you seek buy-in from current employees, it’s important to keep communication lines open and maintain a culture of success and reward.

Faulkner has seen clients find success training the next generation with several methods and scenarios. For example, you could:

  • Move to a chairperson position. Rather than wait until you’ve left the business entirely, you can shift to a chairperson role in the last year or so before retirement. This way, the next generation can manage the business and consult with you for guidance as needed while they transition into management. 
  • Pair your successor with a senior manager: One or more of your senior managers could mentor your successor and develop their skills during the early months of the leadership transition.  A senior manager can introduce your successor to key stakeholders, for example, to help establish mutual respect and set the stage for strong working relationships.

Helping your successor—and business—thrive

Your successor may be eager to put their stamp on the organization with major changes. "Unless there are obvious concerns or defects, a new owner should move cautiously at first," Faulkner said. "Disruptive changes, while sometimes necessary, are unsettling to employees and can be viewed as a repudiation of the prior generation of leaders and cause friction with existing employees."

Company culture can heavily factor into embrace of change and innovation, especially when it comes to new leadership. To keep your properties operating smoothly under new leadership, focus on cultivating or improving communication within the business. This may include establishing mentoring relationships between new owners and meeting regularly to discuss issues. 

Getting an early start on succession planning can mean the difference between wealth creation or depletion.

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