Alan Zafran:

I think two things have really led to this consolidation in the Registered Investment Advisory space. It's a combination of technological advancements that mean even small Registered Investment Advisory firms can now provide reporting and information to design client, probably as well or better than what the large wirehouse Merrill Lynch, UBS, Goldman Sachs, Morgan Stanleys can do. And secondly, particularly in the last five years, there's been a tremendous amount of private equity money flowing into this space. And private equity money typically comes in and encourages businesses to grow rapidly or consolidate.

Nancy Lashine:

Hello and thanks for tuning into Real Estate Capital. I'm your host, Nancy Lashine, of Park Madison Partners. Capital is a lifeblood of the real estate industry, but the decisions on where and how it's allocated are driven by people and personalities. Who are they? What motivates them? What can we learn from their experiences? On this show, we introduce you to some of the real estate industry's most influential thought leaders and decision makers, and we talk about what is important to them, how they make critical decisions, who has influenced them and a lot more.

Our guest on today's episode is Alan Zafran, founder and managing partner of IEQ Capital. Launched in 2019, IEQ is a Registered Investment Advisor or RIA with 33 billion in assets under management, 240 employees and partners. RIAs are increasingly important as sources of new investors for alternative managers. And RIA provides investment and other services for the mass affluent and also for high net worth families. The largest RIAs like IEQ have an active pipeline of real estate, private equity and private debt investments to offer their clients. Alan has a long career in the private banking and RIA space where he's established two independent wealth management platforms, Illuminus, which was sold to First Republic Bank and IEQ. Earlier in his career, Alan was in the private client groups of Merrill Lynch and Goldman Sachs. We discuss Alan's background, the origins of IEQ Capital, opportunities in real estate today, RIA consolidation, portfolio construction, and much more. Alan, how are you?

Alan Zafran:

I'm doing great, Nancy. How are you?

Nancy Lashine:

Good. Welcome to Real Estate Capital. We're really thrilled to have you as our guest today. There's been so much conversation in the real estate business about the increasing interest in real estate from family offices, high net worth and individual clients. And you've spent your whole career in that space. So, I'm really excited to talk with you today just about the evolution of interest in real estate, and also your personal background and what's happening today in the RIA, what we consider Registered Investment Advisor universe. So, welcome.

Alan Zafran:

Thanks. It's a privilege to be here and I'm just excited to talk to you, Nancy. I always enjoy sharing conversation about investing in general and real estate specifics.

Nancy Lashine:

Well, Alan, maybe just start by telling us a little bit about your background. Where's your career start and how'd you get into this business?

Alan Zafran:

Well, like everything else, I fell into this business. So, what happened was I graduated from college with good grades. I didn't know what to do. It was the mid-1980s, and I went to Wall Street, and did the investment banking gig for a couple years and I was burnt out. It was horrifically challenging and I decided I needed to go to business school in order to change a career path. And while I was in business school, I realized there was this whole world about advising individuals about their affluence. And I could also get back to the West Coast in California where I'm from.

So, I was fortunate to get hired by Goldman Sachs and I worked out of their private client services group in 1990. And so, I've really been a two-trick pony, raising a family with four kids, which predominantly my wife did. And then I had my own family, which was growing my business. So, for 35 years I've been helping affluent individuals manage their financial affairs. And it was really the byproduct of trying to be a counselor to individuals directly, which I really enjoy. That's where I found it to be a really exciting opportunity.

Nancy Lashine:

Yeah. So, if you wanted to help individuals manage their money back in the 1990 timeframe, you had to do that at one of the investment banks or maybe a trust company. How has your career evolved? Where did you go from Goldman?

Alan Zafran:

Well, so I spent seven years at Goldman Sachs. In 1997, my partner team members and I, we left, and we went to Merrill Lynch for 11 years and we thought that was extraordinary because we were only able to sell Goldman Sachs specific recommendations. We went to Merrill Lynch and they had a whole world of third party investments, other mutual funds, et cetera. We didn't really understand there was a whole world of alternative investments like real estate investments in funds, in venture capital and private equity. But we finally came to that recognition.

And in 2008, we left Merrill Lynch. We created our first independent Registered Investment Advisory, RIA firm, it was called Luminous Capital. And names mean something for us. Luminous meant twofold. We were trying to be luminaries educating our clients that there was a broader set of investment products and services. And luminaries because we thought a lot of the firms, the wirehouses weren't always offering the array of products and services that they might who are shedding a light on a better way to invest. Almost embracing an endowment-like model for individuals. So, we spent five years managing this RIA called Luminous Capital.

Nancy Lashine:

Can I just back you up there? 2008 is certainly a momentous year in the financial markets. So, you started a business, and then the market had a major crash and everybody thought maybe the end was here. How did you work yourselves through that?

Alan Zafran:

Well, I don't know if it was good or bad luck, but I had a client who in April of 2006 approached me one day and said, Alan, "What do you know about CDS and RMBS?" And I thought it was a farmer John ABCDF. I said, "I don't know what you're talking about." He said, "Credit default swaps on residential mortgage-backed securities. Let me tell you what I learned recently." And he had figured out a credit default swap on residential mortgage-backed security is nothing more than buying insurance on the ability of people to make their mortgage payments.

And so, this gentleman, who owned over 7,000 apartment units throughout the greater Los Angeles area, was trying to find a way to hedge his risk of owning these apartment building units. And his way to do it was to do it through the investment world and he wanted to bet against the tenants' ability to make the mortgage payments. He was relying on them. It was a hedge for him. And he had discovered there was this market. And what happened was through a variety of machinations, I helped this gentleman become the first two-legged individual, non-institution to execute a CDS on RMBS rate. He effectively went short people's ability to make mortgage payments. And this was in April of 2006. 18 months before the shoes really fell out.

So, what happened was once that happened, it informed our team. There was a lot of risk embedded in the financial system we weren't really aware of before. And we were increasingly becoming more cautious on the markets well in advance of the market sell-off. The other thing that happened is after we left Merrill Lynch in 2008 and started our own RIA. By the fall of 2008, we were being contacted by money managers who ran mortgage backed securities desks, and saying things have sold off so much in 2008 that they could buy packages of these non-agency residential mortgage backed securities and they were trading at 30%, 40%, 50% of par value.

And it led us towards a business of trying to generate alternative investments and recognize we can have an endowment like model for affluent families where they can selectively add things like real estate, like private credit, like private equity, like distressed mortgages alongside stocks and bonds. So, we did that from 2008 to 2012 and we were a private company. We were acquired in December of 2012 by a public company called First Republic Bank. We worked at First Republic from 2013 through mid-2019. And in mid-2019 we resigned from First Republic Bank to create where I currently work today, IEQ Capital.

Nancy Lashine:

Alan, your timing in both of those startups reminds me of the saying, it's better to be lucky and smart.

Alan Zafran:

Well, I like to say design begets luck. But I think across all facets of life, and I see this a lot within my client base. Whereas individuals are earnest and working very hard, we still work with a handful where a lot of elements out of their control all fell into place appropriately, and financially they were very fortunate. So, I do believe that they're intelligent and worked really hard to set themselves up for success. But there are elements beyond anyone's control that have to fall into place to have a tremendous economic outcome.

Nancy Lashine:

So, I was curious how portfolios have evolved over the last call it 15 years. When you come out of a crisis like that, drawing an analogy to a crisis like coming out of, say COVID, or to the steep rise in interest rates of two years ago, how your thinking has evolved about creating portfolio strategies.

Alan Zafran:

So, market opportunities shift. So, here at IQ Capital today, of the capital that we oversee, we can go through the litany of holdings. But the way in which that capital has been deployed, shifts as your opportunities shift over time. Somewhat akin to at some point you might be long, large cap stocks versus small cap stocks, or US versus non-US stocks or long duration, short duration. So, what has happened over the course of time in our alternative investments, we've shifted some of our exposures within real estate, as well as whether it's in real estate or other things, but debt crises that affected people's willingness to embrace credit, lending to other businesses, as well corporations.

We began to embrace things like investing in triple net leases and real estate back at that time. We looked at opportunities in multifamily housing back then. It's a pretty durable asset class. We looked at opportunities, began to look at secondaries where you're buying some limited partnership interest in a private equity or venture capital fund that's already eight or nine years in its life and the seller needs money immediately, and we'll accept a discount to the inherent value today in order to get out. And so, we, here as a firm, try to assess all the time, where's the greatest opportunity set given current valuations, market conditions, forward-looking fundamental perspectives? So, even though we may at times be 20%, 30%, 40% illiquid for an entity, how that's expressed shifts over time with market conditions.

Nancy Lashine:

Is that the cap for you, 40% illiquidity in any one portfolio? Or how do you think about liquidity versus illiquidity?

Alan Zafran:

We really believe we need to understand every client household in its entirety, as well as at each individual entity. So, whereas there's no cap per se on illiquidity at 20%, 30%, 40%, 50%, we're adamant about making sure that households at the very top level understand liquidity has negative aspects, as well as positive. The inability to access the capital, the inability to get out of true net asset value at a moment in time if necessary. So, we need to make sure there's cushions of safety for unforeseen events.

One way to think about, it it's not ideal, is you can look at some of our country's university endowments, the Yales, Harvards, Penns of the world, Stanfords, and you can see that they have significantly high allocations to illiquid assets. And of course they have no need to grab more than arguably 5% of the capital in any given year, so they have that long lifeline. And the academics buying this is fairly straightforward. There's something theoretically it's called this illiquidity premium. To the degree you're willing to put your money and somebody you can't access your money to immediately you should expect a greater annualized rate return relative to something comparable that you could immediately access. If you don't really need the principle, there should be on balance and extra annual rate return for the sake of tying up your money. That's what we're trying to capture.

Nancy Lashine:

Have you been rethinking that at all given the last couple of years and the lack of distributions in these illiquid assets? The thought process there is many of the endowments and foundations seem to be revisiting the role of real estate in their portfolio. And looking for more current distributions, more DPI distributed proceeds just a shorter life. And that may just be a response to the fact that over the last, it's really not just two years, probably four plus years because of COVID, distributions have been less than what was anticipated when those investments were made. Does that influenced the universe that you're managing money for as well?

Alan Zafran:

Yes, with three or four ancillary comments. So, it absolutely does. If you expected money capital to come back and it's only come back at 50% of what you anticipated, you would be reckless and not a fiduciary to very carefully reconsider or re-underwrite what you're doing. That said, it poses three or four things to think about. One is, if all things will pushes down your willingness to be illiquid because you need to make sure you have that much more liquidity to meet unforeseeable events. Secondarily, it talks to the importance of really understanding the underlying cash flows. Bottom up manager by manager are most like most clients. So, what we do is we underwrite and we're in constant contact with our managers, and we constantly update expectations on capital calls and distributions. So, it talks to the importance of really doing bottom up fund by fund or manager by manager underwriting of cash flows to have a better semblance of what you can actually expect.

Thirdly, it talks to really diversification, even a greater importance of not putting all your eggs in one basket. And not just one basket, but even within one asset class you may want more than one manager within a respective asset class, because different managers at different points in time, they have different outcomes with respect to the liquidity. And lastly, this also talks to the importance of having some extra liquidity on the side. This is exactly the time when you see secondary opportunities. Whether it's secondaries in the real estate space, or private equity, or venture capital or credit. When overextended investors need liquidity, there's a pretty good opportunity to jump in and take advantage of that if you have the liquidity. So, he who has the gold, makes the rules, the golden rules, in this case cash. So, it talks to the need to underwrite, be diversified and have extra cash for opportunities such as we're being presented today.

Nancy Lashine:

Are you actually raising a fund from your clients for alternatives? Do you have discretion, I guess, is the first question from your clients?

Alan Zafran:

We have discretion from our clients. However, we purposely elect not to take the discretion on anything that has any illiquidity. And the reason is we work on behalf of affluent families. And the last thing I want to do is put my client into a real estate fund with their tenure time horizon and the next week my client says, "I just bought a house and I need a $5 million down payment." And I'll say, "Wait, I just committed you in a ten-year fund." And we don't want that problem. So, we choose not to take discretion on anything that is illiquid. We also think it's really important to go back to the clients and that they fully understand the consequences of illiquidity. So, we choose not to take that discretion.

Nancy Lashine:

And do you raise vintage your funds? So, is there a 2025 alternatives fund and you go and say, "Would you like to be in this fund?" Or does every investment, do you go past the hat amongst all your clients?

Alan Zafran:

So, we have relationships that are bespoke. Every client relationship is unique, so we build portfolios uniquely. We have on a couple asset classes, so we ultimately construct portfolios for each client one at a time, entity by entity, with the exception that there's a couple asset classes, namely private equity primary, where we've felt to protect the client themselves, it was better to structure a vintage specific diversified funding.

Nancy Lashine:

What were your picks for real estate in 2024? Where'd you see the best opportunities? And then you know I'm going to ask you about 2025.

Alan Zafran:

Well, we're really sitting in three arenas. Arena number one is data centers, which has obviously very significant demand dynamics with all of AI and everything attended to AI. So, that's an area that we want to get exposure to. Secondarily where we've seen exposure and it's just a recurring theme, is what I'll call light value add multifamily. It's something we oftentimes jump into. Thirdly is we jumped into self-storage. Self-storage cap rates have come up quite a bit, meaning the attractiveness of that asset class is at a point where we think it makes sense to jump in. And so, we've selectively done that.

And I guess I should talk to a fourth point. We've also put some capital work with managers that are trying to be selectively buying what we'll call distressed properties. It's not that the assets are distressed, it's the balance sheet. So, it's the notion that interest rates have come up, they're part of the pool. It's quite possible the current owner did not envision having to refinance the maturity of the debt coming due this year at today's higher interest rates. So, if you were to find a real estate manager that had the ability to identify a very good asset in the right location, and it just happens to be the balance sheet is messed up by the current owner, you might be able to acquire that property with attractive terms. So, those would be the different arenas we've been in.

Nancy Lashine:

Yeah, we like all those spaces too and a few others. So, when you look forward to 2025, where do you see opportunities?

Alan Zafran:

Well, let me start with a caveat. We receive over 2,000 inquiries a year. We ultimately invest in something like 20 to 25 vehicles. Of those inquiries, I have to tell you that just based off the first couple weeks of 2025, it's amazing how many people have reached out to us on real estate. We've already received decks relating to light value add in the mountain west, light value on multifamily. We've seen decks on senior housing. We've seen decks on student housing. We've seen decks on office and data centers. I mean this is all within two weeks.

There is a push. I think every real estate professional must have decided, "I'm going to wait until the end of the year." We have a new administration coming in. The rates have shifted a bit. It's time now to talk about property values are 22%... according to Green Street, 22% off their peak values. And depending on how you're looking at it, private real estate is as far down from its peak valuation as probably any other asset class, certainly since 2021. So, I think there is a pent-up supply, I didn't say demand, of managers trying to raise capital in the real estate space, and we are already seeing that come our way.

Where I think we're going to look is continuing to push on the themes. I mentioned properties that may be distressed due to the balance sheet, but not actually due to the property type itself or the asset itself. There might be room in selected geographical locations in the US. I want to be careful when I say this about light value add multifamily. We can talk about that. I do think that there might be a possibility. This is a tough asset class. I'm going to throw this out. Senior housing. It's an out of favor asset class that used to be in favor. I don't know if that'll work, but I think it's intriguing. So, we'll consider that. And I think we want to get further thought to self-storage if we've actually got that fully covered the way it has.

So, there are a number of different ways to play the real estate space. I don't think there's a debate about valuations are pretty significantly off their highs. I think the questions are going to be some combination of what property types drew on a focus and how do you like the valuations in which you're jumping in.

Nancy Lashine:

Right. Well, so much of it is a function of what's happening with interest rates. And interest rates are up, I don't know, easily 80 basis points in the last couple of months. So, it's a little hard until they stabilize to know where cap rates should be. And I don't think anyone likes buying it multiple years of negative leverage, which is where so much of the business is right now.

Alan Zafran:

Yeah, it's remarkable. If you just look really since the start of the year on the index. And so, it's telling you that when you would look at the research we read, you'd see the year-end deck saying we're starting into a stabilization on yields and we clearly haven't yet seen that. If you look at Fed funds futures, the markets are signaling very, very little likelihood of a rate cut at the next Fed meeting.

Nancy Lashine:

How are you advising your clients today in terms of portfolio construction and thinking about duration on bonds and hedge against inflation if in fact there is such a thing in the markets?

Alan Zafran:

We work with taxable individuals, there's something out there called the immunity to treasury ratio, which talks about the yield you get on a tax-exempt bond relative to a treasury bond. When that yield is relatively low, it's telling you're not getting compensated enough for the credit you're taking on munis. It turns out muni to treasury ratios right now are reasonably low, or spreads are tight or saying differently. Municipal bonds are in our mind a bit expensive relative to longer term trends. And our belief is really in the public markets for the most part, credit is pretty expensive still. We're not finding lots of compelling opportunities in the public bond world currently. So, we are still fans despite lots of publications about a worry about the craze for private credit. We think there is an explanation. The explanation is the public bank. A lot of the banks have pulled away from lending and we still think there are some extraordinary risk-adjusted rate of return opportunities in private credit, despite publications saying that we're near a peak of private credit mania. And we are worried about inflation a bit.

But our core belief is the economy's fine. Our core belief is the economy is shockingly stronger than anybody could have imagined. We never had the recession that everybody thought we would. With that comes a moderately higher degree of inflation, certainly higher than we saw in the last five years pre-COVID. But not enough inflation to cause detrimental harm to the economy. We think we're going to be in a modestly elevated inflationary environment. It's actually quite a benign environment ultimately once rates stabilize for real estate.

So, our belief is when you get past the noise right now and there's greater clarity with respect to tariffs, and tax policies and immigration policies with respect to the incoming administration what their inflationary effects might be. We think there will be a point where yields will stabilize, cap rates will stabilize. And people will realize that there is a nice inflation adjustment component to real estate, makes it a very important component of a well diversified portfolio. We would tell you that there's still room for public stocks and we still think stocks in the long run outperform bonds and cash. But we still believe that investors who can afford illiquidity should cautiously but thoughtfully diversify across a variety of illiquid asset classes and indeed, to sell off on real estate in the last four years along with this moderately higher inflation environment. Real estate is well positioned in the long run to be part of that diversified portfolio.

Nancy Lashine:

When you think about the risk for real estate investments versus the risk of say private credit, private equity and venture for your clients, where does it fit on the risk spectrum or how do you like to position it on the risk spectrum?

Alan Zafran:

Twofold. Well, there are several fold. You have first of all define what real estate we're going into. We actually have not been as big a fan of development. I'm going to pick one example of real estate development funds, as opposed to funds that are refurbishing existing buildings, because there's entitlement risk, excuse me, and other forms of risk. Those kinds of funds could trigger a higher rate of return if all goes well. As a general investment philosophy, we're generally more content with moderately lower rates of return and what we perceive to be less risk. So, if you really want to tease out risks, we have to get into what kind of real estate. But even more broadly, oh, we find on most, not all, but many real estate funds tend to have fewer properties embedded in them. So, we always want to try and make sure there's ample diversification within the fund itself.

We've seen funds where there's only four or five buildings. That was true on things like opportunity zone funds in particular. So, we just want to make sure when investors look at these vehicles, they're looking not just at the strategy and the manager of the asset class, what's actually underlying the fund. So, that fundamentally, obviously if rates really get out of whack, then we're worried. And then you do understand the kind of asset class. So, for example, to us it's very different to own a class A apartment building in the right location, versus for example a hotel. Because a hotel is the equivalent of having to find a new renter for every room every day. So, there's greater upside of things go well, but there's greater operating risk and greater downside of things for whatever reason don't work out well.

So, we try and tease out the fund itself, how well diversified it is. And then we try and tease out at the asset class on what's the matter of striving to do and what are the operational risks entailed in doing so. I had mentioned as an example, senior housing, which appears to be pretty attractive on a lot of valuation metrics. One of the challenges is it's become operationally far more expensive to manage assisted living centers than it was five years ago. And in fact, you can look at it as a form of a hotel, long-term rents. That is still in our mind in some ways, a higher risk proposition than going into a core apartment building or even a core industrial building for that matter. So, we really have to underwrite every property for different array risks.

Nancy Lashine:

Right. Switching gears a little bit, going back to something you said before that I thought was really interesting. You talked about making sure your clients understand the illiquidity. And I thought how do you build that? Two things, how do you come to understand who your client is and how decisions are made in that family or that unit? And how do you build the trust that kind of you've obviously you, the organization's obviously built over many years with your clients?

Alan Zafran:

I have two ears in one mouth, and I try and use them appropriately despite me talking this entire pod about. It takes a lot of open-ended questions. Trust is built over time. It's teasing out understanding the family's core values, and dynamics, decision-making. We have to be careful to include both spouses. And we have to make sure we understand for legal entities, who the true individual who has investment powers is. We also need to really make sure that we show clients what that illiquidity is. So, we purposely, when we provide reports to our clients, our reporting includes clear delineation as to what percentage of the assets are daily liquid and what are not daily liquid, both today and going forward based on projected future capital calls and distributions. And we build out purposely at least quarter by quarter if not month by month. I think that's the only way you can do it, is be a good listener, and be transparent and build a trusted relationship over time. It doesn't happen overnight.

Nancy Lashine:

No. And then you talked about unforeseen events. And tragically, you're sitting in northern California today where watching the fires in Los Angeles. Do you think that having an event like what's happened with the fires in Los Angeles this past week, will change client.... you have ,any clients in California, will change client views about their risk tolerance or their need for liquidity? Do you see this as a seminal event for many people who've been living through it?

Alan Zafran:

I think this is a seminal event, but people have short-term memories who aren't sitting in southern California. And unfortunately we have a number of clients who've lost homes, as well as colleagues, coworkers, family members, people whom we interact with research-wise. So, it's devastating and it's really hard to deal with. That said, as it relates to your question, my belief is in the short run, all those people will absolutely be affected in a way that they will rethink what risk means. These called three sigma events are devastating and leave a permanent scar with people. However, I'm of the belief that take the Palisades, which is and was an affluent area within LA, it'll be rebuilt. So, crisis breeds opportunity. I fortunately have some relationships with some people that already want to get involved in rebuilding it. And there's already a vision for a more, I'm going to call it a Norman Rockwell-like look, but with a 21st century edge that includes power lines underground rather than above ground, which could trigger brush fires.

There are already visionaries, leaders within that community who are already both leading fundraising campaigns. We've participated as a company already in one, making a large donation. But trying to allow for a way to rebuild in a more constructive way. And that also is frankly an investment opportunity. And I do believe that natural disasters or crises ultimately breed rebuilding. And most individuals look past that and make risk-adjusted bets. As a practical matter, what'll happen is insurance companies are going to the extent they're willing to insure California homes, the cost of insurance are going to go up. So, you can build a spreadsheet and you can calculate the increased cost annually of insurance and take the present value of that. And you know exactly how much the property value has just dropped due to insurance.

The converse of that is to the extent it was already a land-constrained or supply-constrained environment, and now there's at least 8,000 homes last I heard in LA that have gone between Palisades and the Eaton fire. You have a lot of people looking for housing right now. And so, you're going to have this at least short-term effect, both in the rental market and in fact in the residential market, you can see prices go up despite the disaster, because these people need a home. So, it's a complicated question. I think in the long run though, most people have relatively short-term memories other than those that were directly impacted by the fires.

Nancy Lashine:

That makes sense. It is so tragic. I going to shift gears and ask you a little bit about the RIA business because that's become certainly a focus for so many real estate investment firms that are, yes, looking for capital because last two years have been such a tough fundraising environment for real estate. And the transaction environment has also been tepid. So, I guess there's a hope that even if we are higher for longer, as people come to understand what's normalized rates, there'll be more transaction volume and ultimately people will be able to make investments with more reasonable information. But the RIA community has just exploded in growth. And then as I understand it, there's been a lot of consolidation amongst RIAs. So, tell us a little bit about how that has evolved and where you see that going.

Alan Zafran:

Okay. Well, I think two things have really led to this consolidation in the Registered Investment Advisory space. It's a combination of technological advancements, that mean even small Registered Investment Advisory firms can now provide reporting and information to design client probably as well or better than with the large Wirehouse Merrill Lynch, UBS, Goldman Sachs, Morgan Stanleys can do. And secondly, particularly in the last five years, there's been a tremendous amount of private equity money flowing into this space. And private equity money typically comes in and encourages businesses to grow rapidly or consolidate.

Mathematically, if you look at the Wirehouse firms, over 50% of the capital is held by the 10 largest firms, including Goldman Sachs, Morgan Stanley, UBS, Merrill Lynch. In the Registered Investment Advisory space, even today, the top 10 firms control less than one quarter of the capital. But what's happened is if you look at this space, there are roughly 18,000 RIAs in America, 14,000 of less than $500 million of assets under our management. Another 3,000 have less than a billion of assets under our management. There's roughly a thousand RIA firms with over a billion of assets under management. And of those, 700 of those firms have less than $3 billion of assets under management.

And what's happening is the 300 firms with more than $3 billion of assets under management are getting targeted by the private equity firms. And what's happening is those firms are increasingly serving more highly affluent families. And those more highly affluent families, many years ago, it was good enough to show them an interesting investment idea in the public markets. Then a little less recently, it was interesting to show them good public investments and some non-public investments like real estate funds.

Those families today want public investments, private investments, but they want a lot of non-investment related services, financial planning, integrating with their estate planning and estate planner. They want an easy portal for tax reporting. If not, you're doing their taxes. They want bill pay. They may want a medical concierge. They may want you to price out should they buy a plane or lease a plane. They may want to help you find a property manager for six houses across the globe. And so, what's happening is all of those skill sets either doing the proper due diligence on illiquid investments, which is far more time-consuming and requires more manpower than public investments. Or having people in place to do bill pay, tax prep, integration with estate planning require more and more people and are more and more costly for the RIA firms. It requires more capital to validate in their business model the ability to deliver those services.

So, what has happened is, the largest RIA firms are consolidating for economies of scale so that they can afford to offer these non-investment related services to the underlying family. Underlying families, particularly those with significant affluence, are effectively demanding those services. And in order as an RIA firm to be competitive, we have almost no choice but to find a way in which to include in-house estate planning experts, in-house tax experts, having in-house bill pay. So, these types of ancillary services are what families are coveting. And if we're going to continue to grow, and be viable and allow for our young professionals to learn the industry and grow, we need to continue to find a way to meet our client's needs. And so, within the RIA space, I think what you'll see is five years from now, what's now less than 25% of the assets, the top 10 firms are going to control closer to 35%, 40%, 45%, close to 50% of the assets.

Nancy Lashine:

The top 10 firms, not just the top 300. Wow.

Alan Zafran:

No, you're going to see more continued consolidation. Because those firms that are largest will be able to continue to offer not just thoughtful, curated investment research on alternative investments, they're going to also be able to offer an array of non-investment related services that the smaller players cannot afford to offer. They don't have the manpower, they don't have the ability to invest in the software it takes to deliver best of breed performance reports or other reports that their accountants or attorneys need. And so, those that are big enough, have the scale economics to offer this to the large families.

Nancy Lashine:

That's fascinating. So, like the real estate investment management business, which maybe started 30 years ago, largely by entrepreneurs. And as those entrepreneurs have aged and look for exit strategies, for the most part they've been bought out by larger firms, oftentimes private equity, sometimes full service investment managers with different asset classes. What is the natural exit strategy for those large RIAs, whatever it is, 10 or 20 years down the road?

Alan Zafran:

It's very dependent on the culture of the firm and the mindset of the leadership at the firm. So, most RIAs whom I have had the benefit of talking to, tend to be entrepreneurial. Many of them came from large firms and in general... and there's absolutely exceptions, I think in general, really enjoy the seduciary mandate that they have, and being predominantly employee owned and independent, and probably want to find some mechanism to pass that ownership on their employees and next generation rather than sell to a large wire house firm. There's also some evidence now that some of these private equity firms are actually rolling their equity interest in the RIA firm into their subsequent fund. They're not selling it itself because they see it that the business itself has strong economics.

The business itself, when you have literally hundreds or thousands of clients who are all predominantly on a fee, it's a well-diversified business that generates cashflow. It's an attractive business for a private equity buyer. I think the most exit is one whereby the owners of the businesses find a way to pass on the business to the next generation. And in fact, those individuals that are forward-looking are already putting in place individuals younger than them and giving them substantive rules to operate the business day to day, and effectively grooming them to take over the leadership of the business.

Nancy Lashine:

Wow. So, it's a whole other career path similar to when you graduated from business school and went to work at Goldman Sachs as a financial advisor. It's a different opportunity.

Alan Zafran:

The RIA industry today is a business school case study. I actually think running my business today is a business school case study. And if you were to say where is enduring long-term value in this business? We are nothing more than people with phones and computers. And we're aging out the leadership. And so, there needs be,-

Nancy Lashine:

That's why I asked the question.

Alan Zafran:

Yeah, there needs to be real, bonafide ownership leadership of the clients at the next gen. So, if you're a business and you've got a bunch of people over age 50, that's great, and you have experience, and scars and you're about to show all the things you've done wrong, but you need a cohort of people in their 30s and 40s, let alone 20s, that actually have substantive roles to play and are increasingly taking over responsibility, running the day to day as we're really, really understanding at the end, it's a client business. It's a client-centric capital business. And what we need to do is ensure that we have a culture of integrity, and teamwork and client comes first. And if you empower young individuals who are bright and they're young, that's the enduring value of the business. And to the degree you actually allocate real equity to them. And there's a real equity mindset. That's where you create enduring value in a business.

And that's what if you're saying what's the exit? You're passing it on to the next gen. But even if there was a prospective buyer, let's say there was a private equity buyer, the first thing they're going to look at is what happens when you leave? Will the clients leave with you because you're so old? You have to have a credible answer. No, we have a team and this team of individuals younger than me are the ones that actually control the day-to-day investment decisions. And so, it's a cultural answer, but I think you have to have significant forethought with respect to how you choose to have your culture and an equity mindset in order to create and maintain a durable value in your underlying business.

Nancy Lashine:

I mean, 30 years ago if you hired a wealth advisor at any of the big wirehouses, at some point you'd say, "Gee, have they performed well for me? How's my stock portfolio doing compared to the indexes or to whatever else you're comparing it to?" What's the value proposition for your clients in hiring an RIA firm?

Alan Zafran:

I'll tell you the number one enduring value, it's putting someone between you and your money.

Nancy Lashine:

Interesting.

Alan Zafran:

The psychology of money. But that is still today. I know there's all these things I can go through, but just to make my point, we're all prone to being emotional. And when we're in control of our own money, we don't have an arbiter. I'm sometimes accused of being a rabbi, and a priest or a psychologist, But I'm a sounding board. Now. The reality is there's a lot more to it. My team and I have tremendous years of experience. We're in deal flow. There's a variety of investment related services and non-investment, other services that clearly merit a conversation.

We've had conversations, we'll go up to a prospective client, they're a bit skeptical, and we'll say, "Okay, great. Why don't we just describe three investment opportunities we've seen in the last month? Have you seen any of them?" Generally the answer is no. And we say, we will say, "Okay, great. If for no other reason, why wouldn't we have a dialogue? Because we can show you opportunities you're not seeing." But to make my point, the biggest value we add, educating the client of the array of opportunities around the both investment related estate planning related, tax related, wealth transfer related best practices for kids and next generation. And secondly, and most importantly, trying to eliminate as best as possible emotions from objective rational decision making.

Nancy Lashine:

That's a tall order, Alan.

Alan Zafran:

It is a very tall order. I've been doing it for 35 years. I can tell you for tall order.

Nancy Lashine:

You talked at the beginning of our podcast about the name Luminous. Tell us about the name IEQ.

Alan Zafran:

Well, names matter. So, we look at IEQ as the blend of IQ and EQ, but it really cuts across three dimensions. First and foremost, investing. So, I have had this in the past, we have looked at investment opportunities like a real estate investment opportunity. All the numbers pencil out fundamentally looks like a great investment. Conversely, we'll get people come on our door who create a tremendous story, but then we run the numbers and it doesn't work. So, IQ, EQ, number one, is trying to make sure that both the numbers and the people backing the numbers are in sync.

Secondarily, we really pride ourselves on our investment prowess here, and we think of ourselves as almost a teaching hospital for investing. So, we have a weekly research call in series. The 13 people on my dedicated research team are the people who need to be on the call. We have upwards of 40, 50, 60 people that dial in because we want a culture where everyone's encouraged to learn and we want to teach one another best practices about investing. So, the IQ is the people that really are dedicated research to understand. And the EQ is having the patience and thoughtfulness to educate everyone to so they're all in it together to breed an exceptional culture.

And then lastly, it goes back to the client. So, a client could tell me they're anxious and scared, and want to sit in cash all day, and I have to explain that that's probably not going to be a great idea in the long run. You weren't really beat inflation. Conversely, I could get a client coming in who thinks they want to put all their money in cryptocurrencies and call options on the NASDAQ index, and we have to remind them that they have low risk tolerance. So, the IQ, EQ is a combination of rational, thoughtful, academic-backed judgments about how best to create portfolios that tend to someone's risk tolerance, and time horizons, and age and income needs. But it's also trying to make sure clients were sensitive to their family values, their experiences, if they've had bad investments, how to work through that family dynamics. It's not uncommon for different branches of families to have real challenging relationships. So, the EQEQ is trying to make sure we're really attentive to every individual affiliated with that.

Nancy Lashine:

Wow. Well, on that, I don't know how we top that. I'm going to ask you a couple of rapid-fire questions if I could to end our podcast.

Alan Zafran:

Yeah.

Nancy Lashine:

What do you do to blow off steam in your free time?

Alan Zafran:

I'm a exercise freak when I can-

Nancy Lashine:

Freak was self-proclaimed, right?

Alan Zafran:

Self-proclaimed.

Nancy Lashine:

Yeah, yeah.

Alan Zafran:

I try to get up and I'm trying to be in a swimming pool by 5:30, 5:45 every morning, and it gives me an hour of solitude to get my day set up. What happens is I'm inundated all day long with emails, texts, phone calls, people walking in the office, et cetera. I am in control of my day before 7:00 AM. So, that's number one. Number two is I'm passionate about occasionally getting away and taking a hike somewhere exotic. So, I've been Patagonia on four occasions. I've hiked in Japan, I've hiked in India, I've hiked in Alaska, remote locations. Something a little more-

Nancy Lashine:

Wow. Alaska.

Alan Zafran:

Yeah.

Nancy Lashine:

That is exotic. Yeah.

Alan Zafran:

We got dropped at the base of Grizzly Mountain and we're sent see in a week.

Nancy Lashine:

What time of year?

Alan Zafran:

Oh, that was July. That was when the [inaudible 00:46:17].

Nancy Lashine:

Just checking. Yeah.

Alan Zafran:

I'm also an avid reader of nonfiction books. I would happily provide lots of recommendations on any genre.

Nancy Lashine:

Give us a couple.

Alan Zafran:

Hellhound on His Trail is a phenomenal story about the longest standing manhunt for an assassin in US history was Martin Luther King was assassinated. Martin Luther King Jr. was assassinated. It's actually a book about Martin Luther King Jr. and all. The Endurance: Shackleton's Greatest Adventure is a fabulous book about Ernest Shackleton's attempt to cross one side of the Antarctica to the other, and what happened to him and his 28 person crew along the way. I think that's a fascinating book. River of Doubt, which is what happens to Teddy Roosevelt in 1914 after he is out of office for the second time, and he decides to be on a trip with roughly 50 other people and be the first non-natives to go across a river for a thousand miles that's never been navigated before and they don't know what's going to come across.

Nancy Lashine:

Whoa.

Alan Zafran:

There's all kinds of crazy nonfiction stories that to me read far more fascinating than fiction.

Nancy Lashine:

Well, those are three good ones. I'll have to add those to the long list.

Alan Zafran:

I'll text them to you.

Nancy Lashine:

Great. Who would you say has had the greatest influence on your career?

Alan Zafran:

Oh, my father.

Nancy Lashine:

What did he do?

Alan Zafran:

Oh, he was a mechanical engineer by training and he was a rocket scientist focusing on ion propulsion systems to enable satellites to maintain their orbit. Way beyond my skill set.

Nancy Lashine:

Okay. I think I barely understood what you just said.

Alan Zafran:

I didn't understand any. He'd bring home books with more numbers than letters. I didn't understand any of it. But he taught me, I'd like to think, work hard, be humble, lead by example. It's really that simple.

Nancy Lashine:

It's that simple, isn't it? If you could have dinner with anybody, dead or alive, who might that be?

Alan Zafran:

Probably Leonardo da Vinci.

Nancy Lashine:

Ooh, that's a great one.

Alan Zafran:

He was an exceptionally talented individual. If you go back and read about his wide array of interests, he was way ahead of his time.

Nancy Lashine:

How's your Italian? Just kidding.

Alan Zafran:

Terrible. But I like [inaudible 00:48:22].

Nancy Lashine:

The food's good, right?

Alan Zafran:

Yeah.

Nancy Lashine:

Oh, this is such a pleasure, Alan. I could talk to you all day. You're so much fun. And you've built two amazing businesses and an amazing career. And done some really wonderful things for a lot of people, but I think have a great perspective on the part of the industry that's growing very rapidly and people want to understand. So, I thank you for sharing.

Alan Zafran:

It's just been a privilege and an honor to be here. Thank you, Nancy. You yourself have built a remarkable business at Park Madison Partners. I think it's 35 years of putting together exceptional [inaudible 00:48:53].

Nancy Lashine:

Real estate investments. Yeah, yeah. Thank you.

I hope you enjoyed this episode of Real Estate Capital. Before you go, I have a quick favor to ask. We've put a lot of thought and effort into this show, and making sure we bring you insights from real estate leaders that you don't normally find in the mainstream media. So, if you're enjoying the show, please remember to follow it on your favorite podcasting app so you never miss an episode. We'd also love for you to share it with others or give us a review on Apple Podcasts so others can find us. Thanks again for tuning in. For more information about our firm, please visit our website at parkmadisonpartners.com.