If financial advisors ask clients the rate of return for their rental real estate investment property, they should expect to hear a number at least 5 percentage points higher than the actual one, according to the founder of The Real Estate Whisperer Financial Planning.

That’s because of calculations based on “optimistic assumptions, untracked costs and the absence of formal benchmarking” among many owners, said Rich Arzaga, founder of the Monument, Colorado-based firm, in a presentation at this week’s Financial Planning Association Retreat in Oak Brook, Illinois.

“It’s where ownership bias meets the reality of returns,” Arzaga added. “Whatever they say, knock out at least 5%.”

Despite the substantial role of real estate in wealth, the asset class may sometimes get overlooked by planners who leave an often-emotional decision that is critical to clients’ retirements to professionals from other fields who work more closely on investment properties. 

READ MORE: The tax benefits of real estate investing

A void in the profession?

Instead, more planners should maximize their value to clients by taking them through a realistic cash-flow estimate incorporating every expense that they can then apply to a long-term forecast of their assets in retirement, Arzaga said. Even for high net worth clients in particular who generate tens of thousands of dollars in rental income each year, the risks and costs of a property that isn’t meeting their investment expectations can eat up their holdings over time.

“I want to propose that this is an idea that you can use that will expand your thinking about the way we approach this business,” Arzaga said. “I think the way we approach it now is great, but I still don’t see it in any of the curriculum — whether it be the licensing certifications, none of the designations — none of them focus directly on real estate investments.”

Arzaga shared the case study of two 58-year-old clients from San Francisco he called Kevin and Lynn who had a net worth of $3.6 million and rental income of $75,000 per year through a property that was separate from their residence. Through debt service payments and other expenses, however, their costs on the property amounted to $76,000. If the couple followed through on their plan to retire when they turned 65 while keeping the same quality of life that cost them $312,000 a year, they would run out of their assets by age 84, Arzaga estimated.

“Somebody with a $3.6 million net worth, this is kind of not what they expect, right?” he said. “So that’s why they come to us. And luckily, they came to us.”

READ MORE: Ask an advisor: When is real estate an investment?

A better course of action

If the couple were to sell the property in a tax-advantaged 1031 exchange for a better-performing asset or simply spin off their rental holding, absorb the taxes and reinvest the holdings into their long-term portfolio strategy, their assets could amass value hundreds of thousands of dollars or even millions higher than their current scenario.

One of the main misunderstandings stems from the cost of maintaining rental properties, according to Arzaga. In his example, the clients mentioned their amount of income and told him that the number included their expenses. He saw that they had miscalculated when he examined their itemized deductions on Schedule A of their tax returns.

Operating expenses include taxes and the preparation of them, insurance premiums, legal fees related to entity filings and other matters and two major areas — maintenance reserves and property management. In terms of maintenance, the owners should build in costs of about $30,000 to $40,000 every decade for concrete, foundation work, a roof replacement or similar upkeep, Arzaga said. Property management poses difficulty as well.

“Most people like to do that on their own. Most people aren’t capable of that,” he said. “It’s important, and it’s a big asset. And some decisions they’re making are because they’re not professionals in this area.”

READ MORE: The top 20 real estate funds of the decade  

Providing value outside investment portfolios

These realities may be tough for the clients to hear, but they usually come around after planners lay out the cold calculation of the costs and risks involved with a lot of small-scale rental properties. Assisting clients in making smarter choices about their real estate is “more significant than beating the S&P 500” and a “much more noble cause,” Arzaga said.

“Understanding how real estate can impact a family’s finances, I think, is essential to being a comprehensive advisor,” he said. “You’ve got to be comfortable talking about these things. You don’t have to be an expert, but addressing them, to do a service for your clients.

Joel Cooperman, cofounder and former CEO of Citrin Cooperman, left the firm on March 31 after over 40 years.

Cooperman founded the firm, alongside Niles Citrin, in 1979 when two English rock bands provided the seed money needed to open shop in a small New York apartment. Now, the Top 25 Firm reports over $870 million in revenue, with 27 offices, 455 partners and 3,190 employees.

“I can assure you that Niles Citrin and I never had any plans to build a firm larger than the two of us and maybe a couple of others,” Cooperman said in a statement. “In the early years, accounting was still viewed primarily as a profession and not as a full business – this never really made sense to me. We felt that for long-term success it was critical to create a culture and environment that our partners and employees would enjoy as we all worked to build a thriving sustainable business.”

Citrin Cooperman

Citrin Cooperman was one of the first instances of a major accounting firm accepting a private equity investment, from New Mountain Capital, in October 2021. Then in January of this year, Blackstone acquired a majority stake in the firm from New Mountain, making it the first instance of an accounting firm to transfer private equity ownership from one group to another. And since its founding, the firm has acquired or merged over 65 professional services firms and added other lateral partners.

Cooperman offered advice to those early in their career: “I have always been surprised that so many people do not really understand how much they have to offer, how much potential they have.  If I could offer any advice, it would be to figure out what you are good at and what you love to do, make a plan, write it down, and then go after it every day.”

The chair of the Public Company Accounting Oversight Board, Erica Williams, issued a warning Tuesday after the House Financial Services Committee introduced draft legislation that would effectively eliminate the PCAOB by transferring its responsibilities to the Securities and Exchange Commission. 

Speaking at a meeting Tuesday of the PCAOB’s Investor Advisory Group, Williams discussed the improvements in the PCAOB’s 2024 inspection findings for the largest auditing firms, but said the board’s work is far from over.

“Like many of you, I am deeply troubled by draft legislation being considered by the House Financial Services Committee that proposes to eliminate the PCAOB as we know it,” she added, noting that she had previously worked at the commission. “The SEC was my professional home for 11 years. I have deep admiration and respect for the incredible professional staff there. They are excellent at what they do. It is different from what we do here at the PCAOB. The unique experience and expertise built up by the PCAOB over decades cannot simply be cut and pasted without significant risk to investors at a time when markets are already volatile. The disruption to inspections alone while a new program gets up and running could last years.”

Williams pointed to the accounting scandals of the early 2000s at companies like Enron and WorldCom that led to passage of the Sarbanes-Oxley Act of 2002 and the creation of the PCAOB.

“It takes a minimum of 480 experienced staff to conduct the inspections required by the Sarbanes-Oxley Act in addition to many others who are essential to supporting their work, and hiring them would come at considerable cost to the SEC — that is assuming it is possible to hire them at all,” she added. “There is currently an industry-wide shortage of accounting and audit talent, and our team members are some of the most respected and employable members of the profession.”

PCAOB inspections staff members average 22 years of experience, including a decade in public accounting before they ever join the PCAOB, she added. Staffers have experience in over 30 different industries, expertise across 40 different subject matters from revenue recognition to derivatives and technology, and speak 33 different languages.

“That language expertise is necessary because the PCAOB regularly conducts inspections in more than 50 jurisdictions around the world,” said Williams. “Local laws in many of those countries require cooperative agreements that the PCAOB has secured over years of negotiation to ensure we have the access necessary to inspect and investigate completely.”

Those agreements are not necessarily transferable to the SEC, she pointed out.

“None of the agreements contain provisions that would allow the PCAOB’s privileges and responsibilities under the agreements to be transferred to the SEC,” said Williams. “They would have to be renegotiated before inspections could be conducted, which could take years.”

For instance, the PCAOB had struggled for years to gain access to China to conduct inspections of firms located there.

“Of course, this includes China, where for the first time in history, the PCAOB has been successfully inspecting and investigating completely, holding Chinese firms accountable and bringing historic enforcement cases,” said Williams. “The PCAOB secured every concession we demanded from China in the statement of protocol that facilitates our access to inspect and investigate completely. We have their feet to the fire. Scrapping that agreement and starting over gives China the opportunity to exploit the uncertainty in order to avoid scrutiny of its audit work once again, to the detriment of investors.”

She foresees other challenges that would be caused by eliminating the PCAOB, including enforcement and standard-setting.

“Of course, our inspections program is strengthened by tough enforcement carried out by our expert investigators,” said Williams. “And without the talented team working to keep PCAOB standards up to date, there is nothing to inspect against. Every member of the PCAOB team plays a critical role in executing our mission of protecting investors on U.S. markets. And they are irreplaceable.”