FEES IN REAL ESTATE PRIVATE EQUITY (SYNDICATIONS) EXPLAINED
A considerable amount of effort and work goes into making any real estate investment successful and, naturally, there are going to be fees and payments involved to participants as a reward for such efforts.
Most of such work in putting together a successful real estate investment is a result of people or entities which are usually called either “sponsors” “Operators” syndicators” “general partners” (“GP”) or even “lead investors”: herein we will use general partners or GP for ease of reference. Amongst other things, the general partner will have identified and selected the property, analyzed the market, prepared the numbers to determine if the deal was attractive enough, and found a primary lender to fund the project.
And, once the property is secured, the GPs then have to manage the asset to make sure the business plan is being adhered to, plus arrange refinancing or even disposal once some of the expected value appreciation has occurred.
So, naturally, GPs need compensation for their efforts, time, and expenses.
A private Placement Memorandum (PPM) or Subscription Agreement (Sub-agreement) will, typically, disclose in advance the expected returns and compensation/fee structure for all parties involved with the project, as well as confirm whether returns are based on revenue before or after a GP’s fees have been taken into account..
Whilst GP’s fees will vary from deal to deal, and are usually subject to negotiation, knowing the broad ranges of fees will help passive investors or anyone else looking to invest determine if the suggested fees are reasonable and in line with the overall market.
Broadly speaking, General Partners are compensated in several main ways: either through earning fees at different stages of the project (“Management Fees’) and sometimes, a share of the monthly or quarterly cash flow. But most enjoy a share of the equity split after enhancement of the equity position upon the sale of the asset.
When the general partner shares the upside this is often called the “Promote” or the “Carried Interest” and generally make up the greatest portion of the earnings of the GP.
Whilst syndication fees obviously reduce the amount of income and profit available to split amongst passive investors, they are necessary to provide compensation to the project general partner and other professionals who carry out the syndication’s operating plan—and without whom the passive investors would not have a property to invest in nor earn any returns.
So, in this article, let’s take a look in more detail at the fees involved for GPs in Real Estate Private Equity investing.
As mentioned earlier, in practice, the GP will make most of its earnings thanks to a “share of the upside” or taking a share of the realized appreciation on the sale of the property but these are not part of the discussion in this article.
Some typical general partner’s fees include:
This is the fee that a GP charges for finding and facilitating the acquisition of a property.
- Essentially this fee allows the general partner to be paid for and recoup costs involved in matters such as:
- searching for possible investments;
- identifying and inspecting properties;
- financial analysis of opportunities, negotiating terms, preparing LOIs; assisting with the closure of the transaction.
Finding a suitable property amongst all of the dozens of properties on offer and acquiring it ahead of the competition is no mean feat. In fact, it may be that 20, 30 or even 50 properties will have to be considered and reviewed before one is selected as suitable.
This acquisition fee will be payable upon closure of a transaction and may range from 1-3% of the finally agreed price, although the actual percentage may depend upon the size of the deal, and is often negotiable.
This is a very important fee to GPs and most will insist on such a fee, especially if the property was procured through its own connections or via an off-market transaction.
The acquisition fee is a one-time payment paid to the GP at the time of closing.
Construction (Management) Fee
In a “value-added” renovation situation, or where there is major construction involved with a project, it may be necessary to engage a person or entity to oversee the renovation or construction component.
To make sure the project runs smoothly and due attention and oversight are given and the project finishes on time and within budget, the GP may take this role and charge a construction fee for this role. Such fees are subject to negotiation and depend on the actual scope of works required but, on value-add or development deals, a construction management fee of between 5–10% of the expected construction budget is typical.
Apart from overseeing the construction or renovation process, the scope of works may embrace design, actual construction, and, eventually, stabilization of the property’s income stream.
An alternative is that the GP may outsource such development oversight to a third party.
Property Management Fees
Obviously, the property needs property management services and the general partner may either hire a professional property management firm or self-manage.
It is intended to self-manage, a recurrent property management fee can be secured. On the other hand, even when hiring a third party, the GP can receive a fee for finding a property management company. This will be for negotiating terms (for example, ensuring that their fees and charges are in line with other property management companies in the market), contracting with and, subsequently, managing the property manager..
Many GPs choose to contract with professional management companies and, indeed, some lenders require that an outside experienced property management company be engaged to render such services, at least on the general partner’s first project or two.
Some of the key advantages of hiring a property management company instead of self-managing include the fact that such a company should have extensive knowledge of the local rental market (ie vacancy rates, rental structures, and source of tenants). They are also better equipped than the GP to handle day-to-day operations of the property such as handling operational problems or tenant’s repairs, plus collecting rentals of the units.
GPs usually meet with property management companies on a regular basis, often weekly or monthly, to ensure that the property is being managed in a correct manner.
In the event that the GP does self-manage the property, fees are usually in the range of 4-10% for smaller properties up to about 100 units, with a lower range of 3-5% for larger properties 100+ units. Fees are charged on all collected monthly income.
Asset Management Fee
Asset management differs from property management. The latter is related to the day-to-day management of a specific property, whereas asset management is focused on a macro level, such as tracking revenue and sending out investor communications.
As with property management, if the asset management of a property is to be undertaken by the GP, an asset management fee can be charged.
In addition to managing the property management company, on buy-and-hold investments, if the general partner Is also the asset manager they will need to communicate with all passive investors on a regular basis about how the investment is performing.
Apart from sending regular updates to investors, the GP must deal with quarterly distribution checks, ensuring that investors are receiving their dividends as per their original agreement, help with filings. and host any necessary meetings. The asset manager also has to work with the lender to ensure compliance with loan documents.
In short, the asset manager is required to manage the asset and execute on the business plan properly, ultimately working towards maximizing the property’s profit and value, managing risks, minimizing costs whenever possible, etc.
Asset management fees are usually 1% to 2% of the net monthly income and are paid on a quarterly or yearly basis.
If the passive investors in the property were promised Preferred Returns, the GP will collect its asset management fee only after the passive investors have received any preferred return.
After a few years, once the “value-add” strategy has been implemented, and the property’s value has appreciated, the general partner may consider it time to refinance and release part of the accumulated equity with a view to returning some of it to investors. This is often called a “Capital Event”.
At the time a GP successfully refinances the property, they may be entitled to an additional fee—as there is considerable work involved in refinancing, and this enables them to be compensated for the time and expenses incurred. This fee (sometimes called a “refinancing hurdle”) of between 0.5-2.0% is usually charged on the new loan amount or new debt being placed on the property and is earned on the origination date of the new loan.
When it’s time to sell the property, there may well be disposition fees to the GP for arranging or managing the sale. This fee will be charged against the sales price, as one of the closing costs, and is deducted before the net profits are split between the passive investors and the general partner. These fees represent the GP’s compensation for arranging and completing the sale, which will generally involve significant marketing efforts and related expenses.
A typical disposition fee will be in the range of 1-2%, subject to negotiation, and it’s usual to have this and the acquisition fee agreed at the outset with, say, a 2% acquisition fee and a 1% percent disposition fee all pre-agreed.
If the GP engages a broker to market and sells the property on behalf of the syndication, this fee may not be payable but rather a broker’s fee, which may be higher, of 2-3% of the sales price will be payable.