Understanding Private Real Estate Investment Fees
Are you ready to graduate?
I’m not talking about school. I’m talking about moving up from residential to commercial real estate investing.
Now some of you didn’t invest in residential real estate in the first place. But many of us have. And most others inherently understand it. We’ve watched the HGTV shows. We know that lady from work or that college friend who flipped that house.
I was on an HGTV special myself in 2008, and I can tell you the residential real estate game is not hard to get your mind around. Costs, revenues, profits…all pretty straightforward. You could do the accounting on a junk mail envelope. (Trust me, many of these guys do.)
Understanding private commercial real estate is an entirely different ballgame. I spent years scratching my head about how to get into commercial real estate. I knew that most of the wealthiest people on the planet invest there, but I didn’t know how to start.
Who would I trust? How many millions would I need to get in? Where was the on-ramp?
Real Estate Syndication Was the Answer…
Private real estate investing has been around for hundreds (thousands?) of years, though historically you had to be rich and well-connected to participate. It has exploded in popularity since the Great Financial Crisis (GFC). The 2012 JOBS Act, the online revolution, and increasing popularity of alternative investments among retail investors all played a role.
And it hasn’t hurt that the economy has been on a nearly steady rise since the GFC. Even COVID barely dented the popularity and performance of most private real estate syndications, and the rise has continued since then.
But don’t forget Buffett’s haunting words: “You never know who's swimming naked until the tide goes out.”
Syndicators have come out of the woodwork over the past nine years. Some who never invested a penny in real estate in a few years ago are now doing eight-figure deals and training others on how to do so. It’s a good time for investors to be cautious. Also please note that I’m using the terms “syndicator, sponsor, and operator” interchangeably in this article. I’m not using the term “fund manager,” but that can also be a fitting term if you’re investing in real estate funds.
So, I’m encouraging you to treat syndication sponsors, deals, geographies, financials, and other details with great care.
One of those “other details” is the syndication sponsor fees. Don’t overlook this. The type, size, and timing of the fees is important. And understanding how the fees work should help you as you consider your alignment with a sponsor. And your willingness to place your hard-earned dollars in their hands.
Wellings Capital has reviewed 50+ private real estate Private Placement Memoradnums so we have seen just about every fee and structure there is. So, let’s discuss these fees. Though all sponsors and deals are different, we’ll touch on typical market ranges. My goal is for you to get an idea of whether or not the sponsor is aligned with investors and putting them first (they should!). You’ll find these fees outlined in the Private Placement Memorandum (PPM) and the Operating Agreement (OA). Unfortunately these documents can be hundreds of pages long and quite tedious to read.
Most of the time you get what you pay for. NFL franchises pay one quarterback many times more than another and the team reaps massive rewards as a result. The syndication sponsor…their experience, skill, integrity, and team…is the single greatest factor in the success of your investment. We often say we would rather invest in a mediocre deal with a great sponsor than a fantastic deal with a mediocre sponsor.
Also please be mindful that you should never compare public equities fees to private real estate fees. For example, comparing the 0.04% fee for VTSAX to private real estate syndication fees is like comparing a boat to a car. They’re just completely different. We could write a whole separate article about this. As a side note, each of the public companies held by VTSAX have tons of expenses that don’t show up in the fee that Vanguard charges for packaging them together.
Acquisition Fee
This is the cost passive investors pay the syndicator for putting the deal together and closing on it. This will cover the time and resources involved (this could be months or years) to find and vet the deal, get it under contract, perform due diligence, get entitlements, get it to closing, and much more.
It includes the efforts and skills involved in pulling together the syndicated legal offering to make it available to investors. Sometimes a sponsor will pass on dozens or hundreds of deals before closing on one. This fee usually focuses on soft costs and typically doesn’t include all the hard costs of these efforts. Legal fees, filing costs, surveys, title work and dozens of other details are billed as costs to the project.
Typical acquisition fees can run between 1-2.5% of the property purchase price, but I’ve seen them outside this range. Keep in mind that a percentage of the project cost, in a deal with leverage, is a much higher hit to your equity. Take a 75% LTV deal. A 2% (of purchase price) acquisition fee will be an 8% hit to your equity right up front. Ouch.
Capital Placement Fee or Committed Capital Fee
This is similar to the Acquisition Fee. While an Acquisition Fee is most often charged on an individual syndicated deal, this fee is usually charged by real estate funds when placing investor equity. When a syndicator is also a fund manager, they typically charge either a capital placement fee or a committed capital fee. (Take a close look at this issue. If both are charged by the same operator in a single deal, you have reason to question.) This fee is based on the equity invested and it typically ranges from 1-2%.
Asset Management Fee
This is often deemed “the cost of keeping the lights on.” While the Acquisition Fee is charged once upfront, Asset Management fees are typically charged on a quarterly or annual basis. This fee covers the overhead costs of managing the project or asset over time.
This fee usually includes many hard and soft costs to keep the project going. It may cover costs for travel, accounting, ongoing legal, tax preparation, software (like investor portals), postage, and much more. (Note that some syndicators break out an Asset Management Fee and a separate Administrative Fee to cover these items.)
While this fee does reimburse the syndicator, it can also be viewed as ongoing revenue to them. Since the number one factor in your investment’s success is the syndicator and team, you’ll want the staff to be well-compensated. The syndicator needs to have the cash flow to survive and thrive if times get rough. You don’t want them laying off their best people right when they need them most, in times like we saw in the years following 2008.
Asset Management Fees are sometimes based on a percentage of the equity, and sometimes on a percentage of the initial property purchase price. I’ve seen Asset Management Fees ranging from about 1-2% of the equity up to 1% of the purchase price. You may shrug about a 1% charge of the purchase price (vs. 1% of the equity), but that is quite steep. With debt, this could translate to a fee of 3-4% of the equity, a painfully high charge.
Loan Guarantee Fee
Sometimes the sponsor charges a fee for personally signing on the loan, usually only if it’s a recourse loan. I would expect the fee to be about 1-3% of the loan amount annually. In other cases, some syndicators need an outside guarantor. This can be problematic, but there are legitimate reasons for this as well. This should be analyzed on a case-by-case basis, and you should directly ask why the sponsor doesn’t have the liquidity or net worth to sign for the loan. A few examples of why syndicators may need an outside guarantor:
The sponsor has already signed on other loans, and they don’t have capacity to do another one.
They have invested significant cash in this deal and others, and this has reduced their liquidity (which is a major factor in loan qualification).
Property Management Fee
Property management is either conducted in house, by the sponsor, or outsourced to a third party. This is another critical function. There is virtually no activity more critical that will lead to the success or failure of your venture and your resulting investment. You don’t want your operator to skimp here, but you don’t want property management to be a profit center either. Property management fees for commercial real estate typically range from about 2-8% of gross revenues generated by each property. The asset class, grade, location, size and more can impact how high or low the property management fee is.
Construction Management Fee
This is sometimes known as a project management fee or a development fee. Some projects, like full or partial ground-up development or steep value-adds, include a significant construction component. This function must be well-executed to deliver the projected results. This function may require extra staff or contracted managers in addition to significant distractions for the team. Construction or development responsibilities can include gathering and negotiating bids, hiring and firing contractors, making key decisions along the way (e.g. paint colors), reviewing monthly cost reports, approving installment payments, environmental testing, securing zoning, obtaining building approvals and permits, and approving completion.
I have seen these fees all over the board, potentially ranging from 3-10% of total costs. Note that certain projects may be a straight ground-up build, and the operator’s whole value proposition is wrapped up in construction.
Refinance Fee
One of the beautiful things about real estate is the opportunity to extract lazy equity tax-free (usually) to reinvest and expand your holdings. Refinancing can provide a huge benefit for investors locked into a generally illiquid investment. But it comes with a price to the syndicator. It takes time, effort, staff resources, and more. It may include getting appraisals, shopping for debt options, and detailed personal, corporate, and property financial reviews.
Trust me, as an investor, you want your syndicator to be motivated to safely refinance if there is lazy equity to be harvested. Sometimes there is a separate split between the GP and the LPs on refinance proceeds. Other times there is a fee based on percentage of the new loan amount or property value. Sometimes there is no fee at all. It all depends on the sponsor’s business plan. To understand this fee, you need to read the PPM and OA carefully and then ask questions about any confusing parts.
Disposition Fee
Also known as liquidation fees or selling fees, this is a fee charged by the operator to execute the successful sale of an asset. Everyone’s goal is to get the highest price for the asset, with the highest ROI to all parties.
There is a lot of work involved for the operator, and it can take many months to make this happen. Owners and staff employ a lot of effort in addition to their typical duties to keep the asset and the company running smoothly. I’ve heard of deals that take a better part of a year.
Selling a property is often a big payday for the investors and the syndicator, and this fee is typically part of the puzzle. I usually see disposition fees in the range of 0.5-1% of the sale price.
While some may argue this is part of the sponsor’s role and shouldn’t generate an extra fee, this fee, like all others, needs to be considered in the context of all the fees and profit splits involved in a property or fund.
Performance Fees
I’ve covered this topic in detail in past articles on preferred return and waterfall structures, so I won’t belabor it here. This is the big profit center for commercial real estate syndicators, and the fees are typically a means to this end. If this is not true and sponsor fees are their endgame, I would typically recommend you run away.
On the contrary, there are some experienced sponsors who are so confident in their performance that they charge no fees along the way. We invest with one that charges no fees at all but takes a much higher profit split. His staff is compensated from profits and significant cash flow from over one hundred properties they hold long-term. Like everything else, this should be considered in context and viewed through the lens of the operator’s track record and your investment goals.
Concluding Thoughts
I hope this article helps you as you consider the fees charged by various syndicators. It is far from complete since there are so many variables concerning asset class, sponsors, deals, geography, investor type and involvement, investment size, and more.
Please reach out to us if you’d like to discuss this article or learn more about passively investing in commercial real estate. This is one of our favorite topics and our team will be glad to assist you with any questions you have about any deals you’re considering or one of our offerings in particular.
If you have further questions, please email us at invest@wellingscapital.com or use this scheduling link to set up a call to see if Wellings Capital’s investments are a fit for you.
As with all financial matters, please do your own research, draw your own conclusions, and seek professional advice. The information contained in this article is for informational purposes only and is not intended to provide investment advice. Investors should consult their own tax, legal and accounting advisors before engaging in any transaction.