Diving into Sponsor Investment Fees
When a sponsor is responsible to passive investors to generate a return on their capital, many factors need to line up during the term of an investment. To do so, Sponsors change several types of fees to get the mission accomplished. I’d like to start off by saying there is no correct fee structure – or no fee structure that is better or worse than another. Each structure has its benefits, and they all ultimately ‘should’ get to the same place. The key is understanding how they work, and how they affect a particular investment.
Why pay any fees?
In general, there are some investors who feel fees are profit centers for the Sponsor. It’s a fair question, and a natural sentiment that we can all buy into. But one should understand all the variables it takes to execute a successful deal, and in general – be wary of an investment that has claims or advertises being a no fees deal.
Whether its a specific acquisition or fund, someone must find the deal, underwrite and secure the property, create marketing materials, design and/or build it, negotiate legal and financial documents, raise equity, manage the day-to-day activities at the property, execute the strategy and business plan, create reports to investors, provide K-1’s, sell the asset and ultimately distribute the proceeds. Every member of this team is crucial, and fees are the way the team gets paid. If no fees are paid, one must wonder who does the work, and what is the quality?
What are some of the traditional costs?
In real estate investment management, there are usually two types of fees: transaction fees, which are secured and used to operate the investment over the life or term of the asset, and performance-based fees, which are paid at the end of the project cycle, based on success of how well the investment does.
Performance-based fees tend to be similar across most investments or sponsorship structures, but transactional fees can vary and be very different from deal to deal. Most investors would prefer to have all fees back ended and based on performance, and sponsors would love to have all the fees guaranteed, but that misaligns interests on both ends. The right balance is a combination of both, so the sponsor can keep the office running, build and keep a great team, and be incentivized to do well.
That said, one should understand what services are being provided, and are the fees charged for those services market rate. Sponsors can deliver a variety of services, so its good to understand how it works.
Some offerings have either upfront acquisition, bond or guarantee fees that range between 1% and 3%. These fee helps offset staff and formation fees, technology setup and legal costs, accreditations, marketing, and capital raising,
On a Value-Add investment, the management fee is taken from the annual revenue the property generates and is considered an operating expense. It is paid to whomever is managing the property, whether that is you as the sponsor or a third party. On a ground up project, the management fee can be structured as a development fee issued in monthly installments over the life of the project, and paid via the debt or construction loan requisitions.
Disposition fees are applied when an asset is sold, and may be tied to the performance of the property. The fee is paid as a percentage of the property sale, typically equal to or less than the rate of the upfront costs. In certain cases, if the property does not perform well, a sponsor may waive their right to a disposition fee.
Asset Management Fee
The asset management fee is given to the sponsor and used to pay for investment management services and compensate for the oversight of the investment, not dissimilar from asset management fees taken by other alternative vehicles. The fee ranges between 1% and 2% of the total equity invested and is collected on a quarterly or yearly basis.
Different from the management fee, which is given to whoever is in charge of managing the day-to-day operations of the physical property, this fee is given for managing the assets as a whole. The fee is paid because the asset manager sponsors the whole deal, overseeing the group in charge of managing the property, communicating with investors, distributing regular performance reports to investors, and managing the deal’s finances, such as when distributions are made.
How Project Specific Deal Structures differ from Fund Structures
An important question to ask is who is paying the fee? Is the fee paid by the investor, and deducted from the initial investment, or is it fee built into the project or deal structure? In a fund structure, investors commit a fixed amount of capital to the fund and start paying fees based on their commitment. In a project specific deal, the cost is a project expense.
Whether you choose to deploy capital in a specific offering – or investing in a fund, understanding fees in very important.
Investors should get used to digging into offering documents to understand structures and get comfortable asking questions. Qualified sponsors should be able to answer your questions without issue. Fees are a part of the business because it takes time, planning and great teams to execute strategies at a high level.