In a typical private equity commercial real estate transaction, there are two groups of people involved: the sponsor (the private equity firm) and the investors. Each group has a distinct role to play.
In this article, we will describe the high level responsibilities for each group and the fees that are charged by the sponsor for their effort. By the end, readers will understand what a typical fee structure looks like and will be able to use this information as part of their own real estate investment due diligence process.
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Transaction Roles and Responsibilities
As described in the introduction, there are two parties in a typical private equity commercial real estate transaction, the sponsor and the investors.
The investor role is passive< and they do not have any day to day property management responsibilities. Instead, they invest their capital with the sponsor in the hopes of receiving it back, plus interest over time. For most individuals, this is a good arrangement because they get access to the sponsor’s experience, expertise, network, and deal flow to get into deals that they could likely not acquire on their own.
The sponsor’s role is to find, finance, and manage commercial investment properties on behalf of their investors. While this may sound relatively straightforward, there is a lot of nuance that goes into their work. Each sponsor employs one or more individuals in the role of “asset manager” whose job responsibilities are detailed below.
There are two types of budgets that asset managers are responsible for.
The first is the annual operating budget for each property. To create it, asset managers must model key property factors like occupancy, monthly rents, rent collection, maintenance costs, and operating expenses to create a plan for income, expenses and cash flow for the year. Then, they work with the property management company to track performance against the budget and make adjustments throughout the year as necessary. For example, if they find that eviction costs are higher than expected, they would need to take action to reduce them to get them back in line with the budget.
The second type of budget is the capital improvement budget, which are the costs associated with big ticket renovations or projects. Because of their substantial cost, they must be planned for.
In both cases, the budget planning process is a critically important one to ensure that the property’s performance tracks as closely to original projections as possible.
Collaborate With Lenders
At the time of purchase, asset managers must work with lenders to arrange debt financing for the transaction. Often, this involves leveraging existing lending relationships to determine who is interested in the deal and negotiating the most favorable deal on behalf of their investors.
Once the transaction is closed, the asset manager must work to maintain compliance with the original loan “covenants,” which are performance responsibilities mandated by the lender. For example, there may be a loan covenant that states that the borrower must provide the lender with financial statements every quarter. In this case, it is the asset manager’s job to provide them.
Manage Cash Flow
The point of the cash flow management process is to track the property’s performance against the budgeted plan and to make adjustments as necessary. This way, the property can deliver a return similar to the original projections.
For example, a rental property may need to produce $100,000 in annual cash flow before tax in order to meet its budgeted projections. But, if it ends up producing $90,000, the asset manager can take proactive steps to get the property back on track. Perhaps they could take steps to increase the amount of collected rent or reduce the property management cost in some way.
Market The Asset
In order to be successful, a property must stay as full as possible with rent paying tenants. In order to ensure this is the case, the asset manager must market the property to potential tenants. This could include creating social media advertisements, marketing flyers, website listings, and taking potential tenants on property tours.
Manage The Portfolio
All of the previous activities have focused on asset management at the property level. But, if a property owner has multiple assets in their portfolio, they may also need someone to take a higher level view of performance. In other words, all of the activities above need to be completed for each individual property. Then, the cash flows and performance need to be “rolled up” to the portfolio level to make sure that total performance is tracking towards projections.
From the descriptions, it is clear that there is a lot of work that needs to be done to manage commercial real estate assets. It takes a lot of time and expertise, which is why it is helpful for individual investors to partner with a sponsor to do it.
But, sponsors do not work for free. In commercial real estate investing, it is common for them to charge one or more sponsor fees to recoup the cost that goes into finding, financing, and managing the property.
Typical Asset Management Fees in Commercial Real Estate
It is important to note that each deal is different, each sponsor is different, and each fee structure is different. As such, a live deal may or may not have the fees described below. It is important for investors to read all offering materials and disclosures thoroughly to ensure they understand exactly what fees will be charged on any given deal.
- Asset Management Fees: For all of the work described above, the sponsor may charge an asset management fee, which usually ranges from 1% – 2% of invested equity. This is an annual fee that is charged every year.
- Disposition Fee: When it is time to exit, there is a lot of work that needs to be done to list and market the property. To finance this effort, asset managers may charge a disposition fee.
- Sales and Leasing Commissions: When the property management firm leases space in the property, they may be due a commission. Or, when they renew a lease, they may be due a lease renewal fee. In addition, a commission may be paid to a commercial broker upon sale to finance their marketing efforts.
- Legal Fees: There is a lot of legal work that needs to be done to set up the LLC for investment, manage escrow, and review the loan documents prior to closing. To finance this effort, the asset manager may charge legal/set up fees.
- Acquisition Fees: Likewise, there is a significant amount of work that goes into finding potential investment properties and performing due diligence on them to make sure they are suitable for investment. Usually, acquisition fees are charged upfront as a flat fee or as a percentage of the total acquisition cost, like 1% – 3%.
- Entitlement/Development Fees: In a development project, the asset manager may charge a fee for the costs associated with the entitlement of the vacant land and the work that goes into managing the development project. Depending on the size of the project, it can range from 3% – 5% of the total construction cost.
Again, it is important to stress that all real estate investors should read all of the offering documents carefully to ensure they have a full understanding of the fee structure and how it impacts total returns.
Real Estate Private Equity Management Fees
Private equity firms are one type of real estate sponsor and, like the others, they charge fees for their acquisition and management services. The fee structure may vary from one firm to another which again underscores the importance of reading all disclosures to get an accurate depiction of an investment’s fee structure. This exercise is particularly helpful when trying to compare multiple investments to each other.
Asset Management vs. Property Management
There is a distinct difference between managing an asset and managing a property.
Commercial property management focuses on the day to day activities required to keep the property running smoothly. Generally, this includes activities like collecting rent, making repairs, leasing units, and completing the tenant screening process for all potential occupants. These activities can be completed by the sponsor themselves (which we do) or they can be outsourced to a third party commercial property management company. If it is the latter, there may be property management fees to pay, which are typically a percentage of monthly rental income.
Managing the asset involves working with the property management company to ensure that performance is in line with annual budget targets. Think of this as managing the manager.
Asset Manager Goals
At the end of the day, the goal of the asset manager is to deliver returns to investors. Specifically, it is to deliver returns that are consistent with, or greater than, those originally advertised in the investment’s offering documents. But, this takes a significant amount of work and resources so asset managers must charge fees to support the resources dedicated to this effort.
Summary of Real Estate Asset Management Fees
In a typical private equity commercial real estate transaction, there are two groups of participants: the sponsor and the investors.
The sponsor, sometimes called the asset manager or general partner, is responsible for all of the heavy lifting associated with finding, financing, and managing the property. The investor role is passive. They provide equity capital only and have no say in the day to day property management decisions.
To finance their efforts, asset managers charge fees to investors. In some cases, it may be a flat rate. In others it is a percentage of invested equity.
There is a material difference between the responsibilities of a property manager and those of an asset manager.
Asset manager responsibilities include creating and managing the budget, collaborating with lenders, managing cash flows, and managing the entire portfolio if multiple properties are owned.
Property managers are responsible for the day to day operations of the property. For example, they manage repairs, leasing, maintenance, and resident requests.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you would like to learn more about our commercial real estate investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.