For an individual investor, one of the major benefits of working with a professional commercial real estate sponsor – like a private equity firm – is that they do much of the work to find, finance, and manage an investment property. But, it takes a significant amount of work and resources to accomplish this task. For this reason, it is normal for commercial sponsors to charge fees to finance this effort. While fees are normal and necessary, it is also possible that they could impact total returns earned by investors. For this reason, investors must be aware of what fees are charged by their sponsors and how much they cost.
In this article, we will highlight the sponsor’s role in a commercial real estate transaction, why they charge fees, and what fees are customary in a typical deal. By the end, readers will be able to use this fee related information to make a more accurate comparison between commercial real estate investment opportunities.
Like many other private equity firms, First National Realty Partners charges nominal fees to fund our work of finding and managing best in class grocery store anchored retail centers. To learn more about our current investment opportunities, click here.
What Does a Commercial Real Estate Sponsor Do?
At FNRP, we have a saying that we “look at 100 deals and choose one.” We do this because we have rigorous investment criteria that are designed to identify the best potential real estate deals for our investors. While this process helps to deliver strong investment returns, it also means that we have to find and analyze 99 properties that eventually don’t make the cut.
When the right property is identified, it also means that we shepherd it through the entire underwriting, due diligence, and financing processes to ensure that we have made conservative assumptions and negotiated favorable terms on behalf of our investors. In our case, we even manage the property once the transaction is closed.
To fund the staff and resources needed for this level of effort, it is normal for private equity firms – acting as the general partner – to charge a series of fees. But, the fees can be different for each deal so it is important that real estate investors are able to identify what they are, what the normal range is, and how they are charged.
How Are Fees Charged?
In real estate investing, one of the tricky parts about understanding sponsor fees is that they frequently have a different basis for calculation. To illustrate the difference, imagine a deal where a property is purchased for $10MM. The purchase will be funded with $8MM in debt and $2MM in equity.
With this in mind, there are three potential ways that fees could be assessed:
- Total Deal Size: In the above example, the total deal size is $10MM. If the fee was 1% on the total deal size, it would be equal to $100,000.
- Invested Equity: In the example, the equity capital required is $2MM. If the fee was 1% on invested equity, it would be $20,000.
- Committed Capital: In certain deal structures, investors will “commit” a certain amount of capital, even if it is not collected by the sponsor at the time it is committed. If a single investor committed to $1MM of the $2MM needed and the fee was 1%, the cost would be $10,000.
The point is this. When comparing fees, the first step is to identify the basis upon which it is charged. The second step is to identify the amount.
Common Sponsor Fees
It is important to acknowledge that the fees can – and do – vary widely by deal. Investors should read the real estate syndication offering documents carefully to determine exactly what the fee structure is for each deal. However, there are a few expense categories that are common.
In individual deals, syndicators may charge an upfront fee for the effort spent finding deals and putting together the capital to close them. The acquisition fee can range from 1% to 2% of the total deal size.
Property / Asset Management Fees
It is important to differentiate between property management and asset management fees.
Property management is a fee charged by a third party property manager to operate the property on a day to day basis. This is not a fee that is charged to investors, rather it is charged to the property as a percentage of the income it generates. Depending on the property size, market, leasing activity, and complexity, the property management fee can range from 3% – 10% of gross rental income.
Asset management fees are charged by the sponsor to manage the asset as a whole. This covers the cost of the asset manager, accounting, reporting, and admin teams that ensure the investment is going as planned. The asset management fee is typically in the range of 1% – 2% of committed capital.
Acquisition & Disposition Fees
There are costs that are associated with buying and selling commercial real estate and sponsors may charge fees to offset them.
The acquisition fee is one time fee charged to support the administrative overhead associated with all of the work of finding, analyzing, and closing deals. It is typically in the range of 1% and 2% of the total deal size and/or purchase price.
The disposition fee is charged to support all of the work that goes into preparing, listing, negotiating, and selling a property. Much of this work is normally handled by a broker who may charge between 3% and 6% of the sales price. However, it is possible that the sponsor could charge an additional .25% – .75% on top of the broker fee.
Debt Placement & Refinancing Fees
In a value-add real estate investment strategy, a sponsor finds a promising property and quickly purchases it using short term financing. Then they perform some renovations and lease up, which is followed by refinancing into a longer term loan. In this scenario, there are two potential fees.
A sponsor may charge a debt placement fee on the original purchase if a broker is used to arrange the loan. It could range from 0% – 1.5% of the loan amount.
If the loan is refinanced at a future date, a sponsor could also charge a refinancing fee for all of the work that goes into arranging a new round of debt. The fee could range from .25% to 1% of the refinance loan amount.
Why It Is Important to Understand The Fee Structure
It must be stressed that the fee structure is unique to each deal. They are highly dependent upon the business plan for the deal, the sponsor’s corporate structure, and the deal itself. However, one thing that is true for all deals is that fees should not be a profit center for the sponsor. They should be enough to fund the costs they are meant to pay, but not more.
Understanding the structure and amount of the deal’s fees are important for two reasons:
- This effort serves as a basis for comparing future performance on two different deals. To get a true comparison of potential real estate investment returns, the fees must be included in the return model.
- Fees can impact an investment’s rate of return. For example, if one real estate project has a potential return of 10% annually and 3% in fees and another has a 12% annual return, but 6% in total fees, the one with the lower return may actually turn out to be a better deal.
The bottom line is this, it is critically important for potential investors to have a thorough understanding of the fee structure in each individual deal to have a thorough understanding of potential risk and return.
Summary of Sponsor Fees in Commercial Real Estate
In order for commercial real estate investment sponsors to fund the effort required to identify and acquire suitable investment properties, it is normal and customary for them to charge fees.
The type and amount of fees can vary widely by deal, property type, and asset class so it is important that passive investors understand the fee structure to be able to make an accurate comparison between opportunities.
Typical fees include: acquisition fees, disposition fees, asset management fees, and debt placement fees. To determine the type and amount of fees, investors should read the offering documents.
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 are an Accredited Real Estate Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.