The administration of a private equity real estate fund is a time intensive and, at times, laborious process. It takes a highly dedicated team of skilled professionals to start a fund, file the legal documents, raise the capital, find properties, underwrite them, manage them, and oversee all of the accounting, tax, and reporting responsibilities.
For investors considering a private equity real estate investment, potential managers should be compared across a variety of dimensions including: return history, investment philosophy, portfolio composition, experience, management, and fees. Fees are a particularly important point of comparison because of their ability to impact returns over the long term. They are also a necessary component of the fund structure because they pay for the staff, equipment, and technology needed to administer the fund.
The fees that a manager charges should be clearly outlined in their offering and/or marketing materials and their structure should be designed to incentivize the manager to create long term value. When comparing fees across managers, there are two types to be aware of: performance or “success” fees and transaction fees.
Performance/Success Fees
Performance/Success fees are variable in nature and designed to encourage the manager to create value with their stewardship of the property. Performance fees range from 20% – 30% of profits and sometimes higher depending on the manager.
Performance/Success fees are often structured with a “waterfall” methodology, which is a way to split income and profits between investment participants. In the manager’s case, a successful investment, combined with the performance/success fee, can lead to a return is disproportionate to their investment. For example, they may only put in 5% of the equity, but get 20% of the profits if the property performs well.
Often, the Performance/Success fees are tied to something called a “return hurdle” whereby the property must meet certain return thresholds before the manager performance fee kicks in. For example, an investment may offer a preferred return to investors of 8%, above which the manager is entitled to 20% of the profits. On occasion, the manager’s share of profits may increase even higher in tandem with the property return. The preferred return hurdle may be based on IRR, or the equity multiple.
When evaluating Performance/Success fees, it is important to be aware of the exact structure as there are two that are common. In a European waterfall structure, 100% of the property’s cash flow is paid to investors in direct proportion to the amount of their investment. Once they’ve received their preferred return plus 100% of their invested capital, the manager’s success fee kicks in.
In the American waterfall structure, the manager is entitled to receive their performance fee before the investors have received their capital back. To add a layer of protection under the American model, the legal documentation often states that the manager is only entitled to their fee if they reasonably expect the fund or deal to meet or beat the return hurdle. The American model is common with funds or deals that have holding periods in excess of 10 years.
When comparing managers for their Performance/Success fees, the key is to first identify the preferred return hurdle and then the profit split above it.
Transaction Fees
Transaction fees are based on either the total deal size or the amount of capital invested. In addition, they are fixed, meaning that the manager gets them regardless of how the investment performs. There is where terminology may differ across managers, which can make the fees more difficult to compare. The following list outlines common transaction fees:
Acquisition Fee: In individually syndicated deals, as opposed to funds, syndicators may charge a 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 deal size. It is less common for private equity real estate funds to charge an acquisition fee so it’s an important one to keep an eye out for.
Start Up/Organizational Fee: Putting together a real estate deal requires a lot of effort and a manager (fund or syndicator) may charge a start up fee to cover the cost of things like the legal, accounting, marketing, and technology work required to get the investment up and running. Typically, the fee will range from .5% to 2% of the total equity.
Debt Placement Fee: When debt is used to finance a deal, an outside broker may be used to obtain it. If this is the case, it is normal for a fee to be paid for their services. On occasion, the manager may choose to layer an extra fee on top of the broker fee known as the debt placement fee. Combined (broker + manager), the fee may range from 0% to 1.5%.
Investment Management Fee: To pay for the operations and management of the investment, managers may levy a fee of 1% to 2% of invested equity. It should be noted that the investment management fee is not charged on top of the Committed Capital Fee, but instead of it once capital has been invested.
Committed Capital Fee: In some cases, an investor may make a financial commitment to a fund, but the entirety of the commitment may not be drawn down for some time. In such cases, a management fee may be charged on the amount committed, no matter how much is actually drawn down. The fee may range from 1% to 2% of the commitment amount. If charging a Committed Capital fee, a manager should not also charge an acquisition fee as a best practice.
Refinancing Fee: For assets that need repairs and/or renovations, it is common to obtain a short term loan to fund these costs and to refinance the asset once stabilized. Because it takes time and effort to line up a permanent loan, a manager may charge a fee for their efforts. It is normal for the fee to range from .25% to 1%.
Wholesale Marketing Fee: To distribute their product to a wide audience, non-publicly traded REITS may charge a fee that is paid to a broker-dealer for sales efforts on their behalf. This fee can reach 3% of equity, but its existence depends on whether or not wholesalers are used as part of the marketing strategy.
Administration Fee: It takes a team of real estate professionals across different domains of expertise to support and manage a fund’s investments. The administrative fee is charged to provide the funding that pays for the expenses associated with employing them. This fee can range from 0.1% to 0.2% on invested equity.
Advisor/Syndication Fee: Certain companies, including private REITs, use broker-dealer networks to distribute their products through financial advisors. In many cases, the financial advisors are paid an upfront advisory fee ranging from 4% – 7%. In addition, some syndicators will charge an upfront fee, adding it to acquisition and/or transaction charges. On occasion, these fees are buried in the fine print of the “sources and uses.”
Selling Fees: When it comes time to sell a project, it is common for a manager to partner with a broker who has the capability and network to get the best price for the property. For their services, the broker may charge from 1% – 3%, but some managers may try to add .25% to .75% on top of it.
Joint Venture Fees: Often, especially for larger projects, managers may team up to purchase a property by creating a joint venture. In some cases, both managers may charge a fee meaning that the investor has to pay both of them. To avoid this, the bulk of joint venture fees should be paid to the manager doing the majority of the work.
Although there are many fees on this list, it doesn’t necessarily mean that a manager will charge all of them. The best managers will limit their fees to what is fair and needed to cover their administrative costs.
Interested In Learning More?
When working with a professional investment manager, it is a given that they will charge fees. When comparing the fee structure for potential managers, it is important that they be clear, transparent, and tied to performance. Fees should not be a source of profit for the manager and should be limited to what is needed to cover their administrative costs. Finally, fees shouldn’t be considered in isolation, they should be evaluated against the historic performance of the firm. In some cases, it may be worth it to pay higher fees for elite performance.
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’d like to learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.
