The sponsor, or general partner, of any private equity investment is going to charge fees for staying abreast of economic and market information, performing market research and diligence, sourcing and underwriting opportunities, acquiring financing, raising the private capital, and on-going asset management. The types of fees vary and can range in size depending on the type of investment, the syndicator, and the particular deal. For example, a core real estate acquisition that requires little in repositioning efforts and has a simple business plan will not be able to demand as high of fees as a large value-add deal in which there is heavy lifting up front as well as more involved asset management.
I will go over the standard fees and the normal ranges for these fees. An important point to note and remember is that the best sponsorship structures align the interests between the passive investors (limited partners) and the sponsors (general partners). Additionally, most syndicators choose a variety of these fees and compensations, and the structure may change based on the project.
Acquisition Fee – An upfront fee at the close of escrow is very commonly charged and is typically 1% to 5% of the purchase price and is paid through the raised private capital just like any other closing cost. This fee compensates the general partners for time and money spent on market research, finding the opportunity by analyzing roughly 100 deals, raising capital, securing financing, building partnerships with lawyers, property management companies, brokers, CPAs, performing due diligence and closing.
Organization Fee – This fee is paid upfront for putting the investment together and ranges from 3% to 10% of the total capital raised. This fee is similar in nature to the acquisition fee so it is important for investors to be cognizant of whether or not the sponsor of their investment is charging both an acquisition fee and an organization fee.
Asset Management Fee – This is an ongoing annual fee which compensates the sponsors for ensuring the operations of the property are running smoothly and the actual performance matches the budget and the business plan. The fee ranges from 2% to 3% of the effective gross income of the property. The range of the fee can be dictated by how involved the business plan is. For example, if the business plan calls for extensive renovations, the general partners can justify higher fees. This fee aligns the interests of limited and general partners because the fee is based on effective gross income, which means the fee is higher, the higher the income is, generating a higher return for investors. Lastly, some operators put a clause in the asset management fee which places the asset management fee in a junior position to the preferred return. The preferred return is a set percentage annual return which investors are entitled to prior to any of the profits being shared with the sponsors of the investment. This means that if the preferred return is not being met, then the general partners will forgo their asset management fee to help boost cash on cash returns for limited partner investors. Fewer general partners add this additional layer of alignment of interests in their asset management fee.
Preferred Return & Profit Share – As referred to above, a preferred return is extremely common in real estate syndication investments. Depending on the asset class, the track record of the sponsor, and the risk profile of the investment, the preferred return rate usually ranges from 4% to 12%, with 8% being the most common in the value-add multifamily space. After the preferred return, also known as a hurdle rate, is met, the cash flows of the property are split between limited and general partners. The typical split is anywhere from 50% to 80% to investors. For example, a typical operator has an 8% preferred rate and splits the profits thereafter 75% to investors. Let’s say an investment’s cash flows are 10% in a given year. This means the first 8% of the 10% are given to investors and the 2% above the 8% “pref” are split 75/25, which means investors would get paid an additional 1.5% for a total of 9.5% return while the sponsor of the investment would get paid the remaining .5% of the cash flows. There are more complex versions of this profit share structure known as waterfall or promote structures but the above example is very standard and explains the general gist.
Refinance Fee – This fee compensates sponsors for securing a new loan and would be paid at the time of a refinance event and ranges from 1% to 3% of the new loan balance. While this fee is less common, it can be justified if a significant portion or all of the original invested capital is returned back to investors.
Loan Guarantor/ Cosigner – To acquire the best financing possible, the sponsor may bring on a high net worth individual and strong track record to guarantee the loan and/or sign on the carve-outs of the non-recourse loan. These fees a more broadly negotiated and may be paid by both the limited partners as well as the general partners to the guaranteeing/cosigning party.
Construction Management Fee – If the property needs extensive renovations and the general partner is very involved in the renovation process, then the GP may charge a construction management fee. This fee ranges from 5% to 10% of the renovation budget.