Sponsors work hard to source, acquire, and manage real estate investments, acting as fiduciary to investors and taking on more risk when forming a syndication. For these efforts, investors compensate sponsors through various fees, detailed in a Private Placement Memorandum (PPM) that can be difficult to navigate.
Michael Episcope is Co-founder and Principal at Origin Investments, where he has overseen $1 billion of commercial real estate acquisition and disposition. Episcope provides clarification on what to expect from your sponsor and guidance to ensure your next venture is a solid one.
Fees Can Be Frustrating to Understand
There can be a lot of confusion around fees—they can be annual, up-front, one-time, charged on total deal size or on equity invested—they’re a challenge to get a handle on.
Episcope says this is by design. “There’s no standardization in the industry, and sponsors, honestly, they use whatever language they feel is best, and the reality is that a lot of language is opaque, and that’s on purpose because it’s simply better for marketing,” he notes.
Here is a short list of some of the more common fees a sponsor may include in a PPM:
– Acquisition and disposition fees: These are typically one-time fees for the purchase and sale of the property or land being managed. Normally the fee is expressed as a percentage of the purchase or sale price of the property—up to 2% in some cases.
– Ownership interests: Typical ownership interest splits range from 30% to 50% for the sponsor. This is a form of compensation for bringing the investment opportunity to the market.
– Asset management fees: This can be a percentage (1% to 2% of the capital raised) or a fixed amount paid on a quarterly basis to the sponsor. This is for the management of the company, not the real estate.
– Property management (PM) fees: PM fees can be done in-house or contracted to a third-party firm. This fee can range from 3% to 4% of gross revenues.
– Construction management: If the business plan includes significant renovation, sponsors may charge up to 5% of hard construction costs back to investors.
Development fees: For projects that need to break ground, development fees cover pre-construction costs such as zoning, environmental testing, approvals and permits. These fees vary greatly and can be fixed or a percentage of total costs.
Focus on Structure When Reading Your PPM
A Private Placement Memorandum (PPM) is a document that discloses everything an investor needs to make an informed investment decision. It details the opportunity, disclaims legal liabilities, and explains the risk of losses.
It’s got it all. And most importantly, the PPM lists all the fees associated with the investment opportunity. When reading through your PPM, Episcope suggests to watch out for structure. “More important than fee amount, is the structure—who gets paid, when they get paid, and how much—this dictates what happens with cashflow and how the sponsor participates,” he says.
Not all real estate companies are created equal. The main difference is in the infrastructure that keeps their business moving. “A good sponsor has an actively-managed business, and it’s people-intensive, so fees pay for that infrastructure,” Episcope notes.
“You may encounter an operator that may not have a staff, or a lot of value to execute at the property level, their fees should be very different than in a value-add or ground-up development project, where you have a tremendous amount of people who are really helping to execute the business model.” he adds.
Look for Performance Based Fees and Gross to Net
The best structures are those where fees align both sponsor and investor. Sponsors should get paid well when their investors are paid well, but sometimes, deals are heavily-weighted with upfront fees versus a more aggressive promote on the back-end.
Episcope provides some guidance in this regard. “Investors should look for structures where the majority of fees are back-ended, they should be performance-based, and fees should be minimal when a deal doesn’t work out,” he says.
Upfront fees are expected. They keep the lights on, but you don’t want to make this a profit center. Episcope provides an example of a good structure with an 80/20 transaction to performance-based fee split:
If the deal doesn’t work, say it makes 5%, you’re going to see the fees in the range of 1% to 3%, and that’s going to be all real estate investment fees.
And if the deal does work, let’s say a deal generates a 25% return, your all-in fees are at 5% to about an 8% dilution on the IRR. This nets an investor anywhere from 17% to 20%, and that’s pretty standard.
Episcope advises investors to focus on returns after fees. “Look at gross to net—the return at the property level—how much is going into the investor’s pocket after your asset management fees, your performance fees, your debt placement fees, your acquisition fees, etc.”
Episcope provides practical advice on what fees and structure to look for in your next deal, but he urges investors to build a network of professionals to rely on when the details get murky or you need a second pair of eyes to confirm an investment.
Fees can be intimidating at first but it does get easier with experience. The lack of standardization in the PPM and the overwhelming density of these documents lead many investors to gloss over the details when in fact, you can rely on best practices to make the exercise more manageable and get one step closer to reaching your investment goals.
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Tyler Stewart is VP of Investor Relations at RealCrowd. All opinions expressed by Tyler and interviewees are solely their own opinions and do not reflect the opinion of RealCrowd. This article is for informational purposes only and should not be relied upon as a basis for investment decisions.