Think back to the last time you bought a home or a car and you can quickly recall the mind-boggling amount of fine print and fee disclosures you waded through and agreed to. Well, when it comes to investments, there are fees too – that’s how those who research and manage the investment are compensated and an integral part of why and how the opportunity is available to you.
Knowing that there are fees associated with any big transaction is one thing, but understanding what they’re for and how they affect you and your investment partners is another. Having the fees in a commercial real estate syndication decoded alters the dynamic from feeling like the fees or those responsible for them are “out to get you,” and rather that they are important to the success of all involved.
In this article I’ll walk you through the most common fees typically seen in a commercial real estate syndication and, together, we can walk through what each one means and what passive investors should watch out for when examining an investment opportunity.
Deflating Investors’ Myths Around Real Estate Syndication Deals
As with any misunderstanding, therein lies some false beliefs and assumptions. So, let’s take it from the top in our comprehensive fee explanation journey, and debunk the top myths investors believe when it comes to real estate syndications.
Myth #1 – Investors Have No Control
You may believe that when you invest in a commercial real estate syndication, all control over your capital is relinquished. This is far from the truth because, while you may not be selecting paint colors or problem-solving for trash pick up, you have 100% say in what type of asset you invest, the asset class, the capital amount, which deal with which sponsor, whether you choose a value-add deal or not, and so much more.
When you invest in a syndication, your control is exerted up front, during the selection and research process so that once you’ve selected a deal and wired your funds, you can use the precious time you have to do what you want with those you love.
Myth #2 – Investors Earn Lower Returns
Maybe you’ve heard a rumor that syndications yield lower returns, but this is confusing because real estate historically outperforms the stock market. No matter what type of investment you’re exploring, make sure you’re comparing “apples to apples.”
Many investors (even experienced ones!) can make the mistake of comparing gross returns to net returns. Since gross returns are the profits or earnings before any fees are taken out while net returns are reflective of what you’ll actually take home, this could be quite misleading.
When exploring and comparing commercial real estate syndication deals, yes, there are always fees, but there are 3 things to consider as you sort through them:
- Are the fees creating alignment between the investment and asset goals of the general and limited partners and driving performance?
- Can you still make a reasonable (projected) return on your capital that propels you toward your goals?
- Are the sponsors being transparent about the fees being charged and what they’re for?
No one likes hidden or surprise fees, so when the general partnership is being transparent, the fees listed are reasonable, and you still make money, that’s a win!
If you’re like me, you don’t have the time or mental energy for fee gymnastics. Instead, ensure that your investment choice is based on the projected net returns across the board. That is, you want to be comparing investment opportunities’ returns after fees have already been removed so you have clarity on how that passive income might affect your budget and your goals.
The Most Common Fees In A Real Estate Syndication Investment
To further deflate myth #2, it’s imperative to understand why the fees on a deal exist and their purpose. With that knowledge, you can more deeply understand how a real estate syndication works and more confidently peruse through the business plan, PPM (private placement memorandum), and decide definitively if a deal aligns with your goals or not.
Ready to learn about each type of fee? Don’t worry, it’s not that complicated.
Acquisition Fee – This is typically 1-3% of the purchase price of the asset and covers costs associated with the resources and due diligence performed by the sponsor to acquire the asset.
Sometimes sponsors spend weeks or even months researching and underwriting deal after deal to no avail. The acquisition fee is what keeps the lights on, so to speak, and helps afford all that effort during and between deals.
Asset Management Fee – At about 1-2% of either the projected gross income or the capital invested (sponsor’s preference), this money pays for the ongoing bookkeeping, coordination, and communication that’s required to properly manage the asset and execute on the business plan.
Construction Management Fee – On value-add or development deals, a construction management fee of about 5-10% of the expected construction budget is necessary for managing the renovations on the property. Attentive, thorough oversight is required to ensure construction projects finish on time and within budget.
Equity Placement Fee – A fee charged upfront by the broker that covers the cost of obtaining investors, limited partners (like you!) and the marketing, coordination, and behind-the-scenes communication and paperwork. Also sometimes called the equity origination fee, this is usually around 1-2% of the capital invested.
Loan Fee – This fee compensates the sponsor for their work toward obtaining financing because getting a loan of this size takes immense effort. A loan fee is typically 1% of the total loan amount.
Guarantor Fee – Occasionally, loans require a kep partner to personally pledge assets to guarantee the loan. Typically between 1-2% of the loan amount compensates the guarantor for their pledge and support.
Refinance Fee – At about 1-2% of the refinanced loan amount, this fee, also called a capital event, compensates key parties for the time and energy it takes to refinance the property. If you’ve ever received a portion of your investment capital back and experienced the joy of cash-on-cash returns as if all your capital was still invested, you’ll probably agree that the refinance fee is well worth it!
Disposition Fee – Finally, a disposition fee is often charged to cover the costs of marketing and selling the asset once the business plan has been executed. 1-2% of the sales price of the asset ensures a smooth transition from your syndication ownership to the next party.
How To Become A Fee-Savvy Passive Investor
With a deep understanding of the possible fees on a deal – what they’re for and how much they may be – keep in mind that each sponsor may present varying fees (in number and by percentage) depending upon their values.
Here at Viking Capital, one of our guiding values is transparency. So when we publish a proforma, the projected returns are net of fees. It’s important to us that documents are easy for our investors to understand and evaluate.
Typically the cash-on-cash returns (quarterly disbursements) and IRR projections are net of the acquisition fee, asset management fee, disposition fee, and, if applicable, a refinance and/or guarantor fee. In general, people don’t like fees, so the fewer the better! That’s why you typically won’t see more than about 4 fees on our commercial real estate syndication deals.
As part of your journey in getting started as a passive investor, learning about and understanding the fee structure is one more checkbox checked toward being ready to grab a seat in our next deal. If you haven’t already, make sure you join the Viking Capital Investor Club today so you can begin browsing opportunities!
