What to Look for in Private Equity Real Estate Fund Fees
It’s well documented that private equity real estate funds offer investors a good way to generate excess returns over public equities. Real estate investing is an actively managed business, which means that it is labor intensive, and success in this industry is highly correlated to the quality of the team. In real estate, the difference between a good manager and a bad manager can mean the difference between doubling your capital and a total loss.
A great team does not come cheap, and fees help managers attract and retain high-quality employees. However, there is a difference between fees that are used to create investment value and exorbitant fees that simply make the managers of private equity real estate funds wealthy at the expense of investors.
We believe that fees should always align with investment objectives and provide real value to the customer. In other words, transaction fees should be fair and help keep the lights on, but the real payday for a manager should be when the investor wins. That’s how Origin is set up.
At the extreme, investors should be wary of fees that are too low. On the other end of the spectrum, managers that charge fees for every service also should be avoided.
At Origin, we post our fees front and center because we want our investors to be fully informed. We charge a one-time 1.5% Fund Formation fee, an annual 1.5% Investment Management fee, and receive 20% of the profits above a 9% preferred return. This is consistent with institutional fund pricing. For accounts under 500k, we charge an additional 1.5% Administration fee. It’s this last fee that is occasionally scrutinized by potential investors.
There are two questions to consider when evaluating fees:
1. What value do you receive for this additional 1.5%?
Servicing hundreds of investors at lower dollar amounts than our historical minimums simply costs more. In 2015, we decided to reduce our private equity real estate fund minimums from $500k to $100k, with the goal of delivering a truly institutional-quality product to individual investors who’d never before had access to one.
Our high-touch service, transparent reporting and investor relations activities require additional staffing at Origin, which increases overhead costs. Our dedicated customer service associates handle all customer and partner inquiries and we spend a great deal of time providing our partners with status updates on individual investments. The costs of these services actually exceed the one-time 1.5% Administration fee, but this is all we pass through to investors.
2. How does this fee impact your investment return?
As of the writing of this article, our first two private equity real estate funds have outperformed more than 90% of other managers’, according to Preqin data. Origin Fund I is currently on track to generate a 2.20x Net multiple on equity and a 28% Net IRR. Origin Fund II is on track to achieve a 2.0x Net multiple on equity and a 26% Net IRR. In both cases, an additional 1.5% fee on the front end would reduce the multiple by .03x and reduce the annualized internal rate of return by less than .25%.
We realize that people are sensitive to fees and so are we. We have an incredibly talented, institutionally trained team at Origin that sources and manages deals on our behalf, and our service is unparalleled in the industry. We believe the value we provide far exceeds the fees we charge.
Keep in mind that fees are also a function of the complexity of the business plan and should be correlated to the value the manager is able to create. For triple net properties, which require the least amount of manpower and where value creation is outside of the manager’s control, fees should be minimal. Properties that require a substantial repositioning need a larger staff, and a good manager can enhance investment value tremendously.
Here is a list of common private equity real estate fund fees in the industry, and how Origin stacks up:
|Transactional Fees||Origin||Fee on Equity
|Fee on Equity
|Total Transactional Fees||3.0%||1.0%||21.5%|
|Annual Recurring Fees|
|Fund Operating Expenses||0.2%||0.2%||1.0%|
|Total Annual Expenses||1.7%||1.2%||6.0%|
Fund Formation fee: This is an industry standard fee that typically ranges between 1% and 1.5%. We charge 1.5%. Before fundraising starts, it costs a significant amount of money to prepare an offering. These startup fees include accounting, legal, marketing and travel costs associated with the company’s activities around this offering.
Administration fee: This fee is generally associated with technology and marketing costs of the platform and is more common with today’s digital platforms. This fee can range between 0% and 2% on equity. Origin charges 1.5% on commitments less than $500,000.
Acquisition fee: This fee is typical among individually syndicated deals. It is normally shown as 1% to 2% of asset size which equates to 3% to 6% on equity given a 65% levered asset. Funds should not charge a commitment fee and an acquisition fee. Origin does not charge this fee.
Debt Placement Fee: This is a fee that is often paid to an outside broker, which is standard industry practice for lining up debt. The typical fee is .25% to .75% of total debt, depending on deal size. A good broker can save the project a lot more than the cost of this fee. However, some managers try to layer on their own internal fee on top of this to the tune of .25% to .75%. This is doubly impactful to equity as the amount of debt used in a typical transaction is two times larger than the amount of equity. Origin does not charge this fee.
Refinancing Fee: This is similar to a debt placement fee and some managers charge .25% to 1% for this service. We don’t believe this is a justifiable fee, and Origin does not charge this fee.
Wholesale Marketing Fee: This fee is typically paid to the broker dealer by non-traded REITs for product distribution and equates to roughly 3% on equity. Origin does not use wholesalers.
Advisor/Syndication fee: Some real estate companies such as private REIT’s use broker dealers to distribute their products through an advisory network. These advisors are typically paid an upfront one-time fee of 4% – 7%. Some syndicators will charge a smaller upfront fee but add acquisition or transaction charges. Often these commissions are hidden in the “sources and uses” fine print that itemizes capital spending. They can range from 4% to 7% on equity as well. Origin does not charge this fee to investors.
Joint ventures: Joint ventures by themselves don’t add another layer of fees, but these tend to be the most fee-driven structures as you are paying two managers instead of one. If the investment manager is simply providing access, then those fees should be much lower than a manager who adds value to the joint venture. Origin typically buys direct but also partners with other operators at times.
Selling Fees: It’s always good practice to take a project to market to generate the highest value. Brokers typically are paid between 1% and 3% of sales price, depending on project size. Some managers charge their own internal fee between .25% and .75% on top of that. Origin does not charge a selling fee.
Committed Capital Fee: This fee is typically charged by called capital fund structures and is anywhere between 1% and 2% on committed equity. This fee is used to pay for the platform that is sourcing deals on behalf of the fund. Origin charges a 1.5% annual commitment fee.
Investment Management fee: This fee typically equates to 1% to 2% of invested equity, and is used to pay for the ongoing company operations and investment management services. This fee is not on top of the Committed Capital fee but rather replaces it once the capital has been invested. One thing to note is that certain managers charge 1% on total deal size, which sounds like less but is actually 3% on equity, assuming a 2:1 leverage ratio. Origin charges 1.5% on equity, and the committed equity fee is reduced once the equity becomes invested.
Asset Management fee: This fee is often seen in joint ventures and is a fee that is charged above and beyond the property management fee by the operating partner. This fee is typically 4% – 6% of top line revenue and helps to align the interest of the JV partners. However, it is a duplicative fee. Origin does not charge this fee.
Performance/Incentive fee: This fee is typically paid on the back end once the asset is sold. This fee aligns the interests of the manager with those of the investor, and is also the way a manager incentivizes his team. A typical incentive fee can range from 10% to 75% above a preferred return between 8% and 15%. Generally, the higher the preferred return, the more the manager will take on the back end. Origin charges a 20% incentive fee after investors have received all capital back plus a 9% preferred return.
Regardless of whom you invest with, transaction fees should be straightforward and predictable, not obscure, unexpected and a profit center for fund managers. And fees should guide—but not drive—an investor’s decision.
Real estate is not an asset class where the lowest-cost provider will produce the best results. The quality of a business plan and the asset manager who runs it make a critical impact on the success of a project.