Real estate investing is a complex people-intensive business. Someone must find the property, negotiate the price, create marketing materials and legal documents, raise equity, manage the day-to-day activities at the property, formulate and execute the business plan, report to investors, provide K-1’s, sell the asset and distribute the proceeds. Everyone in the chain is crucial and fees are the way the team gets paid.
In real estate investment management, there are two types of fees: transaction fees, which are guaranteed, and performance-based, which are paid based on success. Performance-based fees tend to be similar across each strategy, but transactional fees are very different. As investors, we would love to have all fees based on performance. But how would the manager pay for the operational activities if all of the income were earned on the backend? As managers, we would love to have our fees guaranteed, but that misaligns interests. What incentive would there be to do a good job? The right balance is a combination of both, so the sponsor can keep the lights on and be incentivized to do well.
At Origin, we operate in a called capital fund structure and our fees look very different than fees a sponsor will charge when they syndicate individual deals. One fee structure is not necessarily better than the other. They are just different ways of getting to the same place.
Private Equity Real Estate Fund Transactional Fees
In a fund structure, investors commit a fixed amount of capital to the fund and start paying fees based on their commitment. Origin’s fund fees are:
1. Asset Management Fee. The asset management fee is 1.5% per year, based on committed equity. This is used to pay our acquisition and asset management team, accounting group, investor reporting, office rent and administrative staff.
2. Upfront Fees. There is a one-time upfront fee of between 1.5% and 3% of the commitment amount. This fee helps offset fund formation fees, setup and legal costs, technology, marketing, capital raising, and personnel in our investor relations department. Origin Investments bears all of these costs out of the one-time fee.
3. Administrative Fees. These fees cover fund administration, tax reporting, dead deal costs, and third-party software. They are variable costs and increase as equity is invested. They typically range between .10% and .20% per year on invested equity.
Our latest fund raise of $151 million in equity commitments for Origin Fund III will be paired with debt to acquire more than $450 million in real estate. We estimate it will take approximately three years to fully deploy Fund III’s equity. The chart below shows what a typical fund deployment by year would look like for a $151 million fund.
|Total Asset Size||$167,777,777.78||$167,777,777.78||$167,777,777.78|
It takes time to build a high-quality portfolio and we only call capital from our investors when we find a property. Historically, it has taken us between 24 and 36 months to fully invest our fund capital, and a three-year investment period is fairly typical.
The chart below lays out the fund’s transactional fees over this period as well.
|Asset Management Fee (1.5%)||$2,265,000.00||$2,265,000.00||$2,265,000.00|
|Upfront Fee (2.0%)||$3,020,000.00||N/A||N/A|
|Administrative Fee (0.2%)||$100,666.67||$201,333.33||$302,000.00|
Much of the confusion between comparing fees between a fund structure and a deal-by-deal structure can be explained by terminology alone. For example, Origin’s fees are charged on equity and not total deal size and this is not necessarily the case with syndicators or other fund managers. Unfortunately, there is no standardization of language across the industry and investors should be very aware of this nuance.
Real Estate Individual Deal Transactional Fees
There are typically four types of transactional fees charged in an individual deal structure:
1. Acquisition Fee. The acquisition fee is typically between 1% and 2% of total deal size, and the bigger the deal, the lower the fee. The acquisition fee on a $30 million property capitalized with $10 million of equity and $20 million of debt is typically between 1% and 1.5%, amounting to a one-time fee between $300,000 and $450,000, which is the equivalent of a 3% to 4.5% fee on equity. This is a market rate fee and investors should keep in mind that a sponsor probably looked at 50 deals to find this one and paid all of the dead deal costs and personnel costs out of their own pocket. It’s not uncommon for a sponsor to raise close to $31 million for a property that costs $30 million to pay for these fees.
2. Set Up and Organizational Fee. Set up and organizational costs are typically between .5% and 2% of invested equity. These are the costs to set up the LLC, create and distribute marketing materials and pay for capital raising. These are generally not a line item easily identified in the marketing materials and are often costs that are lumped into the property’s acquisition cost. This is a line item for investors to be aware of and investors should always ask the manager to explain the fee terms in specific detail to know exactly what the equity is being used for.
3. Asset Management Fee. Deal sponsors also charge an ongoing asset management fee in the same way fund managers do. This fee should be no more than 1.5% of invested equity and investors should pay close attention to the terminology. A 1% asset management fee based on total deal size is much larger in dollar terms than a 2% fee on equity in a leveraged investment.
4. Administrative Fees. Deals incur annual ongoing costs for investor and tax reporting, audits and other third-party costs. This fee tends to be .1% to .2% on invested equity per year and is a cost to the deal and investors, but paid to third-party vendors.
The chart below illustrates what the transactional fees would look like if an individual were to build the same $151 million portfolio on a deal by deal basis. Because they are acquiring 50 million of real estate every year, the acquisition fees are spread out over the three-year period.
|Acquisition Fee (1.00%)||$1,677,777.78||$1,677,777.78||$1,677,777.78|
|Set Up & Organizational Fee (1.00%)||$503,333.33||$503,333.33||$503,333.33|
|Asset Management Fee (1.50%)||$755,000.00||$1,510,000.00||$2,265,000.00|
|Annual Administrative Fee (0.15%)||$75,500.00||$151,000.00||$226,500.00|
The fund and individual deal fee illustrations above are representative of a basic and fair fee structure one would find in a typical deal or fund. The purpose of the illustration is to show that one is not necessarily better than the other, but that they get to the same place in different ways. That being said, funds are often misconstrued as higher fee vehicles and this simply isn’t the case. Every manager, whether it be a fund or syndicator, has similar infrastructure costs and needs to charge fees to off-set those costs. Fees will differ between managers and investors should look at the transaction fees in aggregate and also make sure they are justified on an individual basis. The point is, an investor who builds their own portfolio will pay nearly the same fees as a fund investor.
Whether you choose to invest in a fund or pick your own deals, understanding what fees are market rate, how they are charged, what they are used for and the nuances behind the terminology is vital. Unfortunately, many sponsors use opaque language and make investors work to truly understand every fee they are charging. Fees are a part of the business because it takes talented people to execute at a high level. We decided long ago to put our fees up front and center instead of burying them in a line item and we chose the fund model at Origin because we believe it is the best structure for investors.