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. Unless you’ve blocked them from your memory, that is! Well, there are fees with investments, too…that’s how those who research and manage the investment are compensated, and an integral part of why and how the opportunity is being made available to you.
Knowing there are fees associated with a big transaction is one thing, but understanding what they are, what they’re for, and how they affect you and your investment partners is another. By “decoding” the fees in a commercial real estate syndication so you understand them, you’ll alter the dynamic from feeling like the fees (or those levying them) are “out to get you” to understanding their importance to the success of everybody 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. Let’s get started!
Deflating Myths Around Real Estate Syndications
As with any misunderstanding, many of the myths around the fees in real estate syndications involve some false beliefs and assumptions. So, let’s take it from the top and review the common fees comprehensively, so we can debunk the most common myths investors believe about fees in 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 an unforeseen maintenance issue, you have 100% say in what type of asset you invest in, 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 live life on your
Myth #2 – Investors Earn Lower Returns
Maybe you’ve heard a rumor that syndications yield lower returns on investment, but that’s confusing since 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 and net returns reflect what you’ll actually take home after fees, comparing the wrong factors could be quite misleading.
When exploring and comparing commercial real estate syndications, there are always fees. After all, the sponsors (general partners) put countless hours into finding and structuring a deal, guaranteeing the loan, closing the deal, and operating it after closing for the benefit of everyone involved. But for the passive investors (limited partners), the hard work is done once they’ve wired their funds. So here are 3 things to consider as you sort through the fees:
Are the fees creating alignment between the investment 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. But when the general partners are being transparent, the fees are clearly listed and reasonable, and you still make money. That’s undisputedly a win!
If you’re like me, you don’t have the time or energy for mental gymnastics over fees. So you may want to keep things simple by ensuring the materials on your potential investment choices lay out projected net returns, not gross returns. 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. This is a simple matter of choosing to only invest with general partners who communicate their deal offerings this way, like we do at BluSky Equity Partners.
Related article: Exploring Projected Returns in a Real Estate Syndication
The More Common Fees in a Real Estate Syndication
To further deflate myth #2, it’s imperative to understand why a deal’s fees exist and their purpose. With that knowledge, you can more deeply understand how a real estate syndication works, more confidently review the business plan and PPM (private placement memorandum), and decide definitively whether the deal aligns with your goals or not.
Ready to learn about the more common types of fees? Don’t worry, it’s not that complicated.
Acquisition Fee – This is typically 1 to 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. Particularly if they have employees or contract help.
Asset Management Fee – At about 1 to 4% 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 to 10% of the expected construction budget is normal for managing the renovations on the property. Attentive, thorough oversight is required to ensure construction projects finish on time and within budget.
If the sponsor or a company they’re affiliated with is a licensed contractor, this fee may be charged by the sponsor. However, if a third-party company is being used for construction management services (perhaps the property management company), you could also see this service being performed by the third-party company, in which case this would be an expense to the project overall.
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 to 2% of the capital invested, when it applies. But it only applies when a third party places the equity with the general partners.
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, when charged.
Guarantor Fee – Occasionally, loans require a key principal to personally pledge assets to guarantee the loan. Typically between 1 to 2% of the loan amount compensates the guarantor for their pledge and support.
Refinance Fee – At about 1 to 2% of the refinanced loan amount, this fee, also called a capital event fee, 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 may be charged to cover the costs of marketing and selling the asset once the business plan has been executed. 1 to 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
Now that you’ve decoded the more common possible fees on a deal and how much they typically are, keep in mind that each sponsor’s fees may vary, depending on their values and the circumstances. And definitely be careful about a sponsor who charges too many fees, and take the timing of the fees into account with the structure of their own equity share in the deal.
Here at BluSky Equity Partners, one of our guiding values is transparency. So, when we publish a pro forma, the projected returns are net of fees. It’s important to us that documents are easy for our investors to understand and evaluate.
In general, people don’t like fees, so the fewer the better! That’s why you typically won’t see more than an acquisition fee and an asset management fee 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 BluSky Investor Club today so you can begin looking at opportunities!
Further reading: How to Review a New Investment Opportunity in Less than 10 Minutes