Working Capital The Real Estate Podcast

Real Estate Private Equity Fees and Profit| Just Ask Jesse

Apr 26, 2021

In This Episode

Many of you have sent me questions relating to real estate.  As a result I will try to put out bonus episodes to try to directly answer questions. 

In this AMA I discuss real estate syndication fees and profits. Aside from the fees discussed here…there are many others that you may come across such as: financing guarantee fees, refinancing fees, equity management fees, due diligence fees etc. To keep things simple I go over some of the most standard fees and the ‘promote’ or ‘carried interest’. 

For any other topics you would like me to cover…reach out via email or instagram @jessefragale

 

Transcript

Jesse (0s): Hey working capitalists. This is Jesse Fragale. First of all, thanks so much for your continued support on the podcast. If you have not left a five star review, please do so really helps us out. Anyways, on this episode, I thought we’d do a really short one here, and I’m going to try to do more of these where we tackle a specific topic in real estate. And in this case, I did a video which I’m going to play the audio for. And it’s basically a video that explains how the general partner of a deal or sometimes called the sponsor of a deal, earns fees and earns profit on the deal.

So we’re going to take you over the fees associated with raising capital for real estate, securing the deal, but also how a fairly basic profit split would work between a general partner and limited partners. Anyways, listen to the episode, hope you enjoy it. If you have any questions, feel free to reach out to me. The easiest way to get ahold of me is usually Jesse F R a G a L E on LinkedIn, Instagram, wherever there is a social media presence anyways, enjoy all right real estate fees and the upside of deals.

That really is kind of the breakdown of how we think about real estate, private equity and real estate syndication. So for a quick outline on real estate syndication and private equity for that matter, it’s really when you have an individual or individuals, typically a general partner raise money from limited partners and basically in our case buy real estate assets. So one caveat, I am not a lawyer, so this is not legal advice, but what we’re talking about here is the limited partnership structure. So as I mentioned, general partner and a bunch of limited partners limited in the sense that they have limited liability.

So when you invest in a deal, as a limited partner, you have liability for the amount invested. So for instance, if Tom invests a hundred thousand dollars, he can only lose a hundred thousand dollars. The same is not true for the general partner. The general partner will have unlimited liability. And that’s why you typically see them in the form of LLCs in the States. And in other areas like Canada or overseas, you’ll see them in corporations. So what we want to talk about here is how do the general partners make money in these deals? They raise all the capital from limited partners.

So how do they make money? Well, first of all, it should be said that every deal is different. And oftentimes the amount of money that the general partner puts into the deal could be different. And in some cases they don’t put any of their own capital in the deal. In those cases, I would be a little bit concerned because I think there would be a lack of an alignment of interest. However, let’s assume that the general partner is investing in these deals in addition to their investment, they make money. And what I like to break down in four different ways, and we’re going to go through them. There’s an acquisition fee, there’s an asset management fee, there’s a disposition fee.

And then there’s finally what we call the upside of the deal. Also known as carried interest or promoted interests or just the promote. So number one, the acquisition fee, it is exactly what it sounds like the general partner, or will earn a fee basically on the acquisition of the property. Now, some people might think, well, that doesn’t make sense. All they’re doing is acquiring it, but you have to really take a step back and think about what’s happening. Oftentimes these GPS or syndicators are seeing hundreds of deals, underwriting, hundreds of deals, driving to properties, seeing different people.

And there’s a lot that goes into finally acquiring a deal. So they basically want to be compensated for all of that legwork. Now, what I’ve typically seen is anywhere from 50 basis points or half a percent, all the way up to 3% for certain acquisition fees. However, in my market, in terms of an average, what I normally see is one and a half to 2% of the purchase price. Now, sometimes the acquisition fee won’t be a percentage of the purchase price, but will be a percentage of the capital that has been raised.

So moving on, number two, the asset management fee. This again, sounds exactly like what it is. It’s management of the asset. However, it shouldn’t be confused with property management, property management is done at the property level. Those are the managers that are running the day-to-day of the operations. One level above that is the asset manager who is overseeing a more holistic view of the property. He or she is managing the managers and making sure that the relationship between the limited partnership and the general partner is all in line.

Now, this fee, I typically see it as a percentage of what’s called EGI effective, gross income, effective rent, but on more and more complex deals, it might be a percentage of the equity invested or even more complex, a percentage of nav, which is net asset value. Now, the reason I say that’s more complex is to get the net asset value. You have to have a valuation or appraisal every single year. So first simplicity. What I see is I see the asset management fee as a percentage of effective, gross income or rent.

What I see as the norm for an asset management fee is usually somewhere around 2%. I was just looking at a deal the other day. And the asset management fee happened to be 1.7, 5% of effective rent. Number three, the disposition costs again, exactly what it sounds like you were paying a fee to the general partner or syndicator to dispose or sell the asset. Now, this shouldn’t be confused with real estate brokerage fees. You still got to pay those. In addition to those, there’s typically this disposition fee, think of the disposition fee as a fee paid to manage the sale of the property, not the real estate brokers doing the selling of the property.

So like the other fees, the disposition fee can range pretty wildly. But what I typically see in my market is somewhere between one and 2%. For instance, one of the deals I recently saw was a percentage and a half. And that was in addition, as we mentioned to the brokerage real estate fees, which happened to be in that case 4%. All right, lastly, we get to the gravy, the upside of the deal. What is it? It’s the promoted interest or promote or sometimes called carried interest. And it’s really where the general partner makes their money.

Now, if you’ve heard of waterfalls and hurdle rates and preface returns, it’s a lot of jargon in this industry. They’re basically all talking about the same thing. And the simplest way for me to describe the promote is that between the limited partner and the syndicator or GP, they usually agree that over this percentage return, let’s call it 10%. We’re going to have a split on profits might be 50 50. It might be 60 40, really depends on the deal, but they’re going to agree that at that percentage rate, anything above will be split.

And that split the amount that is paid to the general partner in that split, that’s called the promote. Now it shouldn’t surprise you that this is where the general partner really does make their money. It also shouldn’t surprise you that a lot of times, depending on the market and the deals, the promote, usually doesn’t get paid until we have a liquidity event, which could be a refinancing of the property, or it could be an outright sale of the property. And that’s where we get all those beautiful accountants out there that figure out how exactly everything should be broken down based on the limited partnership agreement and subscription agreement.

Ultimately, these deals are very detailed and the devil’s in the details in terms of how everything ends up getting split. So to recap, how does the syndicator or the general partner make their money? They have the acquisition fee, the disposition fee, the asset management fee and the promote or carried interests. Now, what you kind of see from these is that that big one, like we mentioned is the promote. The first three are really just what we say, keep the lights on. So to speak. It’s basically the general partner running their business and their business is raising money for real estate assets and participating in the upside.

Thank you so much for listening to working capital the real estate podcast. I’m your host, Jesse for galley. If you liked the episode, head on to iTunes and leave us a five-star review and share on social media, it really helps us out. If you have any questions, feel free to reach out to me on Instagram, Jesse F R a G a L E, have a good one