Episode 72 – Understanding Fees and Splits: The Backbone of Your Syndication or Fund

You want to put a syndication or a fund together? Well, you probably want to get paid for the work you’re doing, right? So in this video, we’re going to talk about the different fees and split structures that exist. But we’re also going to talk about why I think it’s important to separate the two in your thought process.

When we think about fees, I think the most important thing is to think about it like your pay. It’s the pay that you get for the actual work that you’re doing. That pay itself needs to be commensurate with not only the amount of work involved but also your experience level and time spent away. If you were doing all the accounting, you should get paid for that. Here, you’re oftentimes doing different things like asset management, or putting together the acquisition or disposition of specific assets. So you need to be compensated for those.

Let’s go through the basic fees that I see in most of my structures. In this case, we’re going to really be talking more about real estate fees, just because in a real estate syndication context, that’s more commonly seen as having the larger amount of fees.

The first type of fee is, of course, an asset management fee. When we talk about asset management, that is the fee you should be earning for the work you’re doing to keep the asset or assets managed. This includes things like investor relations, backend accounting before you hand it off to an accountant, keeping an eye on the market daily, and determining when it’s a good time to start disposing of these assets.

The percentages that syndicators and fund managers typically charge for asset management fees range from about 1% to 2%. But the question really becomes: 1% to 2% of what? Most of the time, it’s the amount of money raised from the investors. So it’s that capital account that is typically used. Some people prefer to use gross income, others even use net operating income. Those obviously would be lower amounts of fees.

Besides the asset management fee, many real estate developers will charge a development supervision fee. This is different than a developer’s fee for actually doing the development itself. It’s that relationship between the syndication or the fund itself with the developer that’s being covered here. A lot of times that supervision fee is around 10% of hard and soft costs as they’re incurred.

Another type of fee we often see is property management fees. Now, a lot of people will outsource their property management to a third party. That’s definitely a good idea because your specialty is, in this case, in the fund or in the asset management itself for the syndication. If you own a property management company, you’re obviously going to keep that yourself and be earning those fees.

Another type of fee would be the acquisition fee or disposition fee. These are typically around 1% to 1.5% of the purchase or sale price of the asset. This is for all the work that goes into actually acquiring or disposing of the asset, such as gathering due diligence material and reviewing all those things. That takes a lot of time and should be compensated.

Lastly, in the fee category would be real estate agent fees. If you as a sponsor are getting paid these fees, it needs to be discussed. We need to disclose it not only because it’s a fee, but it also represents a conflict of interest. It’s reasonable to believe that maybe the sales price could have been higher, or the purchase price might have been lower, if it wasn’t being represented by somebody who also had split loyalty.

There are a few other kinds of fees that are less common. These include a finance fee for putting a loan together, generally somewhere between 0.5% to 1.5% of the loan amount. Another kind of fee that happens from time to time is a marketing fee, often seen if a broker-dealer is involved. Lastly, there’s the startup fee for the work of putting together the syndication itself, though this is not very common.

Fees, in general, should be thought of as your income. It’s probably being taxed as income for you and is typically paid out upon completion of the work.

Different from fees are splits. We can think about splits as the profit part. So you have your regular income, but the other piece of the puzzle is the profit you’re making from having done all this work. A lot of times, syndicators will put those splits on the capital gains side of their returns to have a lower tax rate. However, you should definitely speak with your accountant about this to ensure it’s appropriate.

There are three basic kinds of splits out there. The first and most common would be a waterfall split with or without a preferred return. The preferred return is that percentage guaranteed to be paid to the investor before any other distribution of profits can be split out. The waterfall may or may not have a preferred return, may or may not have a catch-up, and at some point, it will have a split like 80/20 or 70/30. Typically, 70% or 80% goes to the investor and the remainder goes to the sponsor, but this can vary depending on how the whole financial structure is set up.

The next kind would be straight equity. So you’ve got a property you’re buying for 5 million, but the reality is that you’re actually buying it for 4,500,000. You’re charging your investors as if it was a 5 million property, taking 10% off for your own equity. So you’re keeping 10% of the deal, and they’re getting the other part. I call this straight equity; sponsors equity is another name I sometimes use.

The reason why this is a great deal for you is you’re guaranteed to get paid. If the property sells, even if it sells for 3 million, you’re going to get that 10% of that 3 million. You’re going to get that $300,000 payday even if it goes under market. So it works out very well for sponsors. Individual investors may or may not like it; they may object or have questions about it. If your deal works for it, great. If it doesn’t, then you probably should choose some other avenue.

The third kind is what I call a harvest promote. This is actually pretty rare, but I think it’s important to talk about because it is out there in the world. A harvest promote says, “Okay, we’re going to sell the property or sell all the assets at year five,” or whatever that time is. Once we’ve sold, we’re going to return all the money to investors. Once investors have been paid back, at that point, the sponsor is going to take the first 10% of profits for themselves. Then the rest will be given out either as a split or straight to the investors. So that way, as long as it’s profitable, the sponsor is going to be making good money on it. But it puts the relief on the side of the investor that, hey, at least I know I’m going to get my money back before the sponsor makes any money.

Those are the general types of splits. Now, splits again, think about those as the profit center. So that’s you profiting from it, not the regular pay that you receive for day-to-day work.

I hope you found this video helpful because what we’re trying to do here is talk about these two categories that are going on: splits and fees. Many people come to me every day and ask about this, or what sort of split they should have, or what sort of fees they should be charging. The answer is, well, let’s look at your numbers. Let’s see what you’re doing.

When I get hired, most of the time I go through in detail the financial picture of it. I give my opinion as to where I think they’re at in the market. If I think that they’re charging a lot of money in terms of fees against investors, I’ll let my clients know that because I want their product to be marketable at the end of the day. It doesn’t do anybody any good if they can’t get investors out there. But I also want my sponsors and fund managers to make as much money as possible.

Many times, I’ll go through what those numbers are, and we’ll talk about, well, maybe if we tweak this or change that, we’ll get a better return that will be more marketable. Because really, at the end of the day, your investors care not only about the story, which I do believe is probably the most important thing you have to sell them. But the second most important thing is that number of what that return is because they need to understand what it is. If it’s an 8% return or a 20% return, whatever it is, if it’s something that they’re interested in, they’re going to invest.

Ultimately, we want to end up with a good solid return that they can rationally believe in so that they can then buy into your story and be a part of your vision as your syndication or fund takes off.

My name is Tilden Moschetti. I am a syndication attorney with the Moschetti Syndication Law Group. If we can help you, please don’t hesitate to give us a call.