Due to the high costs of commercial real estate, investors often need to pool resources to make a deal happen. Typically, this pooling occurs through a process called syndication. An experienced real estate investor – called a sponsor – finds, underwrites, and executes the deal. Passive investors then contribute capital to the deal, receiving a return on their investment. Due to the extra work they put into the deal, real estate sponsors can charge a variety of fees. As such, we’ll use this article to explain different types of real estate sponsor fees.
Specifically, we’ll cover the following topics:
- What is a Real Estate Sponsor?
- Real Estate Sponsor Fees
- Final Thoughts
What is a Real Estate Sponsor?
The Real Estate Syndication Model
Conceptually, real estate syndication connects people who A) find deals but need money, with those who B) have money but want to find deals. Accordingly, two parties exist in a syndication. The deal sponsor (or syndicator) finds, underwrites, and executes the day-to-day management of the deal. The investors (or limited partners if organized as a limited partnership) contribute the equity necessary to make the deal happen, earning a return on their investment.
The sponsor, likely a full-time real estate investor with significant experience, finds and analyzes a deal. As part of that analysis, or underwriting, the sponsor identifies the cash required to finance the deal – usually the difference between the debt financing and the sponsor’s own cash contribution.
Next, the sponsor presents the deal to potential investors, typically through a deal overview known as an offering memorandum, or OM. In the syndication model, these investors generally receive some sort of preferred returns as an incentive to join the syndication. And, if the OM meets their investing goals, they contribute cash and formally join the syndication.
Once the sponsor raises sufficient capital from investors, he moves forward with the deal (e.g. developing a ground-up project, buying a stabilized property, renovating a property with a value-add strategy, etc.). For the duration of the deal, the sponsor oversees day-to-day operations while the investors collect passive returns on investment.
This syndication model accomplishes the goals of each party. The sponsor raises enough capital to finance a deal, and the investors earn a passive return on their contributed capital.
What to Look for in a Deal Sponsor
Prior to discussing sponsor fees, it’s worth outlining what investors should look for in a sponsor. Every deal differs, but at a minimum, a sponsor should possess the following:
- Equity in the deal: If the sponsor contributes some of his own cash, he’ll have a far greater incentive to make sure the deal performs well. He’ll have, as the saying goes, “skin in the game.”
- Experience in the market: Real estate performance can differ drastically from market to market. As such, a deal sponsor should have an intimate understanding of the supply, demand, and general characteristics of the market for a proposed deal.
- Experience with the asset type: Real estate also significantly differs by type. That is, offices likely perform differently than multifamilies in a given economic cycle and market. Furthermore, tenants have far different needs in different property types (e.g. a light-industrial tenant will have different requirements than someone renting an apartment). As a result, sponsors should have significant experience with the property type in a given syndication.
- Integrity: In any deal, the integrity of a sponsor must be beyond reproach. If you have questions about a sponsor’s character, you should not join a syndication.
Real Estate Sponsor Fees
How Real Estate Sponsors Make Money
Now that we’ve outlined the syndication model, the question remains: how do sponsors make money? Broadly speaking, deal sponsors make money two ways: promoted interests and fees.
Promoted interests, or promotes, give sponsors a disproportionate return on their equity investment above a certain hurdle. For example, say a sponsor offers investors preferred returns of 8% over a five-year hold period. Once the deal reaches that 8% return hurdle, the sponsor “catches up” to his own 8% return. The promotes, or returns above this catch-up hurdle, go to the sponsor at a disproportionately higher rate, with the remainder split on a pro rata basis among the investors.
With promotes, sponsors don’t usually make money until the end of a deal. But, sponsors need some cash flow to offset costs during the rest of the deal horizon. Fees solve this problem. That is, in most syndications, sponsors charge a variety of fees to offset the costs associated with handling a deal’s day-to-day management. While fee structures will vary from deal to deal, here are five common real estate sponsor fees:
These fees apply to deals involving ground-up construction or major renovations. To compensate sponsors for managing the construction process, a syndication will include development fees, typically based on the project’s total development and construction cost. Depending on the deal, sponsors may charge anywhere from 2% to 8% in development fees.
Some syndications involve acquiring a stabilized property – not developing a new one from the ground up. While less involved than a new build, acquiring a property still requires a lot of work. Sponsors need to find and underwrite the deal, conduct thorough due diligence, secure financing, and close on a property. These syndications generally include an acquisition fee for the sponsor from 1% to 3% of purchase price.
Property Management Fees
Some sponsors also handle property management services directly. These services include leasing units, collecting rents, addressing maintenance issues, and other property-specific elements of a deal’s day-to-day operations. Property management fees compensate sponsors for these services, and the fees generally range from 4% to 10% of a property’s gross rents.
Asset Management Fees
Similar to property management fees, asset management fees are charged on a recurring basis, normally 1% to 4% of gross rents. However, asset management services focus on the day-to-day management of the investment, not the property’s operations. These asset management services likely include property accounting, investor relations and reporting, debt service, and any other financing requirements.
Disposition (i.e. Sale) Fees
Similar to acquiring a property, sponsors need to put in a ton of work during the disposition, or sale, of a property. For instance, sponsors must acquire financials and other operating results for potential sellers, generate another OM or some form of marketing documentation, address any inspection issues, and just generally ensure the sales process goes smoothly. Disposition fees often range from 1% to 3% of sale price.
For deal sponsors, fees provide a way to compensate you for the additional effort required to find, underwrite, and execute a deal. For passive investors, these sponsor fees can be a small price to pay to provide access to commercial real estate deals. In theory, the ideal fee structure provides a balance between the cash needs of the sponsor and the value provided to the passive investors.
If you’d like to discuss different real estate investing options for your unique situation, we’d love to chat! Drop us a note, and we’ll set up a meeting to talk about available passive real estate investment opportunities.