Lining up all of the pieces for a multifamily real estate deal is no easy task. Especially when the owner is responsible to passive investors who expect to achieve a specific return. The sponsor may earn fees for their management and oversight of the investment during its full cycle, which align with each part of the development lifecycle.
This article provides a more detailed look at multifamily real estate sponsor fees.
The Role of the Sponsor in Multifamily Real Estate Deals
There are two primary partners involved in a multifamily real estate deal. The first is the general partner (GP), commonly referred to as the “sponsor” or “developer”. The sponsor is usually someone, or a team of people who have immense real estate experience. Often are those capable of lining up, managing, and executing multifamily projects on their investors’ behalf.
Here is a great video that explains the role of the sponsor in more detail:
Limited partners, meanwhile, are passive investors in the deal. Passive investors should expect to pay some combination of fees and/or carried interest to the general partner. Compensating them for their many responsibilities as the deal’s sponsor.
The question then becomes: how much should limited partners pay the sponsor for their time and efforts?
Below is an overview of how sponsors make money. Including the types of fees they might charge as part of any multifamily real estate deal.
How do Real Estate Sponsors Make Money?
There are generally two ways multifamily real estate sponsors make money. The first is through fees. Most sponsors will charge a range of fees to compensate them for arranging and overseeing a deal on investors’ behalf.
The fees that a sponsor charges can vary from 0.25% to 5%. This is for each activity of the development cycle that the sponsors are incurring expenses in the daily course of business.
These are typically aligned with each activity in the business. Such as fund formation for legal, acquisition, loan guaranty, property management, asset management, etc. Some sponsors will charge certain fees where others will not. The types of fees are discussed in more detail below.
Sponsors will charge a range of fees to compensate them for arranging and overseeing a deal on investors behalf.
The other way real estate sponsors make money on multifamily apartment deals is through carried interest. Carried interest is the amount of interest (profit) the sponsor makes during the project’s life cycle. Many deals have different ways of structuring carried interest.
Types of Multifamily Real Estate Sponsor Fees
There are many fees that investors might see associated with any multifamily real estate syndication. Below is an overview of the most common real estate sponsor fees. However, it is important to note, that not all sponsors will charge each of these fees. Fees are truly deal specific, and as such, sponsors should weigh the fees associated with each deal on a deal-by-deal basis.
Most sponsors collect an acquisition fee when they close on a multifamily apartment building. This fee is to compensate the sponsor for all of the work they have done prior to closing. These efforts include identifying properties, vetting individual properties, selecting the most appropriate deal, underwriting that deal, and arranging the debt and equity needed to finance the deal.
An acquisition fee is not intended to be substantial. The fee is usually between 1% and 5% of the acquisition price. For multifamily deals in the realm of $10-20 million, the fee is generally about 2% on average.
A company will structure the acquisition fee on a sliding scale that decreases as the purchase price decreases, and investors should anticipate this. In other words, the more expensive the deal, the lower the acquisition fee and vice versa.
This fee can be used to reimburse the sponsor for both staff time. As well as the direct costs incurred leading up to the acquisition. For example traveling to and from the property, and engaging with a broker.
Investors typically finance the purchase of most apartment buildings using both debt and equity. However, the type, amount, and source of debt determine the terms and conditions of the financing. The lender may require the borrower to personally guarantee the loan. In other words, the borrower must put up certain assets as collateral that the lender can take claim to in the event of the borrower’s default.
Typically, the sponsor will be responsible for guaranteeing the loan (instead of the limited partners). The sponsor may charge a guarantor fee. This in exchange for taking on the additional risk associated with personally guaranteeing a loan.
Capital Event Fee
A capital event fee, or sometimes referred to as a refinance fee. The sponsor will often charge this fee for their efforts in refinancing a deal, which will result in investors receiving additional capital. The value of the new loan being procured usually determines capital event fees, which range from 0.25% to 1%.
Project Management Fee
In situations where a multifamily asset is going to receive major capital improvements, a project management fee, also known as a “construction management fee,” is a common occurrence. The capital improvements can range from ground up development, which is arguably the most challenging type of real estate development and therefore, requires significant oversight. To light or heavy value-add deals.
In general, multifamily investors can
expect a project management fee to range from anywhere
between 4% to 8% of total project construction costs.
Depending on the level of oversight needed for individual construction efforts, the project management fee may be more or less. In general, multifamily investors can expect a project management fee to range from anywhere between 4% to 8% of total project construction costs.
Sometimes, a sponsor will be more specific about how they have calculated the fee. With the fee applying to hard costs only (such as materials and labor). Or only specific construction costs, such as tenant improvements.
This fee is to compensate the sponsor for the additional time, staffing and resources needed to manage the redevelopment effort.
Asset Management Fee
Sponsors will charge a separate asset management fee for overseeing the day to day operations of a property. While many multifamily apartment buildings have on-site property managers. The sponsor, in its role as asset manager, will be overseeing what the property management team is doing. The responsibilities include paying all bills on time, ensuring collections are as expected, analyzing the leasing strategy, and advancing the overall business plan.
The asset management fee also covers a portion of the sponsor’s overhead costs. Those needed to manage the deal on investors’ behalf. This including salaries for analysts responsible for investor reporting.
Asset management fees tend to be some of the most variable fees. This is because an asset management fee can be calculated one of two ways. The first way is based on a percentage of a property’s total revenue. In this case, the fee will typically range from 1-3%. In some cases, the asset management fee might be based on the percentage of equity invested. Similar to what you would expect to see in traditional private equity vehicles or hedge funds.
In situations like these, the asset management fee will range from 1% to 2% of all contributed capital. These two methods can lead to very different amounts. Especially in low-leverage or all-cash transactions. It’s important that the investors understand how the asset management fee is being calculated.
A disposition fee, sometimes referred to as an “exit fee”. Is a fee that sponsors charge upon the sale or disposition of a multifamily asset. Not all sponsors will charge this disposition fee. Those that do will generally charge a nominal amount ranging from 0.25% to 2.0% of the gross sales proceeds.
A disposition fee, sometimes referred to as
an “exit fee”, is a fee that sponsors charge upon
the sale or disposition of a multifamily asset.
The disposition fee is intended to compensate the sponsor. The compensation is often for selecting a broker, preparing the multifamily asset for sale, and working through the buyer’s due diligence process prior to sale to ultimately realize a capital event that generates additional profit for investors. These fees will usually range from 0.5% to 1.0% of the sales price.
It is worth noting that the disposition fee is charged in addition to any sales commissions owed to the broker representing the seller during the sale of the property.
Sponsor Fees vs. Carried Interest
As noted above, carried interest is the other way real estate sponsors make money. The carried interest is the share of cash flow and profits that a sponsor will earn during a project’s life cycle.
Carried interest can be structured in many ways. Sometimes, the lion’s share of the profits is slated to go to investors—especially upfront. Other times, profits are split more evenly between the sponsor and its limited partners.
How the carried interest is structured is relevant to investors for several reasons. It is specifically important as it pertains to real estate sponsor fees. If cash flow and profits are more weighted toward passive investors. Then it is reasonable for sponsors to advocate for more and higher fees, both up front and along the way.
In deals with a more equitable split of cash flow and profit between the sponsor and investors on the carried interest side. Investors should expect to see fewer and lower fees charged by the sponsor.
Real Estate Sponsor Fees: What Multifamily Investors Want to Consider
Prior to investing in a multifamily apartment building, via a syndicate or otherwise. An investor will want to closely examine the sponsor’s fee structure. What fees are the sponsors charging, at what cost, and how do these align with market standards?
Here are a few specific things for multifamily investors to consider:
- How top-heavy are the sponsor fees? A sponsor who is driven by fees. Especially if those fees are charged early on in the development life cycle. May not be as motivated to meet and exceed the business plan expectations. If a sponsor knows that they will earn a return regardless of how well they perform, due to these fees, it can inadvertently lead to a misalignment of interests. Ideally, investors will want to see fees more heavily weighted toward the back-end of a deal’s lifecycle.
- Are the sponsor’s fees in line with industry standards? We have provided some general ranges of what an investor might expect to be charged for specific fees. The specifics of a deal might necessitate higher or lower fees in some cases, Meaning sponsors should be granted some degree of specificity. However, it’s important that fees line up with what other projects of similar scale command in that local marketplace.
- What level of effort is required by the sponsor for the deal? Deals that involve a lot of intricacies that will make the acquisition or sale of the asset challenging, may justify steeper acquisition and disposition fees than others. Meanwhile, deals that require significant construction or other value-add strategies may have more weight given to the project management or asset management fees. In either case, it is important for investors to look at the nature of the deal. As well as the type and level of effort that will be needed by the sponsor. Only then will investors be able to gauge whether the fees correspond to the level of effort required.
Any investor considering a multifamily real estate deal, whether that be a fund or syndication, will want to first understand the fees the sponsor is charging. Sponsors deserve to be paid for their efforts. However, these payments should be comparable to the level of work required.
Eventually, the degree of fees will have an impact the level of profits investors can expect to earn. The higher the fees, the less cash flow will remain to be distributed amongst all parties involved. Striking the right balance of fees can be difficult. However, it is important to ensure that interests remain aligned throughout the project’s lifecycle.
Are you considering an investment in multifamily real estate? Contact us today to learn more about Smartland’s typical fee structure.