Bryan Shultz: A Short Introduction To Commercial Equity Fees
We are often asked by investors… What are the fees on our deal pages for? Why are they included? Who is getting paid? I wanted to take the time to help you get a better handle on why the fees on our open investments exist, what they are for and how we negotiate the numbers.
RealtyShares takes fees very seriously and makes sure that any fees attached to a deal go toward generating a viable investment. With a base understanding of why fees exist, it makes it easier to justify why they are included in our commercial projects.
Two Major Types of Fees
There are two types of fees that one typically sees on our commercial equity deal offerings. The first are upfront fees which can include sponsor, asset management, property management, disposition, construction management and financing fees. The second are waterfall fees which are negotiated according to investment returns.
Upfront fees ensure that our sponsors can pay for the work that has already been completed and that needs to be done on an ongoing basis. The percentages on these fees are based on an industry standard (with a typical variance of one to two percent depending on negotiations) and are baked into the deal. Without them, we wouldn’t have deals to offer our investors as our sponsors wouldn’t be able to afford to find opportunities. Simply put, without these fees, necessary work would not be getting done, making the deals themselves of dubious value. In a nutshell, sponsor fees are like a base salary for the work that goes into creating real estate investment opportunities.
Typical Upfront Fees Include:
- Acquisition Fee: The acquisition fee is paid directly to the sponsor. This fee is essentially a finders fee that the sponsor takes for sourcing and structuring the deal, and giving investors the opportunity to invest. Acquisition fees are paid only once, upfront.
- Property Management Fee: Property management fees are paid to either the sponsor or a third party that handles asset management. In general, this fee will run anywhere from 3 to 5 percent. This fee pays for things like ongoing management, lease management, salaries, rent collection and screening of potential tenants. Since this fee is typically tied to effective gross income and cash flow, the higher the cash flow may be, the higher the fee.
- Asset Management Fee: This is another fee paid directly to the sponsor. Asset management fees pay for things like accounting, taxes and issuing Schedule K-1s.
- Construction Management Fee: The construction management fee is a fee for overseeing the construction portion or value-add portion of a project. This is either paid up front as a one-time, lump-sum fee or as an ongoing fee throughout the construction period.
- Developer Fee: Developer fees are used for land, construction, and development of the property. Can be paid as a lump-sum or over the course of the project’s development.
Waterfall fees, or waterfall structures, are a bit more interesting. The basic premise is that we get a base return on investment that’s locked in. Any return above that base is then shared with the sponsor. In this way, the sponsor is an investor as much as our clients are. If a property outperforms the base return, everybody earns more money. It’s a great way to incentivize quality management and smart investments. This is not necessarily considered a fee. It is considered a bonus for the sponsor as an incentive to do well or continue doing well on a project.
How does this affect my return?
Higher fees impact your return and RealtyShares tries to limit how many fees are charged and how much they are by actively negotiating down fees. However, remember the examples above and why fees are necessary. Fees may incentivise the sponsor to continue to do well on an investment, potentially creating a better return for you on equity deals. We do our best to make sure all of our fees are within market norms and it’s important to note that the return objective that you may see on a deal page has already accounted for all of these fees.
Another key point to keep in mind that the smaller a deal is, the higher the potential fee percentage. Contrarily, the bigger the deal, the lower the fee percentage.
How are they determined
Now that you have a basic understanding of why fees exist and what they’re for, let’s talk about how they get negotiated by my team of commercial real estate professionals here at RealtyShares. While industry standard fee rates exist, every deal is unique and our job is to negotiate the best terms possible. In a typical week, we get over 50 deal proposals yet only a small percentage wind up on our platform. That allows us to be selective with deal parameters.
Once we’re confident that a deal meets our high standards, we begin negotiating the fee structure. We’ve assembled a team with experience identifying, assembling and completing due diligence on institutional-quality commercial real estate transactions. Just because a deal has made it through our analysis phase doesn’t mean it lands on our platform. The negotiations are tough and we typically walk away from 80 percent of deals because we can’t get the terms we believe are necessary to make the deal work for our investors. Our goal is to find our customers quality opportunities and our standards are steep.