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Real estate syndications are an increasingly popular way for individuals to invest alongside several others in a larger commercial real estate transaction. The ability to fractionally invest in real estate has lowered the barriers to entry for those looking to access real estate assets that would otherwise be cost-prohibitive to individual buyers.
Syndications also allow investors to be hands-off. When they invest in a syndication, they are entrusting the real estate sponsor to oversee the day-to-day tasks associated with that deal. A sponsor collects a fee for quarterbacking the deal from start to finish, and in turn, investors are freed from the responsibilities of owning real estate while still earning passive income.
Both sponsors and their respective fee structures can drastically vary. In this article, we look at both the role of the sponsor, including how to determine if a sponsor is qualified. We then go on to assess real estate sponsor fees, including types and costs generally associated with different kinds of fees. Understanding the role of a sponsor and the fee structure is critically important for anyone contemplating investing in a syndication - whether for the first or hundredth time, as the fees can influence overall profitability and returns for passive investors.
A real estate sponsor is an individual or organization responsible for overseeing all aspects of a commercial real estate investment. This includes identifying potential investment opportunities, conducting due diligence on those properties, underwriting the deals, crafting a business plan, arranging financing (both debt and equity), and then executing on the business plan.
The sponsor will usually have several other real estate specialists on their team. Depending on the nature of the deal, this might include real estate attorneys, permitting specialists, architects and engineers, leasing brokers, marketing professionals, contractors and more. In a ground-up construction deal, there might be dozens of people working alongside the sponsor to bring the business plan to fruition. Investing in an already stabilized asset is more straightforward and will usually required fewer people at the table, but there will generally be others nonetheless.
A real estate sponsor can therefore be thought of as being similar to a football quarterback. The sponsor is calling the plays, directing the team, and moving the team down the field to reach their goal. Most sponsors will have some equity invested in each deal, which ensures they are equally motivated to achieve superb outcomes - not just for their investors, but for themselves, as well.
Trying to predict the market's future six months' from now is no easy task, let alone three, five or seven-plus years down the road. Nobody has a crystal ball. Nevertheless, real estate sponsors must evaluate each deal based on their best assumptions about how the market will perform at property stabilization and exit.
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Many real estate investors will evaluate investment opportunities on a property-by-property basis. There is nothing inherently wrong with this approach, however, even the best real estate opportunity is contingent upon a sponsor's ability to execute.
Before investing in a real estate syndication, it is important to vet the qualifications of the real estate sponsor making the offering. The sponsor should have a proven track record, ideally in that market and with that same product type.
Real estate dynamics can vary from one market to another; they can even vary from submarket to submarket within the same geography. Someone who has experience in that market will have a strong sense of what's driving demand for the product type in question, and in turn, will know which strategies to employ to improve and lease the building for top dollar.
A lack of experience in a specific geography is not a dealbreaker, though, especially if that sponsor has robust experience with the specific product type. For example, a sponsor that specializes in self-storage facilities may see the opportunity in a new market based on their experience elsewhere. Investors should be wary of a self-storage operator that is proposing, say, a multifamily apartment building in a new market if that is a product type the sponsor has little to no experience with already.
In addition to geographic and product type expertise, an investor will also want to look at the sponsor's business plan. Does the business plan make sense? Does the sponsor's underwriting seem aligned with what you are seeing in that market? Look at how the sponsor is being paid. This will usually be some combination of fees and return on their equity investment. It is important for sponsors to have some of their own equity invested in the deal, as this helps to ensure alignment of interests.
Many deals are structured so that a sponsor only collects a return on their equity after investors have earned their profit (either some or all). Naturally, a sponsor cannot work for free in the interim, which is why sponsors will usually collect some nominal fees in the interim to pay their teams as a deal moves forward.
Retail and office properties were once at the top of the list for real estate investors, until 2020 came along.
Meanwhile, who would have thought that less glamorous investments such as industrial space and self-storage properties would be among the real estate investment options offering the most robust returns?
As noted above, real estate sponsors generally earn their income two ways. The first is through fees (detailed below). The second is through a return on their own investment, often referred to as a "promote". A promote is when a sponsor earns a higher rate of return on their equity investment than limited partner investors, but only after achieving certain hurdle rates of return for their LP investors. Once these hurdles are met, the sponsor will earn a disproportionately higher return than co-investors. That rate can continue to climb if the project exceeds expectations.
The income earned through promotes can vary drastically. If there is a sudden economic downturn, a sponsor may not earn as much income from the promote as they had anticipated. Conversely, if a deal outperforms its initial expectations, the promote can be highly lucrative for the sponsor. However, in situations like these, passive investors are also earning more money. The promote structure is a way to incentivize the sponsor to not only meet but exceed their underwriting expectations.
Of course, because of the unpredictability of the promote, and because promotes are usually not earned until the latter-half of a deal cycle, a sponsor will also usually charge nominal fees in the interim. These fees are used to pay the sponsor's team, to fund predevelopment activities such as architecture and engineering work, etc. Read on to learn more about the different types of sponsor fees.
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Sponsor fees can range from deal to deal. The type of fees will often depend on the nature of the deal. For example, a long-time investor of an industrial property that is looking to reposition the building might not charge an acquisition fee. The fees should always be aligned with the specifics of the deal in question.
Here are the most common sponsor fees associated with any real estate syndication.
Acquisition Fee: This is the fee that a syndicator charges for finding and facilitating the acquisition of a property. The industry standard tends to be between 1-2.5% of the acquisition cost. Most sponsors will insist on taking an acquisition fee, especially if the property was procured through an off-market transaction. If the sponsor is a licensed real estate broker, they might also take a commission on the purchase of the property, which can range from 2 to 3%. Some consider this double-dipping, so be wary of sponsors who collect both an acquisition and broker's fee.
Development Fee: A development fee, sometimes referred to as a construction management fee, is the fee a sponsor charges for a project that involves ground-up or heavy redevelopment. This fee is paid to the sponsor for overseeing the construction or renovation process, from design to entitlement through actual construction and eventually, property stabilization. Depending on a sponsor's capabilities, they might outsource development to a third-party. Whether this is being done in-house or with the help of another firm, investors should expect the development fee be in the range of 3 to 6% of capital expenditure budget.
Property Management Fees: Property management, which is another responsibility that some sponsors can manage in-house or through a third-party, includes the day-to-day oversight of a property that has already been stabilized. This includes conducting routine repairs and maintenance, landscaping, snow removal, etc. It may also include property leasing and always includes rent collections. Property management fees will often cost between 3 to 6% of annual gross revenue depending on the real estate asset class
Asset Management Fees: On buy-and-hold investments, the sponsor will generally charge an asset management fee ranging from 1 to 4% of gross monthly revenue or equity deployed. Asset management includes ongoing management of the syndication, which may have more than one investment property. Asset management is different than property management, in that the latter is related to day-to-day management of a specific property whereas asset management is focused on the big-picture, such as tracking revenue and sending out investor communications.
Refinancing Fee: A refinancing fee, sometimes referred to as a "refinance hurdle," is a fee that some sponsors charge as being compensated for creating additional value once a property is refinanced at a lower rate. This fee is generally equivalent to 0.5 to 2.0% of the new loan amount.
Disposition Fee: The disposition fee is charged by a sponsor upon sale (or "disposition") of the property. This is the sponsor's compensation for arranging the sale, which generally includes significant marketing efforts. This fee may be replaced by a broker's fee of 2 to 3% of the sales price if the sponsor engages a broker to market and sell the property on the syndication's behalf.
that is considering investing in a syndication will want to read through all
offering memoranda with a fine-toothed comb. These investment documents will clearly disclose what
fees will be paid to the sponsor, how those fees will be distributed and when.
The fee structure associated with one deal can vary drastically
from the next. Be sure that the fees the sponsor is charging are logical and in
line with market standards.
Ultimately, the extent to which a sponsor charges fees will influence the overall profitability of a deal. If a deal is fee-heavy, this means there will be less revenue available to return to investors. It is important that fees be reasonable and structured in a way to keep both the sponsor and investors' interests aligned.