The Ultimate Guide to Private Real Estate Syndication Fees

Investing in private real estate syndications can be a lucrative opportunity, but without understanding the various fees of any investment - you run the risk of losing your shirt.

Thankfully, most syndication fees are tied to the performance of the investment and as the late Charlie Munger taught us,

This guide will break down the most common fees associated with private real estate syndications, helping you navigate these investments with confidence and clarity. 

From acquisition and operating fees to performance incentives, this will cover everything you need to know to make informed decisions and maximise your investment potential.

How Syndicators Make Money

As outlined previously in this article, the syndication structure typically comprises a General Partner and Limited Partners who contribute capital.

The General Partner is at the forefront, steering the investment and setting the terms, including the fee structure. 

There are three ways real estate syndicators make money:

1. Transaction fees
2. Operating fees
3. Performance fees

Within these three buckets, there are eleven things you might have. Some of these fees are very common, some are less common, and some are red flags that you should watch out for.

Truth be told, there are really only three things that matter:  

1. What's the acquisition fee?  
2. What’s the preferred return?
3. What’s the waterfall structure? 

These three fees should make up more than 90% of the General Partner’s compensation but the most important thing is finding out how they are structured. 

The structure of the investment points to the why and how it operates.

Like most things in life, there is usually more than one way to do it, so use your best judgement and common sense as different syndicates will require different fee structures to best align incentives between General Partners and Limited Partners.

Knowing and understanding what a fair deal looks like is really important. 

Like any business, General Partners need fees to attract talent and utilise the best technology. 

In a unit trust structure, investors should also be aware that the General Partner can sometimes issue units or options for units in lieu of the payment of all or part of any fee payable to them. 

Any units or options issued here should be at the issue price from the Trust deed.

Let's review the three fee groups in more detail.

#1. Transaction Fees

Transaction fees are the costs associated with key events in the investment process. 

These fees cover the expenses incurred by General Partners in establishing and managing the syndication. 

Understanding these fees is crucial as they directly impact the overall returns of the investment.

Establishment/Acquisition Fees

Common in every deal, these range from 1%–3% of the purchase price, which covers the costs incurred by General Partners in securing deals and setting up the investment vehicle (i.e. the Unit Trust).

It is commonly calculated as a percentage of the total acquisition cost of the property, including stamp duties and other statutory transaction costs, and is paid from the equity raised (not the operations of the trust).

You can expect smaller deals to have a higher percentage acquisition fee, and for this fee to decline as you increase the scale. 

It makes sense. If a manager gets a one percent fee on a $2 million syndication it’s only worth $20k. That won’t incentivise the best managers, considering the amount of work involved.

Due Diligence Fee

A due diligence fee can be charged to investors by the General Partner or investment manager for conducting the necessary investigation of a potential investment opportunity. 

This fee can include things like financial analysis, market research, legal reviews, and property inspections. 

Normally, this charge is embedded in the acquisition fee. 

However, there have been syndications where it has been disclosed separately in addition to a lower acquisition fee (i.e. 1% acquisition fee and 1% diligence fee for an implied 2% total fee).

Equity Placement Fee 

If General Partners are relying on third parties to bring equity for the deal, they generally pay equity placement fees.

These can be up to 3% of the equity raised, paid to parties who assist in raising equity for the General Partner.

The best syndication firms raise their own capital and don't need to pay this, but you may see it in some bigger capital intensive projects where they'll need to incentivize financial planners and advisors to get the capital.

Debt and Refinancing Fees

General Partners sometimes charge fees for organising the debt for the initial financing – this is uncommon, but you may see it.

Similar to the debt placement fee, a refinancing fee can be charged for arranging a refinance.

Disposition Fee

This is charged for arranging the sale of an asset, ranging from 50 to 100 basis points of the sale price.

This fee is also uncommon. The General Partner should be making enough money without this charge at disposition, but you may see it with some syndicators.

#2. Operating Fees

The second bucket of fees is around operating the asset, and these are associated with the ongoing oversight of an investment.

Asset/Trust Management Fee

The asset management fee is paid to the General Partner to cover management tasks like administration, licensing, compliance, and tax work. 

This fee should ideally be based on the investment's effective gross or net income to align interests between General and Limited Partners.

For example, in a $10-million project with a 5% gross yield ($500,000 annually), a 5% asset management fee would be $25,000.

Alternatively, if the fee is based on total equity invested, such as 1% of $5 million, it would be $50,000 annually. If based on the total property value, including debt ($10 million), it could be $100,000, which is less favourable for investors.

It's important to ensure the fee structure is reasonable and tied to income.

Administration Fee

This covers organisational costs like legal, marketing and investor relations, usually minor and charged back to investors at cost.

Property Management Fee

This ranges from 2% to 5% of a property's effective gross income, paid to in-house or third-party property managers.

The choice of being vertically integrated or using a third-party comes down to scale and preferences.

Construction Management Fee

When there is a lot of construction to be managed, General Partners will sometimes charge a management fee on the cost of that construction.

This can range from 3% to 10% of total construction costs.

This typically covers professional, consultancy, and statutory fees associated with overseeing the capital works. 

#3. Performance and Promote Fees

Performance fees are the last type of fees and should account for most of the General Partner's return, aligning their interests with the success of the deal. 

These fees are typically earned at the end of a deal and are based on specific targets like IRR, Equity Multiple, or Preferred Return.

General Partners earn transaction and operating fees regardless of the deal's performance. 

However, performance fees are only earned after achieving a minimum performance target, known as the preferred return. 

If a syndicated investment lacks a preferred return, it’s a red flag. For example, in most syndications, once the preferred return of 8% and all outstanding capital have been repaid to investors, sponsors can then receive 20% of the upside (the ‘promote’).

Preferred Return

The Preferred Return, or pref, ensures that specific investors receive initial profits until a predefined target return is achieved. It is not guaranteed, whether current or accrued.

After meeting the preferred return hurdle, excess profits are distributed based on the deal's terms.

Preferred returns help build trust and protect smaller investors' interests in real estate syndications, where multiple investors pool capital for larger projects. 

They balance investor protection and offer upside to General Partners, aligning interests. 

Preferred returns are stated as a percentage, such as an 8% cumulative return on the initial investment.

There are two types of Preferred Returns:

1. True Preferred Returns
2. Pari-Passu Preferred Returns.

The Preferred Return

In true preferred returns, specific investors receive initial profits until a predefined target return is achieved. Whether current or cumulative, it is not guaranteed. 

After meeting the preferred return hurdle, excess profits are distributed based on the terms of the deal.

Pari-Passu Preferred Returns

In pari-passu preferred returns, investors and General Partners equally share the preferred return up to a certain threshold. 

Beyond this, the General Partner receives a promote, or a share of additional profits.

For example, with an 8% preferred return and $10,000 in profits, both the investor and General Partner receive $800 each up to 8%. 

Any profit beyond this goes to the promote split.

General Partners choose between return structures based on factors like risk profile, track record, and negotiating power. 

Preferred returns ensure investors are first to receive profits up to a predetermined percentage and motivate General Partners to maximise performance. 

Investors should thoroughly investigate the reasoning behind a deal’s return structure as it may indicate higher risk or misalignment.

Waterfalls

In real estate investments, cash distributions to passive partners follow a structured system known as a 'waterfall’.

These frameworks are occasionally creative, determining how profits flow through calculations, prioritising payments to developers and investors in a predefined order.

Return Hurdle

A return hurdle is the minimum rate of return needed for cash flow distribution to advance to the next investor tier, often tied to IRR or equity multiples, which incentivise efficient project management. 

Higher returns trigger greater profit shares for General Partners.

In most syndications, sponsors can start sharing in the promote only after the preferred return and all outstanding capital have been repaid to investors. 

For example, after an 8% preferred return and all equity are returned, sponsors receive 20% of the upside (the "promote").

Breakpoints, using metrics like IRR, define shifts in profit splits. A typical structure might offer an 8% preferred return, transitioning to a 70-30 split after a 15% IRR.

If there are no breakpoints and distributions go straight to an equity split, it's a red flag.

The calculations here can be a little complicated and are outside the scope of this article. 

Investor Beware

Waterfalls come in different types, with the two most common being the Vanilla Waterfall and Two-Tiered Waterfall. 

Vanilla Waterfall

The Vanilla Waterfall, the most prevalent, involves an 8% preferred return and 90-10 or 80-20 profit splits.

Two-Tiered Waterfall

Two-Tiered Waterfalls differentiate between operating cash flow and capital events, offering flexible structuring. 

While complex waterfalls don't greatly affect General Partner returns, they increase the risk of calculation errors, which need careful review.

Understanding industry norms helps General Partners communicate their value to investors. Syndication fees can deter new investors, but they align incentives. 

When assessing fees in syndicated real estate investments, remember that lower fees might seem attractive, but service quality often correlates with fee levels. 

Experienced General Partners who secure great deals and deliver strong returns may charge higher fees justifiably.

Conclusion

Understanding private real estate syndication fees is essential for making informed investment decisions.

By familiarising yourself with the key fees and their impact on returns, you can confidently navigate syndication deals and ensure a fair and profitable partnership with General Partners.

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