Investors looking to pursue the property market might find the concept of syndication complicated and overwhelming. But, the process is not as daunting as one might believe. Like any other type of investment, real estate syndication requires investors to be knowledgeable and have the right partners to help them translate their investments into returns.
There is so much to learn about syndication, but today we’d like to focus on one of the most crucial aspects of this investment – its fees. If you are looking to invest in the property market through syndication, a firm understanding of the applicable fees is essential.
What Are Syndication Fees?
The realm of real estate syndication encompasses various fees. Some include:
- Acquisition fees
- Asset management fees
- Construction management fees
- Disposition fees
- Equity placement fees
Note that these are just the common fees. Additional fees may apply depending on the syndication agreement, the type of asset, and legal requirements. Each of these fees has its unique structures and implications.
An individual looking to get into syndication is typically drawn in by the idea of being a passive investor, where their capital is managed by a managing operator who takes care of the property acquisition, development, management, and eventual sale. But, understanding the fee structure involved in this process is still important to an investor and will give them a clearer understanding of the partnership dynamics and projections of the returns.
Why Investors Have a Hard Time Understanding Syndication Fee Structures
Complexity and Variety
There are numerous types of syndication fees, including acquisition fees, asset management fees, construction management fees, disposition fees, refinance fees, and more. Each of these has its specific function, calculation method, and impact on investor returns. The sheer variety and complexity of these fees can be overwhelming and difficult for investors to comprehend fully.
Lack of Standardization
There is no standard fee structure or percentage across all real estate syndication investments. Fees vary greatly based on factors such as the type of real estate (commercial, residential, industrial, etc.), location, market conditions, the complexity of the deal, and the syndicator’s reputation and experience. This lack of standardization can make it challenging for investors to compare and understand the fees associated with different investment opportunities.
Influence on Return on Investment
The intricacy of understanding how these fees impact the return on investment (ROI) is another challenge. Real estate syndication fees directly reduce investment returns, but their impact isn’t always clear or straightforward. This can make it difficult for investors to calculate their potential ROI accurately.
Legal and Financial Jargon
Real estate syndication fees are often described using industry-specific financial and legal terms. Investors without a background in finance, real estate, or law may find it difficult to understand these terms, making the fee structure seem more complex than it is.
Frequency of Fee Assessment
Some fees, like acquisition or disposition fees, are one-time charges, while others like asset management or property management fees are recurring. Understanding when and how often these fees are assessed can be confusing for many investors.
Dependence on Multiple Factors
Some fees, like the construction management fee, can depend on numerous factors, including the complexity of the project, the duration, and the specific needs of the property. These variable components can make these fees difficult to predict and understand.
Lack of Transparency
Not all syndication companies are transparent about their fee structures, making it challenging for investors to understand the costs they’re incurring. Some syndicators might only reveal basic fee information, leaving investors in the dark about potential additional costs.
In some cases, fees may not be explicitly stated upfront, or they may come up unexpectedly during the investment period. These can include fees for unexpected repairs, legal issues, or refinance costs. These hidden or unforeseen costs can complicate an investor’s understanding of the total fees involved in a syndication deal. It’s always advised to work with a Sponsor who will relay details of the fees and investment performance up front.
The Basic Structure of Real Estate Syndication
As a knowledgeable investor, you have to appreciate the intricacies involved in real estate syndication deals. Let’s take an in-depth look at the basic elements of these arrangements and the general roles of the involved parties.
Anatomy of a Syndication Deal
A real estate syndication deal is a collaborative venture typically structured as a limited partnership (LP) or a limited liability company (LLC). It involves two primary entities: the syndicator, or general partner, and the investors, also known as limited partners. Each party has distinct roles and responsibilities that contribute to the success of the deal.
Role of Syndicators (Sponsors)
The syndicator serves as the spearhead of the deal, assuming primary responsibility for the project’s execution and management. Their key responsibilities include:
- Property Identification and Acquisition: Utilizing their industry expertise, market acumen, and professional networks, syndicators identify potential investment properties. They conduct thorough due diligence to assess the property’s viability and profitability.
- Financing: Syndicators are responsible for structuring the financing for the deal. This often involves a combination of investor contributions, traditional bank financing, and occasionally more creative financing options like mezzanine loans or seller financing.
- Property Management: The syndicator typically takes charge of property management, overseeing everything from renovation and maintenance to tenant relations and conflict resolution.
- Exit Strategy: Crafting a strategic exit plan is crucial. Whether it’s a sale, refinancing, or another route, the syndicator decides the best time and method to exit the property, with the aim to maximize returns for all partners.
Role of Investors
Investors play a crucial role in real estate syndication deals by providing capital. Here are some specifics:
- Capital Investment: Investors provide the financial backing for the acquisition and associated costs, such as renovations or operational expenses. Their investment size can vary widely, depending on the deal structure and the individual investor’s capacity.
- Risk and Reward Sharing: Investors share in both the potential rewards and risks of the deal. The returns are typically proportional to their investment stake. However, as limited partners, their liability is generally capped at their investment amount.
- Strategic Input: In some cases, particularly when the investors are more experienced or invest larger sums, they may have some input into strategic decisions, though day-to-day operations are usually left to the syndicator.
Types of Real Estate Syndication Fees
We’ve already established that real estate syndication fees are a core component of syndication investments, whether in commercial or residential real estate. They are typically charged by syndicators to cover a variety of activities throughout the investment lifecycle. Let’s explore the common types of fees in detail.
This fee is paid to the real estate syndicator or syndication company for the work involved in finding, analyzing, and closing a real estate deal. For example, if a syndicator identifies a promising commercial property listed at $2 million (the purchase price), they might charge a 2% acquisition fee. This would add $40,000 to the acquisition cost, paid by the investors.
Asset Management Fee
This is an ongoing fee charged for the management of the property and is usually a percentage of the property’s gross monthly income. For instance, if a property generates $10,000 in gross monthly income, a 2% asset management fee would amount to $200 each month. This fee compensates the syndicator for tasks such as financial reporting, investor relations, and overseeing property management.
Construction Management Fee
If a property requires significant renovations or construction work, a construction management fee may be charged. This is usually a percentage of the total construction cost. For instance, if $500,000 is budgeted for renovations, a 5% construction management fee would be $25,000.
Property Management Fees
These are charges related to the ongoing upkeep and tenant management of a property. If the property management is handled by an external company, they usually charge a fee of 8-12% of the collected rent. If the syndicator also provides property management services, they might charge this fee.
Equity Placement Fee
When a syndicator raises capital from passive investors, they might charge an equity placement fee. For instance, if the syndicator raises $1 million in equity investment, it might charge a 1% equity placement fee, which amounts to $10,000.
When the property is sold, the syndicator may charge a disposition fee, typically a percentage of the sales price. For example, if the property is sold for $3 million, a 1% disposition fee would be $30,000. This fee compensates the syndicator for preparing and executing the property sale.
If the syndicator decides to refinance the property, they might charge a refinance fee. This fee is usually a percentage of the new loan amount. For instance, if the property is refinanced with a new loan of $1.5 million, a 1% refinance fee would amount to $15,000.
If the syndicator acts as the loan guarantor (which is common in syndication deals), they may charge a guarantor fee. This fee compensates the syndicator for the risk they assume by guaranteeing the loan. The fee can be a flat rate, a percentage of the loan amount, or a portion of the property’s cash flow.
Performance-Based Incentives for Syndicators
Performance-based incentives can also be viewed as fees because they have to be paid to the syndicator based on their performance for generating returns to your investment. However, their structure is a little more complicated, so we are going to look at them separately.
In a real estate syndication context, performance-based incentives are often linked to the profitability of an investment. For instance, a common performance-based incentive is the “promote” or “carried interest,” where the syndicator receives a percentage of the profits above a certain return threshold, known as the “preferred return.” This arrangement aligns the interests of the syndicator with those of the investors, as the syndicator only benefits when the investors do. There are two types of structures for performance-based incentives.
The Promote, also known as a “carried interest,” is a profit-sharing mechanism that gives the syndicator a percentage of the profits from the investment, typically after a specific return threshold or “hurdle rate” has been achieved. This arrangement aligns the interests of the syndicator with those of the investors, as the syndicator’s compensation is tied to the performance of the investment.
For example, a syndicator might receive a 20% promote after the investors have received a 10% preferred return on their investment. This means that the first 10% of profits go to the investors, after which any additional profits are split 80% to the investors and 20% to the syndicator.
The Waterfall structure is a more complex and detailed version of a Promote structure, where profit-sharing ratios between the syndicator and investors change as different levels of return or “tiers” are achieved. Each tier in a Waterfall structure represents a different level of return, and as each tier is reached, the syndicator’s share of the profits (the Promote) usually increases.
Here’s a basic example of a three-tier Waterfall structure:
- First Tier: The first tier, also known as the “preferred return,” is the initial return that is paid out solely to investors until they achieve a certain annual return on their initial investment, say 8%.
- Second Tier: Once the preferred return is met, the second tier kicks in where profits are split between investors and syndicators, but still favoring the investors. This might be an 80% (investors) to 20% (syndicator) split until a 12% total return has been reached.
- Third Tier: In the final tier, once the return threshold of the second tier is surpassed, the syndicator might get a larger share of the profits, like a 50-50 split. This continues for any returns exceeding 12%.
These structures are designed to incentivize syndicators to maximize the performance and profitability of the property. They also align the interests of syndicators with those of the investors, as the syndicator only stands to earn significant profits when the investors do.
However, every deal is different, and the specifics of the Promote and Waterfall structures can vary greatly. It’s important for investors to thoroughly understand these structures in any potential investment and to consider whether they are fair and in line with market standards.
The fees and percentages above are subject to change. We encourage investors to seek advice from a property attorney to get an accurate description of the exact fees that apply to them. You can also get in touch with us and we’ll guide you through our syndication fee structure.
Understanding real estate syndication fees and their impact on yields such as cash-on-cash returns is crucial for real estate investors. Each fee contributes to the overall fee structure of the real estate syndication investment, and investors should take them into account when evaluating potential investment opportunities. A transparent and fair fee structure is a good indicator of a reputable real estate syndicator or syndication company.
Evalutaing Syndication Fees
Evaluating syndication fees is a crucial aspect of due diligence for any investor considering a real estate syndication investment. These fees can significantly impact the potential returns and the overall attractiveness of an investment. Here are some key considerations for investors when evaluating syndication fees:
1. Understand the Fee Structure
First and foremost, investors need to understand all the fees associated with the investment. This includes acquisition fees, asset management fees, construction management fees, property management fees, refinance fees, disposition fees, and any other fees the syndicator may charge. It’s essential to understand not just the type of fees but also how they are calculated and when they are charged.
2. Compare Fees
Once you understand the fees, it’s crucial to compare them against industry standards. Keep in mind that some variance is expected due to the unique circumstances of each deal. However, if a syndicator’s fees are significantly higher than average, it’s a red flag that should be investigated.
3. Evaluate the Syndicator’s Experience and Track Record
A syndicator with a proven track record of successful investments might justify higher fees. If they have consistently delivered high returns to investors, the fees might be a reflection of their skill, experience, and expertise. On the other hand, new or unproven syndicators charging high fees should be scrutinized carefully.
4. Consider the Impact on Returns
Investors must calculate the impact of fees on potential returns. Syndication fees reduce the total return to the investors, so it’s essential to factor them into any calculations or projections of potential returns.
5. Understand Performance-Based Incentives
It’s important to understand any performance-based incentives, such as the Promote or Waterfall structures. These incentives can align the interests of the syndicator and investors, but they can also significantly affect investor returns. Investors should understand when these incentives kick in and how they are calculated.
6. Look for Transparency
A good syndicator will be transparent about all fees and compensation. If a syndicator is unwilling to provide details about their fees, or if the fee structure is overly complicated and hard to understand, it could be a sign of potential issues.
Final Thoughts on Syndication Fees
There is clearly a lot to digest about syndication fees. But, the above information comprehensively covers what investors need to know before getting into a syndication agreement. As a real estate investment firm, we are always looking to answer any questions and clarify any concerns regarding syndication agreements.
Bishop Investing Group would like to help you grow your wealth securely and consistently. But, more importantly, your investment should be able to return passive income, allowing you to expand your financial horizon with little effort.
Bishop Investing streamlines the process of real estate syndication for investors. We identify, assess, and present syndication transactions to you. After completing required documents and fund an investment, all you have to do is sit back and watch your investments work for you. Does that sound like an opportunity you’d be interested in? Give us a call today to learn how to get started growing your wealth in a syndicated investment!
Real estate investing comes with a variety of risks including rising interest rates, lower than expected occupancy and the operator’s failure to execute the renovation and rental increase business plan. Real estate investments are also illiquid which means there is no readily available market for an investor to sell their interest in a real estate syndication. Investors are typically required to be deemed an accredited investor. As with any investment, there is the risk that the entire investment may be lost.