How the General Partner Makes Money from an Apartment Syndication
The types of fees and the range of each fee will vary from syndicator-to-syndicator. But every fee that is charged should be directly tied to a task that is explicitly adding value to the apartment deal.
In order to identify the fairness and reasonableness of the GP compensation structure, you need to understand 1) the types and standard ranges of the general partnership fees for the industry, 2) what tasks they are performing in return for those fees and 3) if each of those fees promotes alignment of interests between the LP and GP.
There a lot of different fees that the syndicator could charge, but here is a list of the seven fees that you will come across most often. An important disclaimer to make is that this is not a list of the fees that every syndicator will charge every single time. Rather most syndicators will mix-and-match the types of fees that charge, depending on the project.
1 – Profit Split
Depending on the type of LP compensation structure, the general partnership may earn a split of the total profits.
For example, the LP may receive an 8% preferred return and a total split of the profits. This split can be anywhere from 50/50 to 90/10 (LP/GP)
If the LP invested $1,000,000 into a property that cash flowed $100,000 for the year, assuming an 8% preferred return and a 50/50 split thereafter, the LP would receive $80,000 as a preferred return, plus another $10,000 as a profit split. Then, the GP would receive the remaining $10,000.
The profit split promotes alignment of interests because the GP is financially incentivized to operate the apartment community such that the annual return exceeds the preferred return. Because if they don’t, they are missing out on an opportunity to make money. Then for the passive investor, when the annual returns exceed the preferred return, the LP receives a higher annual distribution and – since the net operating income is directly tied to the property value – a higher distribution at sale.
On a related note, you want to confirm that at sale, the profit split is calculated based on the profits AFTER the LP’s initial equity is return. Also, when the GP is outlining the LP return projections, you want to confirm that those projections are net of the GP fees. This means that you want to make sure that the projections they show you are AFTER the GP has taken their fees, because if not, the actual returns will be less than what they are showing you.
2 – Acquisition Fee
Nearly every apartment syndicator will charge an acquisition fee. The acquisition fee is an upfront, one-time fee paid to the GP at closing. The acquisition fee ranges from 1% to 5% of the purchase price, depending on the size, scope, experience of team and profit potential of the project.
Think of the acquisition fee as a consulting fee paid to the GP for putting the entire project together. It is a fee that pays the GP for their time and money spent on market research, creating a team (lawyers, CPAs, real estate brokers, etc.), finding the deal, analyzing the deal, raising money, securing financing, performing due diligence and closing.
3 – Asset Management Fee
The asset management fee is an ongoing annual fee paid to the GP in return for overseeing the operations of the property and implementing the business plan. The asset management fee is either a percentage of the collected income or a per unit per year fee. The standard percentage range is 2% to 3% while the standard per unit per year is $200 to $300.
The range of the asset management fee is usually based on the business plan. If the plan is to perform interior renovations and exterior renovations/upgrades, a higher asset management fee may be justified, because the GP will be heavily involved in ongoing oversight of the business plan. But the opposite is true if the property is already stabilized and up-to-date from day one. In other words, the more effort and time required by the GP, the higher the asset management fee. And since the asset management fee is directly tied to the collected revenue, if the business plan isn’t implemented effectively, the GP doesn’t maximize what they could make, which helps with alignment of interests.
Additionally, there is a higher alignment of interests with the percentage-based fee as opposed to the unit-based fee. Since the percentage-based fee is tied to the actual collected income, the lower the collected income, the lower the asset management fee. So, the GP is incentivized to maximize the income, which in turn will maximize your returns. Whereas the unit-based fee is a flat fee that remains the same regardless of the amount of collected income.
For another level of alignment of interest, the GP will put the asset management fee in second position behind the preferred return. That means that if the preferred return isn’t distributed, they won’t receive the asset management fee. Not every GP will have a compensation structure with the asset management fee in second position. So, for the ones that don’t, the alignment of interests is lower than that of the GP that does.
4 – Refinance Fee
A refinancing fee is a fee that is paid to the GP for the work required to refinance the property. Of course, if the business plan doesn’t include a refinance, the GP will not charge such a fee.
At the closing of the new loan, a fee of 1% to 3% of the total loan amount is paid to the GP. However, to promote alignment of interests, this fee should only be charged if a specified equity hurdle is reached. For example, the return hurdle may be returning 50% of the LP’s initial equity. If only 40% is returned, while that is still beneficial to the LP, the GP will not collect the fee. Therefore, this type of refinance fee structure incentivizes the GP to maximize the property value such that they will hit the equity return hurdle at refinance. And the LP benefits by receiving a large portion of their equity back and – again, since the property value is directly tied to the net operating income – higher ongoing returns.
5 – Guaranty Fee
The guaranty fee is typically a one-time fee paid to a loan guarantor at closing. The loan guarantor guarantees the loan. The GP may bring on an individual with a high net-worth/balance sheet to sign on the loan to get the best terms possible. Or, the GP may sign the loan themselves, collecting the fee or deciding to forgo it.
At close, a fee of as low as 0.5% to 1% and as high as 3.5 to 5% of the principal balance of the mortgage is paid to the loan guarantor. The riskier or more complicated the deal, the higher the guaranty fee. If the GP doesn’t have a good relationship with the loan guarantor, that individual will charge a higher fee as well. In some instances, the GP will offer the loan guarantor a percentage of the GP (10% to 30%) in addition to the one-time upfront fee.
Also, the size of the fee depends on the type of loan. Generally, there are two types of debts: recourse and nonrecourse. Recourse debt allows the lender to collect what is owed for the debt even after they’ve taken collateral. Nonrecourse debt does not allow the lender to pursue anything other than the collateral (with a few exceptions or “carve outs,” like in instances of gross negligence or fraud). So, the guaranty fee will be higher for recourse loans compared to nonrecourse loans.
Since the loan guarantor is personally guaranteeing the loan, this promotes alignment of interests. Because if they project fails, the GP is personally liable.
6 – Construction Management Fee
The construction management fee is an on-going annual fee paid to the company overseeing the capital improvement process. If the GP has a hands-on role in the renovation process or if the GP has their own property management company, they may charge a construction management fee.
This fee ranges from 5% to 10% of the renovation budget, depending on the size and complexity of the improvement plan.
For some syndicators, this fee will be built into the asset management fee, while others will charge a construction fee on top of the asset management fee. When a GP charges both an asset management and construction management fee, it may reduce your ongoing returns, especially while renovations are being performed.
7 – Organization Fee
The organization fee is an upfront fee paid to the GP for putting together the group investment. This fee ranges from 3% to 10% of the total money raised, depending on the amount of money raised.
For some syndicators, this fee will be built into the acquisition fee, while others will charge an organization fee on top of the acquisition fee. When a GP charges both an acquisition and organization fee, your overall return may be reduced.
These are the seven type of fees you will most commonly come across as a passive apartment investor.
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Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.