Investment Management Fees: Is It Worth It?
An asset management firm collects money from clients and invests it in a range of assets, such as stocks, bonds, real estate, gold, and so on. Let's take a closer look at its position in real estate.
The sponsor (the private equity company) and the investors are both participating in a typical private equity commercial real estate deal. Each group has a certain function to fulfill. In this post, we’ll go over the high-level tasks of each group as well as the fees that the sponsor charges for their efforts. By the end of the article, readers will have a better understanding of how a common fee structure works and will be able to apply this knowledge to their real estate investment due diligence.
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Roles & Responsibilities in Transactions
A typical private equity commercial real estate transaction has two parties, as indicated in the introduction: the sponsor and the investors. The investor’s position is passive, and they are not responsible for day-to-day property management.
Instead, they put their money into the sponsor’s hands in the expectation of getting it back plus interest in the future. This is a terrific deal for most people since they have access to the sponsor’s experience, skills, network, and deal flow to get into transactions they wouldn’t have been able to get on their own. On behalf of its investors, the sponsor’s job is to identify, fund, and manage commercial investment properties. While this may appear to be a simple task, their work involves a great deal of intricacy. Each sponsor hires one or more “asset managers,” whose tasks are outlined below.
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Asset managers are in charge of two different sorts of budgets. The first is each property’s annual operational budget. Asset managers must model essential property elements such as occupancy, monthly rentals, rent collection, maintenance expenditures, and operational expenses to construct a year’s worth of income, expenses, and cash flow. Then, in collaboration with the property management business, they monitor performance against the budget and make modifications as needed throughout the year.
If they discover that eviction costs are greater than planned, they must take steps to lower them to bring them back into line with the budget. The capital improvement budget, which covers the expenditures of large-scale restorations or projects, is the second type of budget. They must be budgeted for because of their high cost. In both circumstances, the budgeting process is vital to ensuring that the property’s performance follows the initial forecasts as closely as feasible.
Join Forces With Lenders
Asset managers must liaise with lenders to obtain debt financing for the transaction at the time of purchase. This frequently entails utilizing existing loan contacts to ascertain who is interested in the business and negotiating the best offer for their investors.
After the transaction is completed, the asset management must endeavor to ensure that the original loan “covenants,” which are the lender’s performance requirements, are met. A loan covenant can say, for example, that the borrower must produce financial statements to the lender every quarter. It is the asset manager’s responsibility to supply them in this scenario.
Cash Flow Management
The goal of the cash flow management procedure is to compare the property’s performance to the budgeted plan and make required modifications. In this method, the property can produce a return that is comparable to the initial predictions.
To satisfy its projected forecasts, a rental property could need to generate $100,000 in yearly cash flow before taxes. If it only makes $90,000, however, the asset manager can take aggressive measures to get the property back on track. They might be able to raise the amount of rent collected or lower the property management costs in some way.
The Asset Is For Sale
To be successful, a property must be occupied by rent-paying tenants as much as feasible. The asset manager must promote the property to potential renters to accomplish this. Creating social media adverts, marketing fliers, website listings, and bringing possible renters on property tours are all examples of this.
Organize Your Portfolio
All of the past operations have centered on property asset management. However, if a property owner has a large portfolio of assets, they may also want someone to take a higher-level view of performance. To put it another way, each property must accomplish all of the actions listed above.
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After that, the cash flows and performance must be “rolled up” to the portfolio level to ensure that overall performance is on track. It is evident from the descriptions that there is a lot of work to be done to manage commercial real estate assets. It requires a lot of effort and experience, which is why working with a sponsor is beneficial for individual investors.
Sponsors, on the other hand, do not labor for nothing. It is customary for commercial real estate investors to charge one or more sponsor fees to recuperate the costs of locating, financing, and administering the property.
Typical Commercial Real Estate Asset Management Fees
It’s crucial to remember that each transaction, each sponsor, and each cost structure is unique. As a result, the costs listed below may or may not apply to a live sale. Investors should read all offering documents and disclosures carefully to ensure that they understand the fees that will be levied on any individual deal.
Asset Management Fees
The sponsor may charge an asset management fee for all of the services indicated above, which typically ranges from 1% to 2% of invested equity. This is an annual fee that must be paid each year. When it comes time to sell, there is a lot of work to be done to advertise and market the property. Asset managers may levy a disposal fee to help fund this endeavor.
Commissions on Sales and Leasing
A commission may be given to the property management business when they lease space in the property. They may also be charged a lease renewal fee if they renew their lease. A commission may also be paid to a commercial broker on the sale of a property to help fund their marketing efforts.
To establish the LLC for investment, administer escrow, and evaluate the loan documentation before closing, a lot of legal labor is required. The asset manager may charge legal/set up fees to help fund this endeavor.
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Finding potential investment properties and doing due research on them to ensure they are acceptable for investment requires a substantial amount of time and effort. Purchase costs are usually collected upfront as a fixed fee or as a proportion of the entire acquisition cost, such as 1%–3%.
Fees for Entitlement/Development
In a development project, the asset manager may charge a fee for the costs of obtaining the empty land’s entitlement and the labor involved in administering the project. It can vary from 3% to 5% of the entire building cost, depending on the size of the project. It’s worth repeating that all real estate investors should thoroughly examine all of the offering documentation to ensure that they understand the fee structure and how it affects overall profits.
Management Fees for Real Estate Private Equity
One sort of real estate sponsor is private equity companies, which, like the others, collect fees for their purchase and management services. The fee structure may differ from one business to the next, emphasizing the significance of reading all disclosures to acquire an accurate picture of the cost structure of the investment. This technique is especially useful when comparing various assets against one another.
The sponsor and the investors are the two parties involved in a typical private equity commercial real estate transaction. The sponsor, often known as the asset manager or general partner, is in charge of all the hard work involved in locating, financing, and administering the property. The function of the investor is a passive one. They merely supply equity cash and do not influence how the property is managed on a day-to-day basis.
Asset managers charge investors fees to fund their operations. It might be a flat charge in some circumstances. In certain cases, it’s a proportion of the invested capital. There is a significant distinction between a property manager’s and an asset manager’s responsibilities. Creating and monitoring a budget, negotiating with lenders, controlling cash flows, and managing the entire portfolio if many properties are held are all tasks of an asset manager. Property managers are in charge of the property’s day-to-day operations. They handle things like repairs, leasing, maintenance, and resident requests, for example.
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Investment Management Fees FAQ'S:
All direct expenditures involved in managing the investments, such as hiring the portfolio manager and investment team, are included in the management fee. The most significant component of management fees is the cost of employing managers, which may range from 0.5 percent to 1 percent of the fund’s assets under management (AUM).
Investment management and financial planning expenses, like tax preparation fees, might be deducted as a miscellaneous itemized deduction on your tax return, but only to the extent that they exceed 2% of your adjusted gross income (AGI).
Investment fees, custodian fees, trust administration fees, and other expenditures paid for managing your taxable investments are no longer eligible as miscellaneous itemized deductions.