5 THINGS TO CONSIDER ABOUT INVESTMENT FEES AND EXPENSES

Managing Your Concerns About Possible High Fees and Expenses In Multifamily Syndications

INTRODUCTION

Mike and I have discovered that multifamily investments are a goldmine for us as investors.

Multifamily consistently delivers excellent returns, offers several tax benefits, and significantly boosts our net worth. Multifamily syndications can also increase the performance of your financial portfolio.

We know this as operators (General Partners) and everyday passive investors (Limited Partners) like you. I currently am a Limited Partner in four different complexes around the country.

I look very carefully at the fees operators charge, and we suggest you do the same. Fees are one of the main concerns we hear from passive investors.Their concerns are related to the fees and expenses that operators charge.

Read on to gain a deeper understanding of fees, notice red flags to watch out for, and receive tips on discussing fees with syndication sponsors before investing.

Understanding these aspects will give you more control over your investments and the confidence to make informed decisions.

#1 WHY ARE FEES PAID TO OPERATORS?

Operators, also known as ‘sponsors’ or ‘General Partners’, are the backbone of a successful multifamily investment. Their responsibilities are crucial and include:

(a) Find and analyze deals to ensure the property meets investor expectations. They have expenses and put in a lot of time to ensure your investment was “Bought Right” – in the right market, at the right price, with the right business plan in place.

(b) Structure the syndication, including arranging financing and legal documents. This work involves many legal and due diligence expenses.

(c) Manage the asset, overseeing renovations, leasing, and tenant relationships to increase the property’s value. Although they might hire a separate property manager, they still put in plenty of time overseeing the asset as a whole and making the big decisions over the many years of your investment’s life.

(d) Ongoing communication with investors, including quarterly updates and distributions. You will value the time an operator takes to communicate clearly and regularly with you.

Given the complexity and responsibility, operators charge fees to compensate for their time, expertise, and effort throughout the project’s life. These fees also cover legitimate expenses related to operating the property. Look at fees not just as costs but as investments in the operator who controls the success of your investment.

As General Partners on a 128-unit apartment complex for four years, Mike and I and our team had many appropriate fees and expenses. Our investors understood these fees to be a regular part of the cost of the business of running an apartment community.

When appropriate, these fees provide fair compensation for the operator’s efforts and motivate them to ensure the project runs smoothly. This fairness in compensation should reassure you as an investor and build trust in the operator’s intentions.

Similar fees would apply if you were investing in any business. The question is whether they are appropriate. We answer that next.

#2. WHAT ARE APPROPRIATE FEES?

While fees vary depending on the deal structure, here are some industry-standard fees for multifamily syndications:

(a) Acquisition Fee: 1% to 3% of the property’s purchase price, compensating the operator for sourcing and closing the deal. As the total cost of the property increases (into the multiple tens of millions of dollars), we think the percentage of the purchase price should be on the lower side of this estimate.

(b) Asset Management Fee: 1% to 2% of the gross income, covering the ongoing oversight of property operations.

(c) Property Management Fee: Typically 3% to 8% of collected rents are paid to an in-house or third-party property manager. We have found that somewhere in the 5% to 6% range is average.

(d) Project Management Fee: Typically 4% to 8% of the capital expenses. Often, especially with “value add” properties, there are many capital expenses for renovating units, updating the property, replacing major items such as roofs or HVACs, and significant plumbing repairs.

The operator will often act like a general contractor to define the project’s scope, hire subcontractors, purchase materials, and oversee the completion of the projects. Light renovations will be on the lower end of this scale, while more extensive renovations will have fees on the higher end of the range.

(e) Disposition Fee: 1% to 2% of the sale price. This fee is similar to the acquisition fee but on the exit from the property when the property is sold. This fee compensates the sponsor for preparing and completing the property sale. There will also be some costs in the sale, such as the broker’s commission, legal expenses, and other expenses common to the sale of any property.

(f) Refinancing Fee: 1% of the refinanced amount, applied if the operator refinances the loan during the investment.

Notice how many different types of fees there are. These fees are standard across the industry and can vary slightly based on the operator’s experience and the property’s complexity.

Of course, as expenses, these fees will reduce the net income and affect the funds available for distribution to you as an investor. Let’s look at how these fees will impact your returns.

# 3 HOW WILL FEES AFFECT YOUR RETURNS?

Fees will directly impact your net returns. Although operators collect fees to manage the property and cover expenses, high fees reduce the distributable cash flow to investors.

For example:

(a) Acquisition fees are deducted upfront, so the more significant the fee, the longer it may take for the property to generate meaningful cash flow.

(b) Asset management and property management fees are deducted from operating income, meaning higher fees could limit quarterly distributions.

(c) If the disposition fee is excessive, it can cut into the profits earned upon sale.

Even with a successful project, excessive fees can reduce investors’ (your) overall Internal Rate of Return (IRR). Therefore, it’s crucial to be clear about fees before investing. Asking the right questions about fees is a proactive step that can help you make more informed investment decisions.

#4 WHAT ARE SOME RED FLAGS RELATED TO FEES?

While fees are expected, there are some red flags to watch for when evaluating a syndication deal. By a “red flag” I mean something that raises a big question about their appropriateness. Here are a few examples:

(a) Unusually high fees. Anything above the standard ranges may indicate the operator overcompensates at investors’ (your) expense. Check the ranges we list above.

(b) Unclear or hidden fees: If the operator isn’t upfront about all fees, it could indicate a lack of transparency.

(c) Performance misalignment: Be cautious if the operator charges fees without accountability for the property’s success, such as receiving high asset management fees despite poor performance.

(d) Double-dipping: Ensure operators are not charging the same fee under multiple labels (e.g., charging both an asset management fee and a project management fee for the same service).

As you read the documents related to your investment and talk with the operator, be sure to understand the fees and expenses they will charge. We will conclude with some suggestions for having these conversations.

#5 HOW TO HAVE A CONVERSATION ABOUT FEES WITH THE OPERATOR.

Before making an investment, discussing fees upfront with the operator is essential to avoid misunderstandings. Here are some questions to ask:

(a) “Can you walk me through all the fees and when they will be charged?” This ensures you have a complete picture of what to expect. It might be helpful to read through the documents and highlight the fees so you can discuss each one.

(b) “How do these fees compare with industry standards? Asking this helps gauge whether the operator’s fees are reasonable. You have some typical ranges above.

(c) “What steps do you take to align your fees with investor returns?” Look for operators who include performance-based incentives, like profit-sharing, to align their interests with yours.

(d) “How do you communicate about ongoing expenses during the life of the investment?” Regular updates on property performance and expense management are critical for transparency. Ask where to look in the communications they will provide to you.

A candid discussion ensures you understand the fee structure and the operator’s intentions. This clarity helps build trust and allows you to make an informed decision about the investment.

FINAL THOUGHTS

Understanding fees and expenses is essential when investing in multifamily syndication. While operators charge fees to compensate for the time and expertise required to manage these investments, excessive or unclear fees can significantly reduce returns.

Knowing what fees are appropriate, spotting red flags, and engaging in honest conversations with the operator will help you make a more confident investment decision.

Fees are part of the cost of doing business. By staying vigilant and informed you can ensure they do not significantly reduce your returns.

Mike Jacobson and I vet the operators for our personal investments, using conversations about their fee structures as one element of a series of questions on our checklist.

Sometimes we partner with operators to help them raise the funds needed to purchase the properties.

As these opportunities become available, we will gladly share them with you. We provide an extra layer of due diligence for your investments and are seeking properties that are being bought, financed, and managed right by a well-qualified operator team. Get in touch now. These select opportunities often go very fast.

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YOUTUBE CONVERSATION

Mike Jacobson and Harland Merriam discuss fees in an 18-minute YouTube video. Here is the link:

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