Of course, if the sponsor is the property manager, and the property management fee is greater than the fee charged in an arms length transaction, than the excess must be accounted for in the evaluation. These fees should not be confused with property management fees which are fees an investor would pay for property management whether he had invested directly or through a passive investment entity. The sponsor may receive a straight percentage of the current income, a percentage after the investors receive a preferred return, or a fixed fee to “manage” the operation. These fees can be structured a number of different ways. Ongoing Fees- Ongoing fees are fees paid by the investors on a continuing basis usually from the ongoing income produced by the asset.
In summary, any money paid by the investors and not directly going to the original seller to purchase the real estate or the asset is a fee or expense which must be “earned back” by the investment before the investor can get to break even, let alone profit on the investment. If the fund is paying a commission to a real estate broker to represent itself in the transaction, then this is also a fee which must be evaluated. The sponsor might also obtain a percentage of the property ownership for himself while having the investors pay all acquisition costs. An example of a hidden fee would be when the purchase of the property has already been completed and the fund is repurchasing the property from the sponsor at a higher price than the sponsor paid. A thorough reading of the prospectus will usually uncover these fees. They are often “hidden” as part of the purchase price of the property or as part of an ongoing expense. Hidden Fees- These fees are not accounted for separately. These deals will have the best chance of success. Although “no front end fee” arrangements are rare, some sponsors do offer them. This is possible if the sponsor sells directly, has no selling expense and is willing to take his profit on the back end when the investment is sold or as the investment earns current income. Ideally I’d rather pay no front end fees and have 100% of my money invested in the property. I look for front end fees of less than 5% to make a deal worthy of consideration. If these fees are greater that 10% I would eliminate the investment from consideration outright. These fees are transparent and usually listed in the prospectus or private placement memorandum. These can include organizational fees, sponsor fees, commissions to investment advisors, legal fees, accounting fees, underwriting fees, reimbursements to sponsors or any other fees you can imagine. Types of Feesįront End Fees- These are the fees that are taken out of your investment before the money is invested in any real estate or asset. This is a huge amount to make up just to get back to break even. Additionally, only 80% of his capital is working to earn income or appreciation. As an extreme example, if 20% of the investment is eaten by various fees, and only 80% of the investment is actually invested in property, the investor faces a 20% loss of capital as soon as he makes the investment.
The larger the percentage of his investment actually purchasing the asset, the greater the chance for a good return and the less the chance of taking a loss. The investor needs to determine exactly how much of his investment is going into real estate and how much is being eaten by fees. The first item to evaluate is the issue of fees. But how does the investor determine which investments merit his attention, and which should be eliminated outright?
And as proclaimed by their sponsors, these investments can offer the benefits of diversification, professional management, access to “A” type properties, and potential high returns as a passive investor. The types and number of passive real estate investment opportunities are exploding. TICS (Tenants in Common), 1031 exchanges, REITS, Real Estate Mutual Funds, LLCs, Limited Partnerships.
Evaluating Passive Real Estate Investments.