An external manager's fee looks small against assets. Measured against NOI, equity and value per share, it is the largest line after interest, and it rewards growth over accretion.
Measure the fee against NOI and value per share, not against assets. On an illustrative REIT with $4,000M of property, a 0.75 per cent external base fee plus residual costs comes to $36.0M a year, 15.0 per cent of NOI against 7.5 per cent for an internally managed peer. Capitalised, the $18.0M excess is worth $3.00 a share, 12.5 per cent of a $24.00 NAV, and it makes an acquisition that would be accretive internally dilutive externally.
Worked in full in REIT Analysis and Valuation by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
One fictional portfolio run two ways: by its own employees, or by an external adviser paid a base fee on gross assets. Figures in $ millions except per share. Fee levels are illustrative; real agreements add incentive, acquisition and property management fees that make the gap wider.
| Input | Value |
|---|---|
| Gross assets, cap rate (NOI 240.0) | 4,000.0, 6.00% |
| Debt at 5.0% (LTV 40%) | 1,600.0 |
| Shares | 100.0 |
| Internal G&A | 18.0 |
| External base fee on gross assets | 0.75% |
| Costs the REIT still bears when external (board, audit, listing) | 6.0 |
| Cost of equity, long-run growth | 8.0%, 2.0% |
Base fee = 4,000.0 × 0.75% = 30.0; external total = 30.0 + 6.0 = 36.0; internal = 18.0
| Basis | External | Internal |
|---|---|---|
| % of gross assets | 0.90% | 0.45% |
| % of NOI | 15.0% | 7.5% |
| % of equity (NAV 2,400.0) | 1.50% | 0.75% |
| FFO per share | $1.24 | $1.42 |
Less than one per cent of assets sounds trivial. It is 15.0 per cent of the income and takes 12.7 per cent off FFO. Because the fee is charged on gross assets, it is also charged on the borrowed part: the 0.75 per cent base fee alone is 1.25 per cent of shareholders' equity at 40 per cent LTV.
The excess cost is a perpetual, growing claim ahead of the shareholders. Capitalise it like any other income stream:
Excess = 36.0 − 18.0 = 18.0 a year
Multiple = 1 / (8.0% − 2.0%) = 16.7x
Value = 18.0 × 16.7 = 300.0, or $3.00 a share, 12.5% of the $24.00 NAV
Excel: =(GAV*Fee+Residual-Internal)/(Ke-g)/Shares
A NAV of $24.00 built from appraised property and debt is therefore worth $21.00 to a shareholder once the excess management cost is netted. A share price near $21.00 is not a discount to be arbitraged; it is the fee, priced. The whole base fee capitalises to $5.00 a share.
Suppose the REIT buys 500.0 of property at the same 6.00 per cent cap rate, half with debt at 5.0 per cent and half with new shares issued at $21.60, 10 per cent below NAV.
| Measure | External | Internal |
|---|---|---|
| FFO per share before | $1.240 | $1.420 |
| FFO per share after | $1.235 | $1.430 |
| Change | −0.4% | +0.7% |
| Manager's base fee | 30.0 to 33.75 | n/a |
Internally, with G&A unchanged, the deal adds 0.7 per cent to FFO per share; externally it costs 0.4 per cent, because 3.75 of new fee absorbs the spread. NAV per share falls 1.0 per cent to $23.75 in both cases, from issuing 11.57 shares below NAV. The shareholders lose; the manager's fee rises 12.5 per cent. That asymmetry, not the fee level, is the governance problem, and it is why the accretion test in whether a discounted REIT can acquire accretively must be run net of any fee the deal triggers.
| Base fee | Cost as % of NOI | Ke 7.0% | Ke 8.0% | Ke 9.0% |
|---|---|---|---|---|
| 0.50% | 10.8% | $1.60 | $1.33 | $1.14 |
| 0.75% | 15.0% | $3.60 | $3.00 | $2.57 |
| 1.00% | 19.2% | $5.60 | $4.67 | $4.00 |
Each 25 basis points of base fee is worth $1.67 a share at an 8.0 per cent cost of equity, about 7 per cent of NAV.
Internalisation is the same arithmetic in reverse. A termination fee of three times the base fee is 90.0, or $0.90 a share, against $3.00 of capitalised excess: a net gain of $2.10 a share, provided the internal team really can be run for 18.0 a year. Boards should test that internal cost line harder than the termination multiple.
The base fee is only the start. Many external agreements add an incentive fee over a return threshold, acquisition and disposition fees on each deal, and property management fees paid to an affiliate. Each can be capitalised in the same way and added to the excess, and each adds to the incentive to grow assets rather than value per share.
Comparing fees as a percentage of assets. On that basis 0.90 per cent against 0.45 per cent looks like a rounding difference; on income it is 15.0 against 7.5 per cent, and on value per share it is $3.00. The second mistake is valuing an externally managed REIT on a NAV that ignores the fee: a REIT's NAV per share should either deduct the capitalised excess or be compared only with peers that carry the same structure.
The book's companion files run the externally managed case on its own worked REIT, with the fee, the termination payment and the dilution live; they are in the free workbook for this case.
Because the fee is a claim on the assets that ranks ahead of shareholders and grows with assets rather than with value per share. In the illustrative case the excess cost over internal management is $18.0M a year, worth $3.00 a share at a 16.7 times multiple, 12.5 per cent of NAV. A discount of that order is the market pricing the fee, not mispricing the REIT.
No. A fee on gross assets is also a fee on the debt. At 40 per cent LTV, 0.75 per cent of $4,000M of assets is $30.0M, which is 1.25 per cent of the $2,400M of equity. Higher leverage raises the fee per dollar of equity without any change in the fee rate.
Compare the fee with the capitalised saving. Here internalising removes $3.00 a share of excess cost and a termination fee of three times the $30.0M base fee costs $0.90 a share, a net gain of $2.10. The answer flips if the internal team would cost more than assumed or the multiple paid is much higher.
This article is one calculation from REIT Analysis and Valuation. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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