Fees pay for the house; carry is the profit. Running one fund through its eight years shows how much of each a manager really keeps, and how sharply the carry depends on the last tenth of a multiple.
Over the life of an illustrative 300 million real estate fund at 1.5 per cent and 20 per cent carry, the manager collects 29.9 million of fees, of which 10.7 million survives the cost of running the firm, and 33.6 million of carry if the portfolio returns 1.75x gross. Carry is three quarters of the manager's profit, and it falls off a cliff: at 1.60x gross the fund nets 7.8 per cent, misses its 8 per cent hurdle, and the carry is nil.
Worked in full in Raising a Real Estate Fund by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A fictional closed-ended value-add fund. All figures in millions and illustrative, not a statement of market terms; fee bases, hurdles and catch-ups vary from fund to fund.
| Input | Value |
|---|---|
| Commitments | 300.0 |
| Management fee: on commitments years 1 to 4, then on invested cost | 1.5% |
| Investments, three equal vintages in years 1 to 3 | 88.0 each, 264.0 in all |
| Hold per investment, gross multiple | 5 years, 1.75x |
| Preferred return (compound), carry, catch-up | 8%, 20%, full |
| Waterfall | whole fund |
| Manager's running cost (team, office, systems) | 2.4 a year |
Years 1 to 4: 300.0 × 1.5% = 4.5 a year, 18.0 in all
Years 5 to 8: 1.5% of the cost still held: 3.96, 3.96, 2.64, 1.32, or 11.88
Total fees = 29.88; costs = 2.4 × 8 = 19.2; fee margin = 10.68
The investors pay the fees as capital calls on top of the 264.0 invested, so they put in 293.88. The fee step-down after the investment period is what keeps the margin thin: the firm's cost does not fall when the fee base does. The size of that step is worked in management fee on committed vs invested capital.
Notice the shape. The investment period earns 18.0 of fees in four years; the harvest period earns 11.88 in four years while the firm's cost stays at 2.4 a year. In year 8 the fee is 1.32 against 2.4 of cost: the firm is losing money on its fund at exactly the moment it is selling the last assets. That is why managers raise the next fund around year 4, when the fee base first steps down, and why investors in a first fund ask what happens to the team if the second does not close.
Gross proceeds = 264.0 × 1.75 = 462.0; profit to the fund = 462.0 − 293.88 = 168.12
Order of payment: capital back, 8% compound preferred return, 100% to the manager until it holds 20% of the profit, then 80/20
The fund's net return clears the hurdle (net IRR 8.3%, gross 11.8%), the catch-up completes, so carry = 20% × 168.12 = 33.62, all paid in year 8
| Line | Nominal | PV at 10% |
|---|---|---|
| Management fees | 29.88 | 20.93 |
| Running costs | −19.2 | −12.80 |
| Fee margin | 10.68 | 8.13 |
| Carried interest | 33.62 | 15.69 |
| Manager's profit | 44.30 | 23.82 |
Gross revenue is 63.50, 21.2 per cent of commitments over eight years, and carry is 52.9 per cent of it. After costs, carry is 75.9 per cent of what the manager keeps in nominal terms and 65.9 per cent in present value. The fees fund the firm; the carry is the firm's return.
| Gross multiple | Gross IRR | Net IRR | Fees | Carry | Profit after costs |
|---|---|---|---|---|---|
| 1.40x | 7.0% | 4.9% | 29.9 | 0.0 | 10.7 |
| 1.60x | 9.9% | 7.8% | 29.9 | 0.0 | 10.7 |
| 1.65x | 10.5% | 8.0% | 29.9 | 10.2 | 20.9 |
| 1.70x | 11.2% | 8.0% | 29.9 | 24.5 | 35.2 |
| 1.75x | 11.8% | 8.3% | 29.9 | 33.6 | 44.3 |
| 1.90x | 13.7% | 9.9% | 29.9 | 41.5 | 52.2 |
Between 1.60x and 1.75x the manager's profit quadruples while the investors' net return moves half a point. In the catch-up zone, 1.65x to 1.70x, the net IRR is pinned at 8.0 per cent and almost every extra unit of gain goes to the manager. Above it, carry grows at only 20 per cent of each extra unit. That cliff is why a manager's income forecast is a forecast of the exit, and why a first-time manager whose firm lives on 10.7 of fee margin over eight years must plan to survive the scenario where carry is zero.
The firm in this example runs on 0.20 a month. The fee pays it only because the fund is 300 million: smaller funds, or a first close that is small for long, leave the partners funding the gap, as worked in whether a first close covers the management company.
Quoting the manager's income as 1.5 per cent plus 20 per cent of the profit, then multiplying. It ignores three things the calculation shows: the fee base steps down after the investment period, the firm's costs absorb most of the fees, and carry is not 20 per cent of anything until the hurdle and catch-up clear. The illustrative manager collects 63.50 on paper at 1.75x, keeps 44.30, and would keep 10.7 at 1.60x. Investors running the same check on a pitch should ask the manager to show its fee budget against its cost base, year by year.
The book's management company budget, the fee across the fund's life and the burn against the fee are set out in the free workbook for this case.
Gross, the two can be similar; after costs, carry usually dominates when the fund clears its hurdle. In the illustrative 300 million fund, fees total 29.9 million but running the firm costs 19.2 million, leaving 10.7 million. Carry at a 1.75x gross multiple is 33.6 million, 75.9 per cent of the manager's profit after costs. If the fund misses the hurdle, fees are all there is.
Twenty per cent of the fund's total profit, but only when the fund clears the preferred return and the catch-up completes. On the illustrative fund, 168.12 million of profit at 1.75x gross pays 33.62 million. At 1.65x the catch-up is incomplete and carry is 10.2 million; at 1.60x the net return of 7.8 per cent is below the 8 per cent hurdle and carry is nil.
Discounted at 10 per cent, the illustrative fund's fees are worth 20.93 million, its costs 12.80 million and its carry 15.69 million. The fee margin of 8.13 million arrives early and is near certain; the carry arrives in year 8 and depends on the exit. A lender or a buyer of a GP stake values the two streams very differently.
This article is one calculation from Raising a Real Estate Fund. 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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