The rate gets negotiated; the word after it moves more money. Convert every asset management fee into a load on contributed equity.
Multiply the rate by each base and express the fee as a share of contributed equity. On an illustrative 200 JV financed at 60 per cent loan to cost, a 1.0 per cent asset management fee on contributed equity costs 0.80 a year; the same 1.0 per cent on gross asset value costs 2.00 in year one and rises with the value, 2.5 times as much, cutting the equity IRR by 235 basis points against 89. A fee on gross asset value is a fee that grows with leverage and with unrealised appreciation.
Worked in full in Real Estate Joint Ventures by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Term sheets argue about whether the asset management fee is 1.0 or 1.5 per cent. The word after the rate, "of contributed equity", "of committed capital", "of total project cost" or "of gross asset value", usually moves more money. Equity is the smallest base; gross asset value is the largest, and on a levered deal it is a multiple of equity. Every comparison below holds the rate at 1.0 per cent and changes only the base. All figures are illustrative, in millions.
| Input | Value |
|---|---|
| Total project cost | 200 |
| Loan to cost, interest-only at 5% | 60% |
| Senior debt | 120 |
| Contributed equity | 80 |
| Committed equity, including an undrawn reserve of 10 | 90 |
| Net operating income, year 1, growing 3% a year | 11.0 |
| Valuation and exit yield | 5.5% |
| Hold, years; sale costs | 5; 1% |
Gross asset value is taken as each year's net operating income capitalised at 5.5 per cent: 200.00 in year one, rising to 225.10 in year five. Exit is at 231.85, leaving 109.54 for equity after sale costs and the loan.
Annual fee = rate × base for that year
Fee load = annual fee ÷ contributed equity
Excel, fee on GAV for year t: =1%*NOI_t/5.5%; fee load: =Fee/80
Step 1, contributed equity. 1.0 per cent of 80 is 0.80 a year, 4.00 over the hold: a fee load of 1.00 per cent, by construction.
Step 2, committed equity. 1.0 per cent of 90 is 0.90. The extra 0.10 a year is charged on the 10 that is never drawn: a fee load of 1.12 per cent.
Step 3, total project cost. 1.0 per cent of 200 is 2.00 a year, 10.00 over the hold. On 80 of equity that is a fee load of 2.50 per cent, because the base includes the 120 of debt.
Step 4, gross asset value. 2.00 in year one, then 2.06, 2.12, 2.19 and 2.25 as the value rises: 10.62 in all, an average fee load of 2.65 per cent. In year five the fee is 12.6 per cent higher than in year one, with no change in the work.
| Fee base | Year 1 base | Year 1 fee | Fees over 5 years | Average fee load | Equity IRR | Drag, bp |
|---|---|---|---|---|---|---|
| No fee | 12.73% | |||||
| Contributed equity | 80.00 | 0.80 | 4.00 | 1.00% | 11.83% | 89 |
| Committed equity | 90.00 | 0.90 | 4.50 | 1.12% | 11.72% | 100 |
| Total project cost | 200.00 | 2.00 | 10.00 | 2.50% | 10.50% | 222 |
| Gross asset value | 200.00 | 2.00 | 10.62 | 2.65% | 10.38% | 235 |
The IRR is the equity's return before any promote, so it is shared by investor and sponsor; the sponsor, as a co-investor, pays its own share of the fee back to itself. In year one the venture has 5.00 of cash for equity after interest. A fee on gross asset value takes 40.0 per cent of it; a fee on contributed equity, 16.0 per cent.
To compare a quote on gross asset value with one on equity, convert. A market-style 1.5 per cent on contributed equity is 1.20 a year, 6.00 over the hold. The same total on gross asset value is a rate of 0.565 per cent. A sponsor offering "only 0.5 per cent of GAV" is offering 5.31 over the hold, and an equity IRR of 11.55 per cent against 11.39: cheaper here, but only just, and only at this leverage.
| Loan to cost | Equity | GAV over equity | Fee load, GAV base | Fee load, equity base |
|---|---|---|---|---|
| 40% | 120 | 1.67x | 1.67% | 1.00% |
| 50% | 100 | 2.00x | 2.00% | 1.00% |
| 60% | 80 | 2.50x | 2.50% | 1.00% |
| 65% | 70 | 2.86x | 2.86% | 1.00% |
| 70% | 60 | 3.33x | 3.33% | 1.00% |
A fee on gross asset value pays the sponsor more for borrowing more. At 70 per cent loan to cost the investor pays 3.33 per cent of its equity a year for the same asset management, and a refinancing that returns equity raises the fee load further. If the base must be gross asset value, the investor should cap the fee as a share of equity, or fix the base at cost.
Comparing fee rates across bases. 0.5 per cent of gross asset value sounds half the price of 1.0 per cent of equity. Here it is 1.00 in year one against 0.80, 1.25 times as much. The second mistake is forgetting that the gross asset value base is set by a valuation, often the sponsor's own or one it commissions: the fee then rises with every upward revaluation, before any value is realised. Agree who values, how often, and whether the fee is trued up at exit.
The fee bases and the sponsor's total economics are worked in the free workbooks for this case; for how fees and promote add up for the sponsor, see how much a JV sponsor earns from fees against the promote.
Terms vary by market, strategy and size, so treat any figure as illustrative. What matters is the base. In a worked 200 venture with 80 of equity, 1.5 per cent of contributed equity is 1.20 a year, and the same money on gross asset value is a rate of only 0.565 per cent. Quote both ways before agreeing either.
Because it does not grow with leverage or with valuations. On an illustrative 200 venture, 1.0 per cent of gross asset value is 2.50 per cent of equity at 60 per cent loan to cost and 3.33 per cent at 70, and it rose 12.6 per cent over five years as the asset was revalued, with no change in the work done.
Compute the equity IRR with and without it. In the illustrative case the equity IRR before fees is 12.73 per cent; 1.0 per cent on contributed equity brings it to 11.83, on committed equity to 11.72, on total project cost to 10.50 and on gross asset value to 10.38, a drag of 89 to 235 basis points at the same quoted rate.
This article is one calculation from Real Estate Joint Ventures. 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.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: real estate investing, finance and fund management → · All 1340 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.