Co-invest, promote and fees added up across three outcomes on an illustrative joint venture, and what the mix says about alignment.
Add up everything the sponsor receives: its pro rata share of the deal, the promote, and the acquisition, asset management and disposition fees. On an illustrative $150,000,000 joint venture in which the sponsor puts up 10 per cent of the equity, the base case pays it $12,862,545 of profit, 3.50 times its capital, of which fees are 38 per cent. In a weak case the promote pays nothing, yet fees of $4,820,248 still leave the sponsor at 2.27 times against the investor's 1.33.
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 →
A sponsor and an institutional investor buy a $150,000,000 property with a $100,000,000 interest-only loan. The sponsor charges a 1 per cent acquisition fee, which the venture capitalises, so the equity is $51,500,000: $5,150,000 from the sponsor and $46,350,000 from the investor. The waterfall pays both partners pro rata until the investor has an 8 per cent IRR, then splits 80/20 with the 20 per cent as promote. All terms are illustrative.
| Item | Value |
|---|---|
| Purchase price | $150,000,000 |
| Loan, interest only at 5% | $100,000,000 |
| Acquisition fee, 1.0% of price | $1,500,000 |
| Equity: sponsor 10% / investor | $5,150,000 / $46,350,000 |
| NOI in year 1, growing 3% a year | $9,000,000 |
| Asset management fee, 1% of equity a year | $515,000 |
| Disposition fee | 0.5% of sale price |
| Preferred return / promote | 8% IRR / 20% |
| Hold | 5 years |
The three outcomes differ only in the exit cap rate applied to year-six NOI: 7.00 per cent (weak), 6.00 per cent (base, the same as the going-in yield) and 5.25 per cent (strong).
1. Cash flow to the venture. NOI less $5,000,000 of interest and the $515,000 asset management fee gives annual distributions of $3,485,000 rising to $4,319,543. In the base case the property sells for $173,891,111, the disposition fee is $869,456, and after repaying the loan the year-five distribution is $77,636,235.
2. The waterfall. Distributions go 90/10 until the investor's 8 per cent hurdle balance is cleared, then 72/28: 80 per cent of the remainder is shared 90/10 and 20 per cent is promote. In the base case the promote is $4,161,335. The method is the same as in a multi-tier IRR waterfall, with one tier.
3. The sponsor's economics.
Sponsor profit = [10% × (distributions − promote) − its equity] + promote + fees
Base: 3,756,754 + 4,161,335 + 4,944,456 = $12,862,545
Multiple on its capital = (5,150,000 + 12,862,545) / 5,150,000 = 3.50x
Fees = 1,500,000 acquisition + 2,575,000 asset management + 869,456 disposition = 4,944,456
The pro rata share is 10 per cent of what is left after the promote comes off the top; taking 10 per cent of all distributions and then adding the promote double counts $416,134 in the base case. The co-invest profit is also struck after fees, so the sponsor pays its 10 per cent share of its own fees, $494,446 in the base case; its net fee income is $4,450,010.
| Line | Weak | Base | Strong |
|---|---|---|---|
| Deal IRR before fees | 8.7% | 15.9% | 21.6% |
| Deal IRR after fees | 6.7% | 14.0% | 19.8% |
| Investor IRR / multiple | 6.7% / 1.33x | 12.9% / 1.73x | 17.8% / 2.11x |
| Sponsor co-invest profit | 1,701,150 | 3,756,754 | 5,734,145 |
| Promote | 0 | 4,161,335 | 9,104,811 |
| Fees | 4,820,248 | 4,944,456 | 5,068,663 |
| Sponsor profit | 6,521,397 | 12,862,545 | 19,907,619 |
| Sponsor multiple on its capital | 2.27x | 3.50x | 4.87x |
| Fees as share of sponsor profit | 74% | 38% | 25% |
| Sponsor share of profit before fees | 30% | 28% | 28% |
Two things stand out. First, the sponsor takes between 28 and 30 per cent of the total value created in every case, on 10 per cent of the capital. The mix changes, not the share: in the weak case fees do the work the promote does in the strong case. Second, in the weak case the deal earns 8.7 per cent before fees, above the hurdle, and only the fees push it to 6.7 per cent and switch the promote off. The investor bears 90 per cent of fees that turned a deal that cleared its hurdle into one that did not.
Investment committees tend to look at the promote structure, 8 per cent and 20 per cent, and conclude that the sponsor is paid for performance. Here 74 per cent of the sponsor's weak-case profit is fees that do not depend on performance at all, and the acquisition fee is earned on the day of purchase, before anything has been achieved. A sponsor whose fees alone return close to its co-investment, $4,820,248 against $5,150,000 here, is close to indifferent to the outcome on its capital. The question to ask is what the sponsor earns if the deal disappoints. For the sponsor's IRR on the co-invest and promote alone, see what IRR a sponsor earns on its co-invest.
Fee bases matter as much as fee rates. An asset management fee on gross asset value rather than equity would be roughly three times larger on this venture, and it grows when the venture borrows more.
The book sets out every payment to the sponsor and its affiliates, and the free workbook for this case computes the sponsor's total economics alongside the waterfall. The JV waterfall and promote model runs the promote on your own terms.
Common fees are an acquisition fee on the purchase price, an asset management fee each year, and a disposition fee on sale, sometimes with construction or financing fees. In the illustrative venture, 1.0 per cent on a $150,000,000 price, 1 per cent of equity a year and 0.5 per cent of the sale price come to $4,944,456 over five years in the base case.
More than its share of capital. In the example the sponsor puts up 10 per cent of the equity and takes 28 to 30 per cent of the value created, before fees, in every outcome: through the promote when the deal does well and through fees when it does not.
Yes, when the hurdle is measured after fees. In the weak case the deal earns 8.7 per cent before fees and 6.7 per cent after them, below the 8 per cent hurdle, so the promote is zero. The sponsor still earns $4,820,248 of fees, borne 90 per cent by the investor.
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 681 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.