A fee on the gross sale price is paid entirely from the equity, so the debt in the deal magnifies it. Here is the arithmetic at four levels of leverage.
A disposition fee is charged on the gross sale price but paid entirely out of the equity, so leverage magnifies it. On an illustrative $100m asset bought with 60 per cent debt and sold for $125m after five years, a 1 per cent fee is $1.25m: 3.125 per cent of the equity invested, and it cuts the investor's IRR by 39 basis points, from 15.42 to 15.03 per cent.
Worked in full in Private Equity Real Estate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Disposition fees look small in a term sheet. One per cent of the sale price sits beside a 1.5 per cent asset management fee and a 20 per cent promote and rarely gets negotiated hard. The number that matters to the investor is not the rate but what it takes from the equity's return, and that depends on two things the fee clause does not mention: how much of the sale price belongs to the lender, and how much profit the deal made.
| Input | Figure |
|---|---|
| Purchase price | $100m |
| Loan, interest-only, repaid at sale | 60% LTV, $60m at 5.5% |
| Equity | $40m |
| Net operating income, year 1 | $5.5m, growing 3% a year |
| Hold period | 5 years |
| Gross sale price | $125m |
| Disposition fee | 1.0% of gross sale price |
NOI less interest of $60m × 5.5% = $3.3m. Years 1 to 5: $2.20m, $2.37m, $2.53m, $2.71m and, before the sale, $2.89m on NOI of $5.50m rising to $6.19m.
Without the fee: $125m − $60m of debt = $65.0m. Fee: $125m × 1.0% = $1.25m. With the fee: $63.75m.
Without fee: −40.00, 2.20, 2.37, 2.53, 2.71, 67.89 gives 15.42 per cent and 1.94x.
With fee: the last flow becomes 66.64, giving 15.03 per cent and 1.91x.
=IRR(B2:G2)-IRR(B3:G3) on the two rows. The fee alone in equity terms is =Sale*Fee/Equity: $1.25m ÷ $40m = 3.125 per cent.
The investor's profit falls from $37.70m to $36.45m. The fee takes 3.3 per cent of the profit for one transaction, at the very end of the hold, which is why it moves the IRR less than an annual fee of the same total size would.
The fee is a percentage of a number that includes the lender's money. Of the $125m sale price, $60m goes straight to repay the loan, yet the fee is still charged on it. Measured against what the equity actually receives at exit, the 1.0 per cent fee is 1.92 per cent. Measured against the equity invested, it is 3.125 per cent. The higher the leverage, the bigger the gap.
| LTV | IRR before fee | 0.5% fee (bp) | 1.0% fee (bp) | 1.5% fee (bp) | 1% fee as % of equity |
|---|---|---|---|---|---|
| 0% | 9.91% | 9 | 19 | 29 | 1.25% |
| 50% | 13.70% | 16 | 33 | 50 | 2.50% |
| 60% | 15.42% | 19 | 39 | 59 | 3.125% |
| 70% | 18.08% | 24 | 47 | 71 | 4.17% |
Unlevered, a 1 per cent fee costs 19 basis points. At 70 per cent LTV the same fee costs 47. Leverage raises the IRR, but it raises the cost of every fee charged on gross asset value faster than it raises the return, which is the same leverage arithmetic the book's capital stack workbook runs from no debt to 85 per cent LTV: debt amplifies whatever reaches the equity, costs included.
| Sale price | IRR before fee | IRR after 1% fee | Cost (bp) | Fee | Fee as % of profit |
|---|---|---|---|---|---|
| $110m | 10.33% | 9.92% | 41 | $1.10m | 4.8% |
| $125m | 15.42% | 15.03% | 39 | $1.25m | 3.3% |
| $140m | 19.71% | 19.34% | 37 | $1.40m | 2.7% |
A fee on gross price is paid in full whether the deal made money or not. At a $110m exit it takes 4.8 per cent of the profit; at $140m, 2.7 per cent. The manager is paid most, relative to the investor's gain, on the deals that did least well.
The usual error is to compare fees on their headline rate. A 1 per cent disposition fee and a 5 per cent share of the capital gain cost the same here, $1.25m on a $25m gain, but they behave in opposite ways: the gain-based fee falls to zero on a flat exit, the gross-price fee does not. The second error is to judge the fee unlevered. A committee that hears “about 20 basis points” has been given the 0 per cent LTV row of the table for a deal financed at 60 per cent.
Negotiating point: ask for the fee on net proceeds to equity, which at the same 1 per cent rate cuts it from $1.25m to $0.65m on this deal, or for a fee payable only above return of capital, which disappears in an exit that merely gives the equity back.
Convert any fee on gross asset value into a percentage of equity and an IRR cost at the deal's actual leverage. Here, 1 per cent of the sale price is 3.125 per cent of the equity and 39 basis points of IRR. The same layered view of fees is applied to the whole four-tier spectrum in the free workbook for this case, and the entry-side equivalent is worked in what acquisition fees add to a real estate fund's cost.
Disposition fees are usually expressed as a percentage of the gross sale price, and the rate varies by manager and is negotiable. What matters is the equity effect: on the worked deal at 60 per cent LTV, a 0.5 per cent fee costs 19 basis points of IRR, 1.0 per cent costs 39 and 1.5 per cent costs 59.
Because the fee is charged on a sale price that includes the lender's share, but only the equity pays it. On a $125m sale with $60m of debt, a 1 per cent fee of $1.25m is 1.92 per cent of the $65.0m that reaches the equity and 3.125 per cent of the $40m invested.
For the investor, a fee linked to profit is better aligned. In the example, 1 per cent of a $125m price and 5 per cent of the $25m gain both equal $1.25m. On a weaker $110m exit, the gross-price fee still takes $1.10m, 4.8 per cent of the profit, while a gain-based fee would shrink with the gain.
This article is one calculation from Private Equity Real Estate. 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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