Deal fees look like a trade for a lower management fee. Charged on gross asset value, they are also a fee on the fund's borrowing, and the trade only breaks even on an unlevered fund.
More than they appear, because they are charged on the gross price of the property, debt included. A 1.0 per cent acquisition fee on gross cost is 2.0 per cent of the equity at 50 per cent LTV. On an illustrative 250 million fund, a 1.25 per cent management fee plus 1.0 per cent on acquisitions and 0.5 per cent on disposals costs investors 28.26 million, against 24.99 million for a flat 1.5 per cent fee: the same as a flat fee of 1.70 per cent.
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 offered on two term sheets. Figures in millions and illustrative; fee levels and bases differ widely between managers. Carry is left out so that the fee comparison is clean: it would sit on top of both structures.
| Input | Value |
|---|---|
| Commitments | 250.0 |
| Equity per deal, three deals in years 1 to 3 | 74.0 |
| LTV at purchase (gross cost 148.0 a deal) | 50% |
| Hold, gross equity multiple | 5 years, 1.70x |
| Management fee basis | commitments years 1 to 4, then invested equity |
| Term sheet A | 1.50% management fee |
| Term sheet B | 1.25% + 1.0% acquisition + 0.5% disposition |
Acquisition fee = 1.0% × 148.0 gross cost = 1.48, or 2.0% of the 74.0 of equity
Disposition fee = 0.5% × gross sale (74.0 loan + 125.80 equity proceeds = 199.8) = 0.999, or 0.79% of the equity proceeds
In equity terms: fee ÷ (1 − LTV). Excel: =AcqFee/(1-LTV)
Both fees are charged on the asset, so the borrowed half of the building pays them too. At 65 per cent LTV the same 1.0 per cent acquisition fee is 2.86 per cent of the equity.
| Line | A: 1.50% only | B: 1.25% + deal fees |
|---|---|---|
| Management fees | 24.99 | 20.83 |
| Acquisition fees | 0.00 | 4.44 |
| Disposition fees | 0.00 | 3.00 |
| Total fees | 24.99 | 28.26 |
| Fees as % of commitments | 10.0% | 11.3% |
| Net IRR before carry | 9.17% | 8.91% |
| Net multiple before carry | 1.53x | 1.51x |
Management fees in A run at 3.75 a year in the investment period, then 1.5 per cent of the equity still invested. B saves a quarter point on that base, worth 4.16 over the life, and gives back 7.44 in deal fees. Net, investors pay 3.27 more and lose 0.26 of a point of IRR on a portfolio that grosses 11.20 per cent.
Flat management fee that would cost investors the same as B: solve A's fee for B's net IRR = 1.70%
| LTV | B acquisition fees | B disposition fees | B total fees | B net IRR | A total fees | A net IRR |
|---|---|---|---|---|---|---|
| 0% | 2.22 | 1.89 | 24.93 | 9.18% | 24.99 | 9.17% |
| 50% | 4.44 | 3.00 | 28.26 | 8.91% | 24.99 | 9.17% |
| 65% | 6.34 | 3.95 | 31.12 | 8.68% | 24.99 | 9.17% |
Unlevered, the two term sheets are the same price to within 0.06. Every turn of leverage moves term sheet B away from A, because its deal fees grow with the gross asset value while A's fee is fixed by commitments and equity. A manager pitching B as a lower fee is, on a levered strategy, offering a higher one. The deal fees also pay for activity: buying more, borrowing more and selling sooner all raise B's income, which is the alignment question investors will raise in the terms meeting.
Timing pulls both ways. The acquisition fees are paid in years 1 to 3, as the deals close, while the management fee saving accrues over all eight years, and money paid earlier costs investors more in IRR terms than the same money paid later. The disposition fees work the other way: they come out of the sale proceeds in years 6 to 8. In this case the two effects nearly cancel, but on a fund that buys early and sells late they need not, which is why the flat-fee equivalent is solved on the IRR rather than on the sum of fees.
Two fixes investors commonly ask for: an offset, under which deal fees reduce the management fee, and a basis on equity rather than gross asset value. With a full offset, term sheet B costs its 1.25 per cent base fee and nothing more. The mechanics of recomputing the fee after offsets are worked in how to recompute a management fee after offsets.
Comparing fee rates rather than fee money. A term sheet that reads 1.25 per cent looks cheaper than 1.5 per cent, and the deal fees, quoted as one per cent and half a per cent, look small. Translate every term into money on the fund's own business plan, deployment and leverage, then into a flat-fee equivalent: 1.70 per cent here. That is the number a first-time manager should expect an investor's analyst to produce, so it is better presented in the deck than discovered in diligence. The fee basis itself, commitments against invested equity, is worked in management fee on committed vs invested capital.
The book takes a term sheet term by term and sets the management company budget against the fee across the fund's life; the companion model is in the free workbook for this case.
Terms vary by manager and strategy, so treat any figure as illustrative; where charged, acquisition fees are often quoted around 0.5 to 1.0 per cent of the purchase price. The key is the base: 1.0 per cent of gross asset cost is 2.0 per cent of the equity at 50 per cent LTV and 2.86 per cent at 65 per cent. Ask for it in equity terms.
It depends on leverage and deployment. In the illustrative fund an unlevered portfolio makes the two structures almost identical, 24.93 against 24.99 million. At 50 per cent LTV the deal-fee structure costs 3.27 million more and equals a flat 1.70 per cent fee; at 65 per cent it costs 31.12 million in total. Deal fees also reward buying and borrowing, which a fee on commitments does not.
Many investors ask for exactly that, so that the manager is paid once for the same work. With a full offset, the 7.44 million of acquisition and disposition fees in the illustrative fund would reduce management fees one for one, and the structure would cost no more than its base fee. Offset only the 4.44 million of acquisition fees and the 3.00 million of disposition fees still sit on top. Partial offsets fall in between; the fee schedule should show the net figure.
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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