As a limited partner, you get a lot of advantages: no hassles from the three Ts (tenants, toilets, termites), no handling of non-paying tenants (managing evictions), and just the upside of the cash flow and gains on disposition or refinancing.
So what do the syndicators get?
Answer: All that and then some. It is a good gig, to be a syndicator. You participate as a limited partner typically and then also participate as a general partner. In the general partnership, the upside can be much, much greater than it is for the limited partner.
It's important for limited partners to understand the many ways that the general partners can be compensated. There are more ways that those we will highlight here but these will give the basics for most syndicated deals:
- Split of the proceeds: The biggest upside is the general partners' split of the proceeds, often 20% to 30% (sometimes more; see below). It has many names: "promote reward" is one. It is like "carried interest" or "carry" in the private equity world--ostensibly from the 16th century when a ship's captain would receive 20% of the returns on sales of goods in return for "carrying" them to their destination.
- Acquisition fees: often 1% - 2.5% of the purchase price is paid to the general partners for locating and putting together the deal. There's a lot of work that goes into finding the deal, locking it up, doing the diligence, raising the money (from you the limited partner on the equity side and then from banks or others for the debt), and so forth. Note that this acquisition fee is different from a real estate broker's fee (often 2% - 4%). While a syndicator might also be a real estate broker and charge this fee, that would be unusual--and, by some, quite frowned upon.
- Management fees: often 1% - 2% of the annual gross asset revenue is paid to the syndicator for asset management--including bookkeeping, communication, and coordination of the many players involved in managing properties. There is often a fee paid to the general partners for managing the real property or fund. Note that asset management fees are distinct from property management fees, which are possibly paid to the syndicator but more likely passed on to a separate property manager or property management firm. These fees might be 3% - 6% of the annual gross property revenues. Note also that these fees are typically paid whether or not the property is making you (as the limited partner) any money. If things are going really badly at a property--in other words, the syndicator is not doing a good job of asset management--sometimes they will stop charging these fees for a while (or at least they should stop charging them).
- Disposition fees: there is often a fee paid to the general partners upon sale. The general partners will get paid alongside you based on the upside, so we as limited partners don't always love this fee--but it's often in there to compensate for the heavy paperwork load of selling the asset and managing the wind-down and transition to a new owner. Another 1% to 2% would be customary.
There are other fees you might see depending on the type of deal (and/or the creativity of the syndicator!): construction fee, development fee, marketing fee, financing fee, guarantor fee, and more. Read the Private Placement Memorandum (PPM) closely to understand what you are paying--and ask hard questions.
We pay attention to all these fees and to the levels of the fees when we are assessing a deal or fund. They can all matter--they certainly do add up.
To us, the basic fees are typically well-earned by the syndicator in a deal that goes well, so we don't sweat the 1% or 2% for these core functions.
We do pay a lot of attention to the overall split of the proceeds. There is a huge range in this aspect of deals. The best deals we've seen in recent years for limited partners typically have a straight 80/20 split of the proceeds. These are pretty rare recently. More offerings seem to be in the ballpark of a 70/30 split. We are OK with these splits if we really like the deal.
But do compare this to other fees paid for investments: even venture capitalists, hedge funds, and private equity funds have historically charged the famous "2 and 20," meaning a 2% management fee and 20% of the upside. So when a syndicator is charging you 30% or more, they are getting a HIGHER fee than a hedge fund manager or venture capitalist potentially. (And compare that to the fees on an index fund for an extreme: as low as 0% or 0.05%.) You may be aware that some hedge funds dropped to 1 and 15, and so forth. So syndicators are definitely not offering an inexpensive "deal" when they get these multiple fees plus 30% or more of the upside.
Lots of deals give the syndicator MORE than 30% of the upside, too, if they reach certain hurdles. In deals that have so-called "waterfalls," it can be the case that the percentage of profits increases substantially above the initial split between the limited partners and the general partners. That's very common and pretty complicated--so it will get its own post. The basic idea: after reaching a preferred return of, say, 7% or 8% to the limited partners, the 70/30% split may kick in. After a certain internal rate of return is reached--say, 12% to 15%--then the general partner might claim a higher percentage of the next profits, say a 60/40 split or even 50/50.
We recently received a proposal from a syndicator we favor for a syndicated multifamily real estate fund. The fee structure included a 65/35 split. We said "no thank you." I am sure others did too. While the syndicator explained that with waterfalls, limited partners often get 65% or less of the proceeds and they simply were going for "transparency," we thought this split was a bridge too far in terms of paying for their services on top of all the other fees involved. That's the market at work: you can make your own call, deal by deal and fund by fund.
Do you wonder why so many people are becoming syndicators? The ways to get paid are many. It's hard work, requires a lot of different skills, AND it can be very lucrative.
As limited partners, it's your job to decide how much to accept in fees and splits of the proceeds. Comparing notes with one another, reading PPMs and other materials with great care, asking hard questions--all these approaches and more are essential to good syndication investing.