Development fees - am I thinking correctly
Let’s say partner 1 fee is 2.7% for development fee and partner 2 is 0.3% for development oversight fee for a total of 3% management fees, totaling $2M on the life of the project. It looks like the $2M is now a part of the capital budget, which then runs through the cash flow while also being allocated based on the project stage (like a higher portion of the $2M gets paid upon completion). Then the monthly cash flows are funded by however the debt and equity is structured. Correct? It isn’t literally a fee paid by partner 2 to partner 1 each month in exactly 2.7% of applicable costs? I don’t see on the cash flow that the amount gets split further, just a line for development fee/oversight fees combined (the $2M in my example). I guess I’m having a hard time grasping what the term Development fee means - is it literally just a way to add more money into the overall budget?
Typically, the development fee is a project cost just like the cost of buying the land, paying the building permit fee, paying the GC's monthly application for payment, etc. You count it with the other costs that together add up to the total development cost. You pay it with the same funds (debt and equity) that you use to pay the rest of the costs. The timing and allocation of the fees is negotiated and is determined in the agreement between the developer GP and the LPs (and approved by the lender). So, in your example, yes- the total development cost would be $2M higher than it would be if there were no developer's fee.
As to the reason developer's fees are common: they're part of the way that developers make money (or, at least, pay their overhead and avoid losing money). The outside LPs and the lender, who typically fund most of the development cost, are paying the developer for their work assembling the deal and managing it through completion.
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