I spent most of my college career thinking that you truly had to produce superior risk adjusted returns in order to make money as a developer or REPE guy. Now I’m starting to realize that’s only one part of the equation. For every Jonathan Gray there’s 100 guys buying up dollar stores in Central N.J. at a 7% cap rate and raising preferred equity at 5% or over leveraging the shit out a luxury condo deal with no GP commitment (bull market continues and they get rich and in a bear market they lose none of their own money). Other than IRR, WACC is probably the most important investment metric out there from the GP’s perspective.
I’m curious to know what are some of the more egregious LP terms you guys have seen? I’ll start with a couple examples:
1) 6% preferred return with a 50% promote before ROC and no mechanism to force a sale.
2) A 14% preferred return and a 100% promote on a highly leveraged luxury condo deal with no GP commitment. It was essentially a call option for the developer.
Fees, it's the fees. Those pay regardless of deal performance in many instances. Here are some common ones:
Acquisition Fees - % of deal price just for doing deal Asset Mngt Fees - % of AUM for managing year to year Debt Placement Fees - % of debt placed on deal (in addition to 3rd party fees) Prop Management Fees - Not for doing PM, but like hiring the PM, not joking (this is isnt that common) Exit Fees - % of sale price on dispo (not related to promotes or co-invest)
These fees tend to rake off the top, before prefs, co-invests, and promotes. This is where the crazy stuff happens. To note, sophisticated institutional investors will not tolerate much of this, but syndications with smaller investors see these often. Add to it that some sponsors also provide third party services (like brokerage, PM, etc.) to the deal. It's like double or triple dipping!
This. For smaller developers, a lot of them are just raising through a bunch of local wealthy individuals, $50k-$100k here, $50-$100k there, the occasional $1-2M, who want to diversify their portfolio to have some money in real estate and aren't seeking huge outsized returns (or aren't sophisticated enough to know any better). This allows them to sneak in extremely favorable terms in terms of capital commitment, promote, and fees.
But yeah, if we're talking about GPs using institutional money, you'll see a lot less of that. Asset management fees and project management fees are still very typical, as well as property management if that is part of the GPs vertical, but acquisition, debt placement and exit fees are much less common.
My company does this, although we don't gouge our LPs with fees. The big advantage of this approach is that none of the LPs have enough invested to get major decision rights, so the GP controls every aspect of the deal.
It is more work to raise the money initially, but after you've done it once or twice you can go back to the well easily. We just raised a new fund, and it was as simple as sending out a prospectus and getting checks in the mail a few weeks later.
This^
I took a look at taking over a distressed fund (GP was siphoning funds after things went south a real mess). The fees were just as criminal, 2.50% AM, 3% acq fee in and a 3% disposition fee out on gross sale price (regardless of under-performance). Even with lackluster performance dilution was 450+ bps.
And this was a $300M+ of equity fund, so much for economies of scale
To be fair, fees are how you keep the lights on.
Years ago I was thinking of doing a deal on my own and a guy who is now pretty well known in NYC, but at the time had just gotten started, told me that I shouldn't succumb to pressure to pay myself out of a promote. Fees are there to make sure you have the physical and mental tools to do the job (e.g. paying rent, eating) and the promote is to incentivize you to do a good job.
Didn't end up doing that deal but advice that stuck with me nonetheless. Any CRE shop that is using equity to keep the lights on should pack up shop and call it a day. That business is a failure. I agree that there are places that over-fee deals, but fees in general are not a bad thing. I think I do a pretty good job in my role, and my salary gets paid through the fees the firm brings in - if my principals didn't take fees, they wouldn't be able to hire folks to help them execute projects on-schedule/budget.
EDIT: Sorry, this was meant to be a reply to emceedrive, not sure how I missed the right post to quote! I will repost in the right spot
Definitely agree with this x1000.
So many shops have to do deals to keep the lights on, because they don't have any actual money to invest. They need to keep cobbling up partners who they can bilk with fees, because thats how they're actually making money.
To be fair, fees are how you keep the lights on. Bilk is a strong term
Years ago I was thinking of doing a deal on my own and a guy who is now pretty well known in NYC, but at the time had just gotten started, told me that I shouldn't succumb to pressure to pay myself out of a promote. Fees are there to make sure you have the physical and mental tools to do the job (e.g. paying rent, eating) and the promote is to incentivize you to do a good job.
Didn't end up doing that deal but advice that stuck with me nonetheless. Any CRE shop that is using equity to keep the lights on should pack up shop and call it a day. That business is a failure. I agree that there are places that over-fee deals, but fees in general are not a bad thing. I think I do a pretty good job in my role, and my salary gets paid through the fees the firm brings in - if my principals didn't take fees, they wouldn't be able to hire folks to help them execute projects on-schedule/budget.
Not sure who I need to talk to. Been trying to raise as a GP. We put up 20% of the equity at the very least, no promote for ourselves but straight pari passu, we pay ourselves a 4% fee (3% prop management, 1% asset management) annually. Have had some difficulty raising funds. Even had one LP saying our fees were high lol. Literally taking a fee just to manage, no acquisition fee either. Yet I see all these GPs getting the best terms for themselves. Literally trying to do this at Walmart prices with difficulty.
I think part of the issue for a lot of people is that getting HNW LPs to sign on for dog shit terms has more to do with your ability as a salesperson than your ability to actually create positive risk adjusted returns. A top performer in a boiler room type operation is better suited for this job than a former Blackstone analyst.
That being said, you can always hire people like that or pay fees to people for lining up capital.
Have you seen this model used? How exactly does it work, and what are the fees like?
I have development execution experience but no personal experience raising capital and not much of a HNW network. A friend of mind has no development experience, but wants to work with me in the future. He works in the nonprofit world and has amazing fundraising skills and a HNW network, so I could see something like this working out.
Eh, I don't know about this. HNW LPs are generally investing in deals that are brought to them by friends/family. Or colleagues, whatever. In some ways, and I agree it's not "rational," this is a risk adjustment in and of itself, because your trusting in the personal relationship to keep the GP honest.
My experience in witnessing this has been that someone who has $1mm to casually invest (as in, losing it will not be a meaningful impact to their lifestyle) is just as interested in doing a friend a favor as in maximizing their returns. Again, rational? Perhaps not. But it's a very relatable instinct. Moreover, think about the way in which most HNW/UHNW people invest their money - they're probably paying a couple points right off the top to various advisors, placement agents, etc... so at the end of the day, cutting out that middleman means that your typical "country club" deal is marginally more attractive in an all-in sense than it might be on it's face
You might be short of the sweet spot. Until you get to a certain check-size, you need to show returns to get retail investors psyched.
After a certain point, you don't need to show crazy returns so much as you show the opportunity to put out a large enough check size so someone can move some dry powder - so here a GP can make money even without crazy fees because they're doing it at a large enough scale.
The sweet spot is where you can really bilk - you're dealing with the guys who are one step above retail investors but perceive themselves as the true institutional players. Generally speaking, guys who think too much of themselves are good profit centers for everyone else. Sad but true...
That's hilarious that your LP said that's high. A lot of quality GPs are charging 3% AM, 3% PM..
Hell, even offered to increase our piece to 30-40% of total equity, but not budging. Just trying to do these deals for cheap on our end to build the relationship, but its a bit tough if you dont have an established network.
You ever think this is an issue of chunk dollars, rather than a percentage. Nobody balks at the bigger deals cause 5% of a billion dollar allocation is 50 million, that's a real return.
Cardone Capital's non-accredited fund is easily the dumbest offering I have ever seen.
It's a 65%/35% promote out the gate w/ Cardone Capital contributing $0 of capital. That's on top of charging 1% in & 1% out + a 1% annual asset mgmt fee. The only saving grace is that at the time of a capital event prior distributions from operations is not considered to be RoC, but that provision just saves it from being absolute dog shit.
IMO the way his fund is marketed is immoral at best, and could possibly even be considered fraudulent. His website promotes a 6% preferred return for accredited investors but 6% "cashflow" to the non-accredited. Those not familiar with REPE probably think they're getting the same deal as the accredited investors, but in reality they're literally giving Cardone a free loan & paying him 35% of their profit interest to take their money. I do not like that guy.
Terrible person. All he is doing is marketing himself. He's probably not doing anything illegal, but I find it immoral. He had outbid us on a few deals by a huge margin. Buying 4 caps in places that dont deserve that valuation. We always use to think that brokers were lying once they told us it was under contract at an X amount. It turns out it was the truth and Cardone did it. He is the laughing stock of the industry, but he's still worth more than me, so I guess I can't say much.
I can't imagine what a B&F call with him actually sounds like... Sellers must scratch their heads.
He recently posted a video titled" Commercial Real Estate Debt Update" which was his attempt to break down Freddie's forbearance program. It's like watching a fish attempting to walk.
If capital event cash flow doesn’t count towards ROC, how does a sale work?
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