Developer Fees ‑ A Confused Developer

MO_Developer's picture
Rank: Monkey | banana points 56

I'm a little confused over how the finance community defines "developer fees" when financing a deal. I would appreciate the financing community responding.

I found an old thread on this forum from 2014 on "developer fees" could go as high as 9%, but there seemed to be a consensus that developer fees are in the 4% range, and should be tied to project completion, e.g. 25% at the financing, 50% during the construction and 25% at completion.

My firm is involved in an $30 MM historic renovation in Iowa, plus a non-historic addition that will be $15 MM, so the project will be $45 MM in total $. Now a little patience please on this next item. My firm is identifying the opportunity, developing the concept, doing the upfront architecture, arranging hotel flag and approval, getting state/city/federal approvals, doing the project management that interfaces to the city/state/community groups throughout the project, applying for all the financial credits, arranging the financing with the bank/HUD, selling the credits, signing as responsible for the project bank debt, will act as general contractor, and, at completion will own (along with bank debt) and manage the property. We're taking an abandoned historical building in an urban renewal district and breathing it back to life as market rate apartments as part of a neighborhood gentrification / revitalization effort. We take the risk of all upfront costs, and then do a developer fee payment of fees at 25% at financing, 50% during construction, and 25% at completion, and will consider deferring schemes if necessary. However, we plug in 10% - 12% for the the overall project, or 15% of renovation costs (after acquisition), as the "developer fees".

I believe my concept of a "developer" and "developer fees" is a little more extensive than normal, and would like to hear how the finance community would see this on a financing application or partnership agreement.

Many thanks. I look forward to responses.

Comments (26)

Oct 10, 2016

I have worked on a few Historic Renovation deals. Typically, our fees will range from 4-6% depending on the project size in addition to a Historic Tax Credit sourcing fee (1-2% of allocation). Throw New Markets Tax Credits in the mix for another 1-2% over allocation if the project is eligible.

Since you are handling the CM, I would charge 10% of hard costs. Not sure what you mean by "upfront architecture", if you mean renderings and conceptual plans, I wouldn't be too greedy.

As far as the disbursement of fees, your schedule seems reasonable, but I have not worked on enough of these deals to know what the market standard is for historic renovations.

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Oct 10, 2016
CRE_Erector:

I have worked on a few Historic Renovation deals. Typically, our fees will range from 4-6% depending on the project size in addition to a Historic Tax Credit sourcing fee (1-2% of allocation). Throw New Markets Tax Credits in the mix for another 1-2% over allocation if the project is eligible.

Since you are handling the CM, I would charge 10% of hard costs. Not sure what you mean by "upfront architecture", if you mean renderings and conceptual plans, I wouldn't be too greedy.

As far as the disbursement of fees, your schedule seems reasonable, but I have not worked on enough of these deals to know what the market standard is for historic renovations.

CM Fee of 10% of hard costs? That seems a bit excessive...

Best Response
Oct 10, 2016

Generally: total project costs - (working capital reserve, financing fees, legal/closing/etc., land/acquisition costs) x 4-5% = dev fee.

In the end, it's what the project can support and what a capital partner will buy off on. Institutional capital often dictates how the developer fee is calculated and when it's paid out (e.g. 20% at closing then monthly during the construction term). You have a little more leeway with private individual capital (i.e. accredited investors,) as they tend not to be as sophisticated as institutional capital.

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Oct 10, 2016

I work for a developer that does the exact same thing - if not more (excluding the architecture) - and we only do 3.5%-4% developer fees. Sounds a little fee intensive to me. Not sure how big of deals your doing but you're killing some IRR by taking a 12% development fee. I get the risk part, but welcome to the business. You're not in the equity side for a reason, you're taking on the risk as a developer - that's what we do. Maybe it's just our firm and the others in our area, but those fees just seem a little intensive. Not sure how you got a Bank, Life, CMBS, etc. to agree to that.

    • 1
Oct 10, 2016

Our developer fees are in the 3-4% range on hard+soft costs combined of the entire deal. We source, acquire, arrange finance, design, construct and lease. Institutional level and from anyone I have talked to in a similar model with similar capital partners, this is consistent.

    • 2
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Oct 11, 2016
pere797:

Our developer fees are in the 3-4% range on hard+soft costs combined of the entire deal. We source, acquire, arrange finance, design, construct and lease. Institutional level and from anyone I have talked to in a similar model with similar capital partners, this is consistent.

Yup

Oct 13, 2016

Confirmed.

We charge a 4.00% development fee of hard + managed soft costs. Not acquisition costs - if we do try to get a fee on purchase, we structure that as an acquisition fee (typically 1.0% of Purchase... if deal is something like $50m+, we scale it back).

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Oct 11, 2016

If you want to have your cake and eat it too, then I would defer the larger (15%-20%) developer fees as equity. Assuming the deal pencils with those fees, it will incent you to complete the project and thus make the lender more comfortable with the deal.

Maybe you take the fees as part of the refinance of your construction loan?

In general though, I have seen both scenarios you describe, e.g. the 4% range and the 20% range. But don't be surprised when the lender reduces the loan size when they see 20% on there...

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Oct 11, 2016

It seems that the general feedback is "developer fees" should be submitted to banks in the 3.5% to 5% range, but there are other additional fees banks have been willing to accept:
CRE-Erector says he has seen:
o Historic Tax Credit sourcing fee (1-2% of allocation).
o New Markets Tax Credits in the mix for another 1-2% over allocation.
Both are included in my project. We are also acting as the construction management on the site, so I'm thinking of breaking those out separately.

Again, my apologies for seeming dense, but this is our first major historic renovation project, but our subcontractors are experienced with dozens of historic renovations under their belt. It's the banks that consistently mystify me with ever changing hoops and new information submittals. Can you get banks to allow the recovery of upfront soft costs if you are limiting "developer fees" to the 3.5% to 5% range? We are seeing upfront costs of easily $250,000 to $300,000 before closing on the construction financing.

Oct 10, 2016

I'm not quite sure what you're asking.

Your monthly draw on the construction loan includes all project costs, which would typically include most or all of any pursuit costs (design, precon, travel, legal, civil/geo, etc.)

Assuming you have a competitive project there really is no right or wrong way to go about this; it's all a negotiation. You can fee the hell out of a project to see what you can get away with but if a capital partner thinks your being greedy they'll just push back on you or walk from the deal.

For a loan, you just need to make sure you can get a solid appraisal so rents and product offering need to be inline with market. To that end, you can't boost rents a ton to subsidize a bunch of fees.

Also, not to state the obvious but fees make the project more expensive and thereby reduce its ability to hit returns on the backend. And, unless you're shop is ridiculously risk averse, the big money in development is in sale profit (due to leverage, pref returns, etc.)

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Oct 11, 2016

I'm new on managing the finance side of projects for our company, so I need to get a feel for how finance types react to sources and uses submissions, and what their hot buttons and flags are.

While it's obvious increased fees reduce the ability to hit returns on the backend, it's also obvious that in a major development you blow through $250K to $300K plus 6 months to a year of time (and salary expenses) of upfront soft costs. As a business owner you want to recapture the upfront soft cost expenses immediately and plug those funds into the next project, optimally creating a pipeline of projects. Deferring the upfront soft costs to the end of construction or some backend payoff means you are waiting 2 years, 3 years, or longer to get a return. While the potential higher return may make sense on an individual project payout basis, the lack of cash flow can kill the business. The end result is a stuttering business engine between projects. Hence I would like to include the upfront soft costs of the project as some sort of deal finder fee or accelerated payback mechanism.

I'm trying to understand the project deal parameters of what the banks typically see and typically allow. As you point out, it's all negotiation.

Oct 12, 2016

The bank will generally count pre-development costs towards the equity required for the deal

Oct 29, 2016

Slightly off topic, but where in Iowa is the deal?

Oct 11, 2016

Sorry for the delay in my response.

We're using historic tax credits on this deal. When the deal is signed off in a few weeks with the City and State bureaucracies, I'll be happy to disclose the location.