Developer Fees ‑ A Confused Developer

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MO_Developer - Certified Professional
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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.

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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.

    • 1
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...

    • 1
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 11, 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 12, 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

I've never argued against a development fee of deferring pursuit costs to the backend. The purpose of the dev fee is to cover the overhead that's involved in pulling the deal together + some margin. All I'm saying is I've seen many deals fall apart or never happen because investors/owners felt like they were being feed to death. Be open, be reasonable, and you shouldn't have a problem.

For reference, we usually start our dev fees in the neighborhood of the calc I mentioned above. But, in the event construction costs or other items come in over budget and we don't want to VE the shit out of something, it's also one of the first things we look at trimming back. If we don't achieve the fee we want at the start of the project, we try to negotiate a clawback on project savings (usually due to a good buyout or fast leaseup,) in the DSA that makes us full on our original dev fee calc.

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Oct 16, 2016

Coolhandlucus: "All I'm saying is I've seen many deals fall apart or never happen because investors/owners felt like they were being feed to death. Be open, be reasonable, and you shouldn't have a problem".

Very true. We walked away from two banks because of the "fees of death" made the project "feed to death".

Oct 13, 2016

You don't have to recover your expended capital through development fees, just include all of your costs related to your project in your development budget. If you spent $300k prior to going to the bank or investors, that $300k should definitely be in the total costs which will get lent against and they'll probably let you count it 100% as equity.

For this deal, I see no problem with 3-4% development fee, a small tax credit fee, a financing fee, possibly a small guarantee fee and a modest CM fee - don't know your market but maybe 5-7%? All of the other things that you mentioned you do upfront are all part of being a developer and the 3-4% fee should cover the overhead to carry out those tasks. You don't want too many fees as others have said. Also, if there are no investors, just the developer/owner, banks may balk at the fees besides developer fee & CM fee.

    • 4
Oct 13, 2016

If you are the GP in the JV you will owe savings pari passu to the JV. The alternative is the clawback on dev fee first then any savings above and beyond pari passu to the JV. As the GP you will miss out on substantial savings if you opt for the first strategy.

To each their own.

Less important if you hare the 100% owner.

    • 1
Oct 13, 2016

Savings? In a development? Ha just kidding, but do you mind elaborating? Never thought of how savings on the project are affected.

Oct 13, 2016

Seriously!

Example: If you are the GP (10%) in a 90/10 JV usually savings are shared at the project level. So, every $ of savings generated is split 90/10 LP/GP. When negotiating a DSA with an LP, you can try to carve out clawbacks on certain budget items so 100% of the savings goes to the GP vs. 90/10 to the JV. Things like the development fee (especially if a developer has had to cut it to hit a ROC benchmark for the LP) and construction allowances are fair game. That way, if you have a fast lease up or a good project buyout, the savings are funneled 100% to the GP first until it's able to recover a'market' developer fee and then to the JV 90/10.

    • 3
Oct 13, 2016

Great stuff, thanks!

Mar 3, 2018

Overspending can actually make a deal worth more to the partnership because tax credits are ultimately based on the eligible basis of the project. If you go over budget on some hard costs via soft cost savings, you could easily increase your basis above and beyond the allocated amount. If you have a 9% deal this doesn't matter because you're locked in. But if you have a 4% deal you can pay an upward basis adjuster and get more credits from the agency. So the ILP benefits from more credits and the GP benefits from getting a slice of a larger pie, because the size of the pie is dictated by the (higher) eligible basis. Savvy developers often take advantage of this and plan on burning through their whole contingency.

    • 1
Oct 13, 2016
coolhandlucas:

When negotiating a DSA with an LP, you can try to carve out clawbacks on certain budget items so 100% of the savings goes to the GP vs. 90/10 to the JV. Things like the development fee (especially if a developer has had to cut it to hit a ROC benchmark for the LP) and construction allowances are fair game.

This is all gravy when you are under budget.; the opposite could very well happen and the developer could be 100% responsible for cost overruns (obviously dependent on the intention of the JV / how the agreement is worded..).

If I were the Capital Provider / 90% LP Investor, I wouldn't want all savings going to the developer when under budget, but all overruns shared pari-passu when over budget...

    • 2
Oct 16, 2016

In this case my firm is the only owner, outside the bank loans. We feast on the budget savings (or reduce our eventual bank debt) or starve on the budget overruns (take out larger loans).

There is, of course, the clawbacks these days from energy savings with the utilities that can become substantial if the project can pencil out to hit green construction targets.

Oct 16, 2016

My firm has been burned multiple times legally by partnerships.
We are going to run this project by ourselves. Other than the mortgage at the bank,
we will own the entire project, and own / manage the completed building.

Oct 16, 2016

RE Dev / All:
Interesting. You're saying just put the $300K into the financing as valid expenses.
Just be honest with it.

I can tell you from my previous experiences that the about 1/2 the banks push back on almost any expense before closing, either dismissing it as sunk costs or telling us to take it in equity, which defers it out 2 to 3 years. This is an especially frustrating experience when the lending officer then asks you "what is your skin in the game"? Again, creating a whole in the cash flow of the business. Then each project get hit with the multiple bank fees that have to be paid up front and cannot similarly be deferred.

It is what it is. It's a matter of negotiation. It's a matter of finding a bank partnership. ;>)

Oct 12, 2016

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

Oct 29, 2016
Nov 13, 2016