As a developer moves into a general partnership role, it is important to understand the various fees, when and how much should be charged, and how the market operates. Fees should reflect the work done by the GP, and if leveraged properly, should benefit returns to the limited partners, not detract from them.
Chris Powers of Fort Capital (@fortworthchris) created an often referenced podcast on that topic. We took the time to transcribe it below for ease of reference for ourselves and others. Thanks to Chris for taking the time to educate on this subject. Please find the podcast linked here and the transcription below: https://open.spotify.com/episode/5qbq3Z6KfrETUoEjayFBDE
Chris Powers – GP Fess and The pathway to building a world-class REPE operating platform.
SUMMARY:
- Chris Powers discusses the importance of fees in the real estate private equity (REPE) industry and building a world-class operating platform.
- He emphasizes that charging fees and making a profit is crucial for long-term sustainability and success for the operating businesses (GP, General Partner).
- Profitability allows for hiring better talent, investing in operations and technology, and expanding resources.
- GPs should be able to charge market fees while delivering consistent high returns over time.
- Chris encourages transparency in explaining the operations and value provided beyond just the deals offered.
- Understanding what is included in the fees charged by GPs is important, as not all fees are created equal.
- GPs should find the right balance between charging appropriately and avoiding subsidizing free labor.
- The execution and operations of a GP significantly impact the outcomes of a deal.
- Fees should reflect the value provided and contribute to the success of the operation.
- It’s important to reassess fees as the company grows and additional services are added.
- Building an exceptional team requires generating revenue to pay them and attract and retain talent.
- Profitability and justifying fees based on the operation are crucial for long-term success in the REPE industry.
TRANSCRIPT:
Thank you so much for listening. I would love to hear from you, so please feel free to tweet me @fortworthchris on Twitter. You can also find this podcast on Apple Podcasts, Spotify, or whatever platform you’re using. If you’re listening on Apple Podcasts, leaving a review would mean a lot to me. You can also check out all the episodes on YouTube. Once again, thank you for joining me, and enjoy the show.
Today’s episode is brought to you by none other than Fort Capital, a privately-owned real estate investment firm committed to technology and a world-class culture. Stay up to date with all things Fort Capital by following them on LinkedIn and signing up for their quarterly newsletter on fortcapitallp.com. Subscribers of Fort Capital’s quarterly newsletter are the first to receive business and real estate news, videos, podcasts, free resources, and more.
Today, I want to discuss a word that is crucial in our industry and often misunderstood: fees. It’s a topic I am passionate about because it impacts organizations and their structures, ultimately driving success. Keep in mind that everything I discuss today has nuances, and it depends on the goals you set for yourself and your business. This is not a one-size-fits-all approach; everyone’s experiences and goals may differ. I will share insights based on our experience, having listened to numerous great companies, general partners, and operating companies in the real estate private equity space.
When it comes to fees, there is a common misconception that charging fees and making a profit in operating businesses is a bad thing. The amount you charge should cover your operating expenses and ideally lead to profitability. Profits are not a negative outcome. Just as in any other industry, operating businesses, including those in real estate, aim to be profitable. Why would you invest in a company that isn’t profitable? Profitability leads to numerous benefits and allows businesses to thrive in the long term. I’m talking about sustainability over decades, not just years. Profitability makes companies more successful and ultimately benefits the LPs.
So, when it comes to fees, a GP that charges lower fees may increase my returns. Some may argue that artificially high returns are unsustainable and not the right approach. Any GP that offers such discounts likely cannot sustain them in the long term. If they plan to grow into a larger company over time, sustainability is essential.
Over the long term for me, decades not years, and when you look at the best performing GPs irrespective of their structures, they consistently provide high returns. I would argue that over a long period of time, these GPs charge fees whether they’re higher or lower. I really respect that, irrespective of the outcome long-term. So it shouldn’t be a blip on the radar if you invest with somebody over 10, 20, or 30 years. A lot of money off the returns don’t match up. There will always be those companies, but that’s not the type of business I’m talking about today. I’m talking about companies that charge market fees and also get great returns.
I would add that it’s not for me about dancing there. There is a reason why even the top-performing companies, regardless of their fees, continue to thrive. There is a market, and there are also other benefits to investing with these businesses that might not be so black and white to someone reading a headline. For example, sidecar opportunities are situations that can give special access to investors. They provide insights, inside deals, and other advantages. You have access to and become a part of their favorable returns in the main fund. So, there are lots of reasons why these top companies, irrespective of their fees, continue to thrive. They understand the market, and I would challenge any GP that is charging high fees and not seeing high returns to consider what’s behind all that. It’s not so black and white.
Each company has different incentives, long-term goals, different investors, and they are set up differently. It’s not anyone’s right way. But for today, I’m really trying to talk about the companies that charge market fees and build wonderful organizations while still maintaining high returns over a long period of time. Not just one deal here and there, but consistently over a long period of time.
Before we dive deeper, let’s talk about the benefits of a profitable company. Today, we’re talking about real estate companies, but this applies to any company in general. When you’re profitable, the best thing you can do is hire better talent. At the end of the day, businesses are people, and the better talent you can hire and pay, the better outcomes you can achieve. When you have really smart and capable people, they can do a lot of things that ultimately should result in a positive bottom line. Profit allows you to invest in business operations, expansion, software, technology, and resources that provide better decision-making capabilities. You can invest in resources that help you travel, meet new people, and open up new opportunities. You can reinvest in processes and systems to become more efficient.
With profit, you have more money to invest in the business, which should ultimately lead to positive outcomes over a long period of time. A company that has something going right for itself over a long period of time likely has lower costs of capital. When a GP is profitable, they can go to borrow money and build a better organization. They can often borrow at lower interest rates and better terms than some other companies that are not profitable. Profitability might not show up on the bottom line based on their cost to operate. They’re often able to lower expenses as they scale and build better relationships with their vendors. As the company grows and becomes more profitable, they make better deals with vendors that operate after and touch the assets, ultimately benefiting the bottom line.
A great organization has many tools with which they can increase value and ultimately increase profit, not only at the property level but also at the operational level. Many investors are interested in the long-term success and profitability of a company. A profitable and healthy business can weather storms and be around for the long term. I believe that companies not treating profit as a priority will face challenges when there’s a storm ahead. They’re going to need resources and capital to get through, and a lack of profit will magnify that. So, if I’m investing with a GP, I want to look at their long-term track record and how they can weather the storm. A profitable business is more likely to have the resources it needs when it’s most needed.
A positive bottom line shows that the company is earning more than it’s spending, which is a good sign that the company will remain successful. This is useful information for investors looking for positive opportunities and company leadership hoping to increase overall revenue. Young companies may not show high profits as they begin their operations. But as a business develops a more focused operating model, it can begin to earn higher profits. GPs that don’t charge or reduce fees are hurting their op-co in the long run. Imagine any other company, like a t-shirt company, not charging or offering discounts on all their services or products. Running a business that way for the long term wouldn’t be profitable and wouldn’t allow for reinvestment in the company to make it better. It sounds crazy when you think about it that way. But when it comes to a GP, that’s not the case. It’s expected. Some people understand that, and I’m saying for the hundredth time that a GP that operates profitably is likely the one you want to get behind over the long term.
Again, when I say even a 5-person company will do things differently than a 30-person company, and a 30-person company might do things a little differently than a hundred-person company. I would say the differences between a 30-person company and a hundred-person company are probably a lot less different than a five-person company to a 30-person company.
Let’s talk about the operating company. Often, the general partner charges fees to the LPs for the labor that is performed. There are all different types of labor, and I charge for the services that I’m providing. It goes to the operating company, and again, the operating company should be doing things that help drive value to the LPs. So, you charge fees to your LPs to reimburse the op-co for services performed.
The real estate industry does a terrible job of – specifically operators and GPs – telling people what’s behind the fees. It’s often not all fees are created equal. When you see a deal from an operator, a lot of times, it’s all the highlights of that deal itself, but you don’t learn very much about who are the people who will be driving these outcomes. This is where GPs and operators have different things they’re doing differently than the next operator. So, when you hear things like, “It’s only a 2% asset management fee,” what does that 2% asset management fee from one operator to another look like? It could be the money being used totally differently. 2% asset management can mean different things. In one case, you might have an operator charging 2% but they’re outsourcing a lot of the day-to-day labor. In the other case, you might have an operator charging 2% but they’re internally executing a lot of the day-to-day labor. So, I try to do a better job, and I recommend all GPs do a better job, of not just telling people about the deals you’re doing, but telling people about the operations behind those deals. Because at the end of the day, it’s the operation behind the deal that is going to drive the returns. So, I challenge all GPs to do a much better job talking about your operations and what’s behind the fees you’re charging, because it’s not all apples to apples.
When someone asks us about our fees, and they might say, “Well, so-and-so charges less,” they’re doing something differently than the other. And oftentimes, it’s different, again, not different because it’s better or worse, but it’s just different. One way to get into this is GPs, especially emerging GPs, often ask me how do we know what we can charge for and what we can’t. It’s a good exercise to go through. I often tell people to write down all the things that they, as the operator, are doing for the assets, everything they’re doing, and then think, “Okay, are we charging for some of these services or are they very necessary?” If we’re not charging for them, somebody would have to be doing the work. So maybe go to the market and say, “Well, if we’re not going to do it in-house or we’re going to do it for free, but we had to outsource all this to somebody else, what would we be paying third-party providers to do this work?” And what you’ll find is that those third parties are going to charge a lot more than what you would charge, but they also don’t have the same ownership mentality that the GP does.
I want to encourage this exercise. A lot of the folks that don’t understand how they should charge for their work are doing a lot of rework. And it might be leaving higher returns to the LPs, but again, they’re subsidizing that with free labor. And over the long term, in the event that something were to happen, the GP had to let people go, they might have to outsource their services to third parties to still get the job done. This can be as nuanced as getting ready for tax returns at the end of the year. That takes a lot of time. Or are you making enough money to just support the labor on your team that’s helping to do that?
Back to the other things, like when you’re onboarding an asset to a company, all the software setup that has to happen, all the transaction work that has to happen, somebody’s doing that work, and are you getting paid for it? Marketing tends to be a big one. I talk to GPs all the time, and I’ll say, “Who pays for the ‘For Sale’ sign, the time of the ‘For Sale’ sign on your property, and the update for it?” And they say, “Well, you know, we pay for it.” But the LPs needed that to be there. Why does the LP not pay for the ‘For Sale’ sign? And now just saying, “Well, I didn’t think about it,” but at the end of the day, somebody’s paying for something. And if you’re a one-person company outsourcing literally everything, you as the GP would have to be paying someone to do that work. No one is going to do it for free. And I don’t recommend that the GP should be doing it for free. I’m also not recommending that they charge what third parties charge, which is likely much higher. They can find a healthy balance. But going through your company again and listing out everything you provide and then assigning value to whether you’re charging for that or not, it will at least give you the decision to say, “Well, maybe we should be charging.” Maybe you decide, “Now, we’re just going to keep doing this for free,” or maybe you’re going to decide, “Hey, we’re really not getting this even though we’re doing it. We should just outsource it.” And then you’re going to go get a bid for what it’s going to cost to outsource. And once you get that bid, you might think, “Well, maybe we should just hire somebody internally to do it. We can probably do it cheaper, and we’re going to have an ownership mentality.” And you kind of work backward. What you find most of the time with folks that have not figured out the proper way to set up the organization and charge for their work, they’re just doing a lot of busy work and labor that if taken to third parties would not be that way.
I’ve seen plenty of GP companies operating in the red for a long time. We were one. We were providing services, and we were paying people to do the services even though the fees weren’t there yet to cover it. We chose to do that mainly because we wanted to get to scale and be an operating company that owned 100% of the decision-making rights. When we got to some future destination, a lot of people might sell off pieces. But our intent was to hold onto as much as we could because we were doing things differently. But it was a conscious decision, and we knew at the time it set the tone for some of the things we’ll dive into. But again, having a profitable operating company that you understand why you’re profitable, you understand why you’re generating the fees you are and that you can communicate that to investors is important.
And what I would tell you as it relates to talking to LPs, five years later, it’s what happens in those five years that will ultimately determine execution, and it’s why a lot of people may pass on a deal that somebody else ends up taking, and it still works out. Just because two different groups, GP1 and GP2, bid on the same deal does not mean they will have the same outcome. It’s about the execution and how they operate, which has the largest influence on the asset’s performance. It’s the only thing that you can really control. You cannot control the market, interest rates, or external factors, but you can control your operation.
So, it’s important to pay a lot of attention to the operations. In this scenario, let’s say GP1 charges a 1% asset management fee to the deal. GP1 is probably undercharging, and GP2 may be overcharging. GP1 is delivering a superior service to the property, while GP2, although doing a great job, doesn’t have the same advantages. GP1 might have close vendor relationships and the ability to start work quickly. They might have a job that comes up, and they don’t have to wait a month to get on the schedule. They can pick up the phone and have a vendor on-site performing the job quickly. This matters when there’s a vacancy and you need to get ready for re-lease every 30 to 60 to 90 days. The longer the property sits vacant, the more returns are being lost. GP1, with their close vendor relationships, is able to provide better deals and cheaper insurance to the property because of their size.
GP1 might have a team of tenured professionals who have been in the industry for a while. They work well together, are paid well, and are accountable to the organization. They have the ability to source better terms for the property and have an investor relations team that provides exceptional service. They also have a deep understanding of the business plan and work on executing it. GP1 has sophisticated technology that increases productivity and provides real-time data to stay on top of deals, market trends, forecasting, and more. They have an in-house professional team that keeps records daily and provides timely quarterly reports. They might have a full-time marketing team that not only markets the GP but also helps market the properties to attract tenants.
GP1 probably has a finance team dedicated to building lender relationships and servicing current loans. They might have a technology team that has innovative tools to operate better and obtain better data for sourcing the next great investment. They might have a construction management team with deep relationships with vendors to ensure quality and cost control. They have better market intelligence and brokers who bring them information. All these factors contribute to GP1’s ability to provide a higher level of service and potentially achieve better returns.
So, should GP1 actually be charging 2% while GP2 charges 1%? Does that mean lower returns for the deal? Absolutely not. Over the long term, 2% is paying for an array of services that GP2 might not be providing. It’s an investment in a superior operation. While fees shouldn’t have an overall drastic impact on the deal, GPs that don’t charge enough are often short-staffed, overworked, and confused about how to improve. They may struggle to figure out how to make the next step. It’s important to find the right balance where you’re not charging third-party prices but also not subsidizing free labor.
There’s a lot of margin to find your sweet spot, and the baseline for understanding what you should be charging is dependent on the situation, the operating company, and the team. It’s important to consider what you’re currently providing and what you want to provide in the future. If you want to create the best possible team and operation, there needs to be money to pay them. Charging the right fees provides for a talented team that can drive operational excellence and create more value for the assets. It’s not logical to consider the operating company as a break-even business or to subsidize it with future performance bonuses. Profitability and fair compensation are crucial for attracting and retaining talented individuals who can deliver exceptional results.
There’s no right percentage for fees. It depends on the situation and the operating company. GP1 and GP2 may have different structures, advantages, and resources. GP1 might have invested in technology, proprietary processes, and an exceptional team, while GP2 relies on brokers and pays more of a market price. Charging 1% or 2% should be based on the value and services provided. GP1’s added acquisition cost still offers an overall net gain based on the investment, even with the 2% fee. GP1 chose to do all the work that brokers would have done, and they should be compensated for that.
In conclusion, the execution and operations of a GP have a significant impact on the outcomes of a deal. GP1, with its advantages and superior operation, may warrant a higher fee compared to GP2. It’s important to assess the value provided, understand the budget, and strike a balance between charging appropriately and not subsidizing free labor. Having a profitable and well-run operating company is crucial for long-term success in the real estate industry.
So justified by better investment and the simple fact that they did the work, GP2 maybe they should just get 1%. There are other brokers involved who are getting paid the base fee, which is probably higher because it was a marketing deal. GP1 is probably reinvesting some of that acquisition fee to improve over time and incentivize the right people. GP2 probably doesn’t have the extra dollars to do that due to their different operational setup. When talking about acquisition fees of 1% or 2%, it’s important to understand what’s behind those numbers. Often, one company is doing a lot more than the other, and it’s not okay to charge the same fees when not providing the same services.
Here are some things to consider as you grow your company. These are services that are being paid to somebody at any given time. For example, financing: GP1 might have a team focused on sourcing the best possible deals and working with lenders throughout the closing process and ongoing relationships. They have close relationships and trust formed, and their effort in sourcing is generated in-house. On the other hand, GP2 may solely rely on deals with brokers and participate in auctions without making much effort in sourcing off-market deals. In this case, they may outsource financing to a capital markets broker who charges a fee, typically ranging from half a point to 2%, to find a lender from their network.
If you’re not charging financing but are generating all the loans yourself, why are you doing it for free? You could outsource it to a team that will charge a fee. GP1 could consider charging 1% for sourcing financing, finding a balance that covers the expenses while still delivering value. It’s important to understand that in either situation, someone is getting paid for their work. If GP1 decides to spend their time on it for free, it raises the question of why. Is it because they’re scared or because they made a logical decision that it’s best for the company? LPs should understand the logic behind these decisions.
Accounting fees, sales fees, and property management fees are other examples. GP1 might have an in-house accounting team that works on property and operational accounting, prepares financials, and handles tax returns. This team is crucial to any real estate operation. Similarly, software plays a significant role in generating value for the GP. GP1 uses software purposefully to enhance operations, and that software should be accounted for in the fees. If the software improves how a property is run, it should be included in the fee structure.
All these fees matter. Drop the apples and oranges comparison; they are not the same. Fees should be tailored to match the value proposition of each company. Understanding what makes up the fees and justifying them based on the operation is important. Not all companies are equal in the services they provide and their capabilities. LPs should understand why they might be paying 1% to GP1 for asset management versus 2% to another company. Charging the right fees for your business structure is crucial for building the operation you desire.
Building an exceptional team requires money to pay them. Generating revenue and charging fees properly allows for a great operation. LPs should see positive returns over time. GP1 shouldn’t rely solely on future performance bonuses to compensate their team. The best GPs understand this and are able to explain their reasoning to LPs. If the fees are causing deals to underperform, it’s important to ensure that the fees are being used to the best of their ability to generate returns.
There is no third party that will do free work. GP1 needs to understand what they are not charging for and what others would charge for. It’s not necessary to have a list of a hundred fees, but breaking down the components of fees and understanding what each encompasses helps in finding the right fee structure. Fees should reflect the value provided and contribute to the success of the operation.
In real estate private equity, there’s a difference between fees charged to allocate capital to GPs and fees charged by GPs who actually operate the assets. Understanding this distinction is important. Each company has its own services and capabilities, and fees should be structured accordingly. It’s crucial to understand what’s making up the fees and justify them based on the operation behind them.
Fees should not be viewed as a one-time decision. As the company grows and additional services are added, it’s an opportunity to reassess fees and explain the reasoning to LPs. The goal is to build an operation that attracts and retains top talent, and that requires generating revenue to pay them. The best teams generate the best outcomes, and over time, fees aligned with operational excellence can lead to higher returns.
Property management is a different thing, so when we think of property management, it’s not the same as a refinancing or disposition fee. The structure of these fees depends on the deal. For a refinance, we have the option to outsource the refinancing process or do it internally, and how we charge for it depends on the circumstances. When it comes to disposition, even if you’re hiring brokers, there is still a lot of work involved, especially when selling large portfolios with multiple buildings and tenants. The sale process requires significant effort, including due diligence and answering questions. Should you be charging for all that time and work? I have my opinions on this.
These considerations apply to different property management scenarios. Managing a small asset with a single tenant is different from managing a value-added property with multiple tenants and ongoing work. The fees should reflect the level of complexity and effort required for each type of property management.
In terms of construction management, we may provide it in-house as the GP, and the fee structure depends on the investor’s share. Alternatively, we can outsource the construction management at a higher cost but potentially slower pace. Owners often approach things differently than third-party providers, and there may be cases where outsourcing makes sense even if you can charge for it. It’s about understanding the resources and capabilities of both options.
The question of acquisition fees and their allocation is dependent on the company’s lifecycle. For smaller teams, where the GP’s equity contribution is similar to the acquisition fee, it may be used as a working capital reinvestment. However, as the company grows larger, the acquisition fee is typically used to pay the team involved in the acquisition process. It’s not going into the owner’s pocket as a down payment. There are various team members, such as finance, acquisition, and due diligence teams, who work on acquisitions. The fee is distributed among them. Understanding the context and the utilization of the fee is important.
As we scale and hire more people, there may be changes in fee structures. When we started, we didn’t have the resources to charge for certain capabilities, so we did a lot of free labor. But as we grew, we realized the need to charge for those services to generate revenue and invest in the team and systems. It’s about creating a sustainable business model and being able to attract and retain talent. We shifted our mindset from viewing people as expenses to recognizing them as assets that generate profit for the company. This shift has made us more profitable and allowed us to pursue our dreams.
Regarding third-party management and leasing, we initially chose to outsource these services because we didn’t have the resources and knowledge. But as we reached a certain portfolio size, we realized we could bring property management in-house and create a profitable business unit. We hired a capable team in advance and launched it successfully. We still believe in outsourcing leasing in some markets because hiring the best leasing agents is more effective than doing it in-house.
Building an exceptional company and operating team should be the goal, and charging the right fees to support that is essential. This benefits investors and creates a better experience with higher returns. It’s crucial to understand the value proposition and reasons behind the fees charged.
Thank you for joining me on this journey, and I look forward to our next discussion.