Do management fees on undeployed capital make sense, or is that just the manager getting paid to wait

Your description of the costs is right and the number that matters is the absolute dollars, not the percentage.

Two percent on a $50M fund is $1M a year. That covers a manager, two analysts, admin, audit, insurance and travel with something left over. Two percent on a $400M fund is $8M a year and no one needs $8M to run a real estate fund. The fee is the same number in both LPAs and it means completely different things.

So I'd stop arguing about whether commitment-based fees are fair in principle and start asking what the actual budget is. Some managers will show you one. The ones raising their fourth fund generally won't.

@tender is pointing at the right thing but the deployment deadline is what actually protects you and most people skip that clause.

Look for the investment period length and what happens to the fee if capital isn't called by the end of it. In a decently negotiated LPA the fee steps down to invested capital at the end of the investment period whether or not the money went out. If it doesn't say that, the manager can extend and keep charging on the full commitment.

Ran the drag once on a fund I passed on. Four year investment period, average deployment pace meant roughly 55 percent of the fund was invested across those four years, so I was paying 2 percent on 100 percent while earning on 55. On $100k committed that's about $8,000 of fee over four years against maybe $4,400 if it were charged on invested. The $3,600 gap has to be earned back out of the returns before I'm even.

That's not fatal. It's also not nothing, and nobody in the deck presents it that way.

I've committed to four funds and the fee basis has never once been the thing that determined the outcome.

What determined the outcome was whether the manager bought well in years two and three. One fund I'm in charged on commitments the whole way and returned fine because he bought three assets in a soft window. Another charged on invested capital, felt very investor friendly on paper, and sat on dry powder for two years waiting for prices that never came, then panicked into two mediocre deals at the back of the investment period.

The second one had better fee terms and I lost money in it.

So I vote for the deployment deadline option, because that's the only one of the four that's actually about behavior. The rest is arguing over 40 basis points of drag on something whose spread of outcomes is 15 points wide.

Two clauses to read alongside the fee section, because they change what the fee number means.

First, the fee offset. Some funds charge acquisition fees, asset management fees at the property level and financing fees on top of the fund management fee. In a well-drafted LPA a percentage of those flows back to reduce the management fee. In a badly drafted one they don't, and the 2 percent you're looking at is closer to 3.4 percent all in. Search the document for "offset" and if the word doesn't appear, that tells you something.

Second, recycling. If the LPA lets the manager reinvest returned capital during the investment period, and the fee is on commitments, he can turn over $50M twice and charge you on $50M the whole time. That's usually a good deal for both sides. It's still worth knowing it's in there.

@canton is right that deployment behavior swamps fee terms in the outcome. Where I'd differ slightly is that the fee section is a readable signal about the manager. Someone who has thought carefully about offsets and step-downs has generally thought carefully about other things too.