Asset management fee to the operator during the hold, or make him wait for the promote

I'm still learning this vocabulary so tell me if I've got it wrong. The promote is the extra share of profit he gets above what his 5% contribution would earn, correct? And the fee is separate from that and doesn't reduce it at all? If so the fee looks like the operator gets paid twice for the same work and I don't understand why anyone signs it.

@vellum you have the definitions right but the conclusion doesn't follow. The promote pays for outcome, the fee pays for labor, and they're compensating different things. A property doesn't manage itself for three years on the strength of a future payday.

The question that matters is where in the payment order the fee sits, @cobalt. "Paid monthly out of operations" can mean above the debt service, above your pref, or below both. Same 1.5% number, completely different risk. I'd ask for the fee to sit behind your preferred return, so if the deal isn't hitting, his fee accrues instead of paying. That's the version I'd sign.

1.5% of what, exactly. I've read agreements where the fee is on invested equity, on total capitalization, on gross revenue, and one where it was on "total project costs including reserves," which grew every time he called capital. Nobody ever decided it should grow, it just did.

@cobalt, on invested equity at $600k the fee has a ceiling you can see. On total capitalization with $1.4m of debt behind it, 1.5% is $30k a year and the same sentence looks identical at a glance. Pin the base. Then pin whether it's paid on contributed capital or committed capital, because on a deal that draws over 18 months those are different for most of the hold.

Modeled both ways this morning out of curiosity. On a five year hold, $9k a year of fee is $45k. If you instead give him five points more promote above an 8% pref and the deal exits at a 17% IRR, he ends up ahead of the fee version. If it exits at 9% he ends up well behind it.

So the no-fee-bigger-promote trade is you paying more in the good case to pay nothing in the bad case. That's insurance and it's priced like insurance. Whether it's worth it depends on how wide you think the outcome range is on this specific deal. On a stabilized building with a fixed rate loan I'd take the fee version and keep the promote tight. On a heavy reposition I'd want him hungry.

@sextant that's the clearest framing in the thread. Nobody told me the fee question was an insurance question but that's exactly what it is.

The thing I've learned checking a lot of these is that the asset management fee is rarely the fee that hurts. It's the acquisition fee, the disposition fee, the refinance fee, the construction management fee on top of the general contractor's own overhead, and the affiliated property management agreement at slightly over market. Add those and 1.5% annually is the small line.

@cobalt, ask him for a single page listing every dollar that will ever go to him or any entity he owns, over the whole life of the deal. Not the operating agreement, a plain list. How he reacts to that request is itself information.

@canton's one page list request is going straight into my notes for the syndication I've been looking at, even though I'm nowhere near a JV myself. I hadn't thought to just ask for it in that form.

The payroll argument is real, @cobalt, and I've seen it across five years of running a service business. An operator with zero current income does take side work, and then your building gets the leftover hours. I've watched it happen from the vendor side, you can tell which owners are distracted because nobody answers the phone until something floods.

But $750 a month isn't payroll, it's a partial offset. If his overhead genuinely requires $9k a year from this deal to function, he's undercapitalized as a business and this deal is subsidizing that. I'd ask how many deals he needs running at once for his company to break even. If the answer is four and he has two, you're funding the gap.

@thatch that break-even question is better than anything in the operating agreement. I'm building a service business and if a capital partner asked me that I'd have to answer honestly and it would be revealing.

I'll take the unpopular side since I'm the operator in this picture on my own deals. I hit the ceiling last year exactly because I had no current income from the assets I was running and I ended up taking on brokerage work to eat. My existing partners got worse attention that year and I couldn't tell them why without admitting the fee I'd waived was the reason.

A fee that accrues and pays when cash flow allows, which is @warrant's version, is the one I'd have taken and it would have solved it. Zero fee sounds like alignment and it produces a distracted operator. @cobalt, the fee isn't the thing to fight over. Fight over the affiliate management agreement and the promote hurdle.

Voting for subordinate to the pref. @keystone's post is the reason I won't vote for zero fee, and @fathom's is the reason I'd never sign the fee without nailing the base it's calculated on.