Real estate's fastest growing forum

A related party management fee understated by half in a QOF's operating budget deserves real scrutiny

Consider a passive investor with roughly $95k to place, evaluating a QOF offering on a 34-unit 1920s walkup gut rehab from a sponsor with a decent construction record. The operating budget is where the story tends to break. Property management at 4 percent of collections on a 34-unit walkup in a condition class with above-average tenant turnover is not a realistic number. Market management on that profile typically runs closer to 8 percent, and at 8 percent the deal loses money in year one under the sponsor's own numbers. When that fee also flows to an affiliate of the sponsor, it's a related party line, and understating it by roughly half deserves real scrutiny. On $340k in year one collections, the difference between 4 and 8 percent is about $14k a year of NOI counted that isn't there, which at a 6 cap is a quarter million dollars of value baked into the exit assumption. With a projected sale nine years out at a 5.75 percent exit cap, the compounding effect of that error is worse than the annual number suggests. Whether the discrepancy is sloppiness or a deliberate marketing subsidy from the affiliate matters less than getting a straight answer before committing capital. An answer like efficiencies at scale, from an affiliate managing only a couple hundred units total, is not a number, and it's reasonable to hold a sponsor to producing a real comparable management quote before funding closes.

2 replies

laurenkim53 PF4APRO 14

In small rural markets, 4% often doesn't exist at all, the floor is a per-unit minimum that works out to 9 or 10% on low rents. So this read matches what tends to hold true broadly. But there are two separate questions here. One is whether the pro forma is wrong, and it clearly is. The other is whether the sponsor knows it's wrong. Ask them what the affiliate's actual charged rate is on the other 200 units they manage, with a statement to prove it. If they're charging 7% elsewhere and modeling 4% here, that's an answer. If they genuinely charge 4% across the portfolio and the portfolio is losing money on management, that says something else about them.

laurenkim53 PF4APRO 14

nicole_adeyemi SS3APRO 13

One line item catching attention is exactly the one to walk over, because it happens to be the line an outside reviewer knows cold. Every other line in that budget has the same chance of being off, and those are harder to see from outside. That's the real information here. And on a nine year hold with a 5.75% exit cap on a 1920s walkup in a designated tract, it's worth knowing what the sponsor thinks the roof and the boiler cost in year seven, since the sale assumes a buyer who has looked at those. Ask for the capital reserve per unit per year. If it's under $300 on that vintage, the exit number is decoration.

nicole_adeyemi SS3APRO 13

A related party management fee understated by half in a QOF's operating budget deserves real scrutiny

2 replies