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In a crowdfunded real estate deal, there are three main parties involved. Obviously, there are the investors who provide the capital to fund the deal. There’s also the crowdfunding platform that advertises crowdfunding investment opportunities, verifies the accreditation status of investors, and makes sure regulatory requirements are satisfied.
Third, there is the deal’s sponsor. This is the individual or company that actively participates in the real estate project. For example, they will find and evaluate the opportunity, hire contractors, supervise the project, hire a manager to lease space to tenants, and eventually oversee the sale of the property. And that’s just to name a few of the sponsor’s activities. A deal’s sponsor will also generally contribute some of the project’s required capital.
With that in mind, it shouldn’t come as a surprise that sponsors don’t do all of this for free. So, here’s a rundown of how sponsors get paid.
How a deal sponsor gets paid
As in any business partnership that involves an active investor and several passive investors, the active investor receives (and deserves) compensation for their efforts.
There are two main ways a crowdfunded real estate deal’s sponsor gets paid -- acquisition fees, and a compensation method known as sponsor return. Let’s look at each of these individually.
The first, and easier of the two compensation methods to understand, is the acquisition fee. This is a one-time fee that is paid to a deal’s sponsor upon the successful closing of the purchase of the property involved in the deal. For example, if a crowdfunded real estate investment’s objective was to purchase and renovate an office building, the sponsor would get their acquisition fee once the purchase of the building closes.
In most cases, the acquisition fee is expressed as a percentage of the purchase price, and fees in the 1%-2% range are common. So, if a sponsor acquires an office building for $5 million and gets a 1% acquisition fee, they would be entitled to a one-time $50,000 payment upon the purchase of the property.
Sponsor return: How sponsors really want to make their money
The second way a sponsor gets paid is known as sponsor return. This is the more complicated of the two, and is how deal sponsors can end up making the vast majority of their money if the project turns out to be successful.
Here’s how sponsor return typically works. In most cases, the first 6%-10% of a deal’s annualized returns go to the investors -- the sponsor doesn’t get any of it. This baseline percentage is known as the preferred return. Above that percentage, however, the sponsor gets a certain percentage of the returns, say 25%. This type of compensation structure ensures that the sponsor’s interests are aligned with those of the investor.
It’s also common to see a multitiered sponsor return, which further incentivizes sponsors to generate as much return as possible for investors. Hypothetically, you might, for example, see a sponsor return structure that looks like this:
- A 7% preferred return for investors. This means that the first 7% of annualized returns from the deal would go straight to the investors who funded the project -- the sponsor won’t get a dime unless the returns are greater than this threshold.
- From 7%-12% annualized returns, 80% of the profits go to investors, and the sponsor gets 20%.
- From 12%-18% annualized returns, 70% of the profits go to investors and the sponsor’s return jumps to 30%.
- Above 18% annualized returns, the sponsor’s return jumps to 40%, with 60% going to investors.
As you can see, this type of structure ensures that the more a sponsor gets paid, the more the investors get paid. If a crowdfunded investment is highly successful, a sponsor’s portion of the project’s return can easily climb into the millions of dollars.
On a similar note, you might see two target return figures listed. The project or deal’s return is the overall rate of return that’s expected, before the sponsor’s cut is deducted. The investor return is the targeted internal rate of return that investors will see, inclusive of the sponsor’s expected compensation.
Investor return: A third way sponsors make money
Although it’s technically not a form of sponsor compensation, there is a third way sponsors get paid from a successful investment. As I mentioned, the sponsor will typically contribute some of the capital required to fund the deal -- this shows investors that the sponsor has some of their own money at risk, and is even more incentivized to deliver strong returns.
This means that the sponsor also gets a proportion of the investment’s income and eventual sale profits as an investor. For example, if a sponsor contributed 10% of a project’s equity capital, they would be paid just like every other investor. If a deal’s profit was $3 million, they would be entitled to $300,000 of the profits on their investment, in addition to the sponsor return on the rest of it, according to the deal’s specific terms.
Unfair Advantages: How Real Estate Became a Billionaire Factory
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