Fees are an almost unavoidable aspect of investing in real estate funds. While excessive fees can eat into distributions and reduce return on investment—tempting investors to choose funds with low fees—it is unwise to base real estate investments solely on the basis of fund fee structures.

Most of these fees pay for services that contribute to a fund’s proceeds, including negotiating the price of assets purchased, creating marketing materials and legal documents, raising equity, managing the day-to-day operations at the property, formulating and executing a business plan, reporting to investors, selling the assets, and distributing the proceeds. Without those fees, the fund would undoubtedly suffer.

It is important to ask fund managers questions about their fees before making an investment. The level of transparency a fund has regarding fees should give investors good insight into that fund’s ethics and operating culture and should be considered before completing any transactions.

Further, it is wise to become educated on a category of compensation called the ‘promote,’ also known as ‘carried interest.’ The promote is a form of compensation paid to the sponsor out of the fund’s cash flow—after commitments to lenders have been satisfied—for the purpose of motivating and incentivizing the sponsor to do their best to ensure a successful, profitable project. The higher the promote, the lower each investor’s share of the profits tends to be.

Sometimes the level of promote is based on the sponsor’s responsibilities to the fund. For example, the promote would be higher if the sponsor renovates the asset and manages property operations and resident relationships, in addition to managing the deal.

Seasoned sponsors may provide for tiers of promote called ‘breakpoints’ that offer investors greater preferred returns for higher levels of investment—a strategy commonly used when a fund is in the capital-raising mode—or when higher internal rates of return (IRRs) are reached.

For example, our Fund II offers breakpoints in order to reward investors who showed a greater commitment, while at the same time not making it too punitive to our smaller investors, who are the backbone of our community.

Another aspect to the promote that investors should be aware of is the ‘double promote,’ whereby the sponsor’s fund invests into a deal but is not the sole investor. In this case, investors in the fund would be paying the sponsor a promote at the fund level and paying a promote at the deal level.

Trion does not double promote. While our fund managers do co-invest in individual deals, we rebate our firm’s upside at the deal level back to the fund, and we don’t take our promote on that deal on the fund’s investment. The result is that we only get an upside when fund metrics are achieved, not on any specific investment in which the fund is invested. Investors should look carefully for the double promote when investing in funds that themselves invest in different projects.

Required fees and profit participation structures are just one aspect to real estate investment, but they should be taken into consideration as part of investors’ overall vetting process for funds. It makes sense to understand how compensation is assessed, where it goes, and what the payoff is before committing to any real estate investment fund.

Related: What is Fund II?