Select the right measure for you performance fee – or you will risk losing a lot of money!
Many real estate funds do not only have a fixed management fee but also a performance fee. A performance fee for how the fund is doing: the better the return, the higher the fee for the manager.
Logically and what many RE managers not realize is that you are the way you calculate the performance fee – e,g, the way you calculate returns – can vary a lot, The results may therefore be totally different. For example, when you take time-weighted returns as a basis instead of money-weighted you can get very different outcomes and get a very different fee structure.
I am curious to what extent you have thought about this when setting up the funds that you are currently working with. Has that been a conscious decision? Have you also calculated differences in performance fee outcomes with different measures? Or have you taken the company default without thinking about it further?
And I am also curious what you think about its ethics, Do you think it is ethical to think about this?
Just leave a message and I see you again in the next video!
What is the better: time weighted or money weighted returns?
You probably heard of timeweighted and moneyweighted returns. This is a way of measuring the performance of your portfolio.
Timeweighted is used a lot in external benchmarks line INREV and MSCI. It is valuing every quarter equally, regardless of the assets under management in each quarter. It is therefore a good measurement when you are not responsible for acquisitions.
Moneyweighted is the standard in most of the investment proposals or underwriting models. The money that you invest in a quarter matters. It is therefore a good measurement when you are responsible for acquisitions.
Let’s take an example. Let’s say we are starting a new fund. In the first year we buy assets for 100 million. We have a lot of vacancy and startup costs for the new fund. In that first year we have to accept a loss of 5%.
In year two we buy new assets for another 100 million. We get a net rent of 5%.
Now let’s check the results. We see that the money weighted return is 17 times the time weighted return.
Wow, what a big difference! Why? Because the assets under management is not equal in each period. The loss in the first year has more weight in the time weighted return.
So when you are in the startup phase of a fund, the time weighted return will always be lower than then the money weighted return. And that is good to know and understand!
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How to tune your Investment Proposal?
I was standing in the Skylounche of DoubleTree, Hilton in Amsterdam. This building has been sold twice over the last 2 years. And I was thinking to myself; why shouldn’t I buy it?
When working out the Investment Proposal (IP), I noticed the main financial measurement in the IP is the Internal Rate of Return (IRR). So I started thinking: what is exactly this IRR and how can I tune it?
When I zoom in the IRR, I realized that the timing of cashflows is crucial. For example my rental income: the moment it hits my bank account matters big time.
In the negotiations with Hilton, I can steer having a Monthly or a Quarterly rent. I know that, since timing is important, the monthly rent will give me a higher IRR. So in the negotiations, I can give them a discount on the rent, asking back a monthly rent, and still end up with a higher IRR.
Receiving my money earlier means a higher return. And the IRR is how you measure that timing effect precisely.