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How Do You Compensate Your Third-Party Developer?

December 9, 2019

We are often asked how third-party developers (“Managers”) should be compensated and what the various options are.  The developed lot fee structure is the most common, but it isn’t appropriate for more complicated transactions. 

Here are some structures that we’ve seen over the years.

A. Developed Lot Fee.

A developed lot price (e.g. $2,500 per developed lot or a certain percentage of the base lot price) is paid to the Manager. The fee is often paid at set intervals such as: $500 paid at plan application; $500 paid after mass grading; $500 paid after pipe installation; $500 paid after paving is completed; and the final $500 paid at substantial completion of the lot development work. Sometimes the Manager receives a bonus if substantial completion has occurred by a certain date

B. Mixed Use Structure – Revenue Based

  • A percentage of the gross sales revenue of the project, based upon the projected gross sales revenue, to be paid in equal monthly installments over the period of horizontal development of the project. True-up at certain points to reflect actual revenue received.
  • A percentage of the gross sales revenue of the project, based upon the projected gross sales revenue, to be paid in equal monthly installments over the period of vertical development of the project. True-up at certain points to reflect actual revenue received; and/or
  • A percentage of the gross sales revenue from each home sold at the Project, payable upon the close of escrow of each home, provided this payment may be delayed until such time as the Budget and Operating Plan projects a certain IRR on Capital Contributions.

C. Project Cost Percentage

An amount equal to x% of the costs to develop and construct the Project (the costs to be included in this calculation vary from project to project but often include hard development and construction costs as set forth in an agreed-upon budget and development plan for the Project) paid in equal, calendar month installments over a __-month period. After the owner's receipt in full of a certain preferred return on invested capital (“IRR”), the development fee may increase to y%. No separate reimbursement for overhead expenses in deals with high percentages, but in others, with a lower percentage, overhead is often reimbursed to the Manager.

D. Reimbursement Plus Incentive Fee (mixed use project)

  • Reimbursement of all of Manager’s overhead expenses incurred by the Manager;
  •  $__ a month during the term; and
  • An incentive fee of _% of all gross revenue so long as Owner achieves a __% IRR (money was escrowed along the way and paid when Owner exits the Project).

E. Fee plus promote (escrowed promote)

  • Manager receives a monthly development fee equal to the salaries of Manager’s employees plus reimbursements for Manager’s expenses and overhead costs.
  • If an IRR of __% or more is achieved at completion of a project the Manager receives a promote.  Typically involves a percentage of gross sales revenue being deposited into an incentive escrow account as sales occur.

F. Invested Capital Percentage Plus Fees

  • Manager receives __% per annum of the aggregate amount of invested capital in the project, plus reimbursable expenses.
  • Manager receives _% disposition fee for finished lots, and _% for paper lots. 
  • If any horizontal development is performed, Manager receives _% of costs of development as a development fee.
  • Manager receives additional promote “Incentive Fee” equal to (i) __% of distributions following 100% return of all capital contributions and member loans, until members receive ___% IRR, and then __% of distributions after members receive ___% IRR.

G. Fixed Fees plus Incentive Fee plus Disposition Fee

  • Monthly fixed project management fee and asset management fee.
  • Promote incentive fee after __% IRR to members.
  • Disposition fee of _%

H. Development/Profit Participation

  • Development fee of ___% of gross sales revenues of all land sales.
  • One-time fee upon achieving certain entitlements.
  • Profit participation fee of ___% of annual profits of the project as reflected in Owner’s financial statements.
  • Reimbursement of all third-party expenses consistent with approved budget, and for project employees approved by Owner.

In promote/incentive fee scenarios, the promote or fee often has a vesting period, and if the Owner terminates a Manager without cause, then only the vested part is paid to the Manager.

As you can see, Development Management Agreements can be structured in quite a few different ways, and these are just a few. Please let us know if you would like to discuss any of these or other structures for your project.

About The Watson Firm

The Watson Firm provides legal services for master-planned, mixed-use and resort communities. Our industry experience, both on the business and the legal side, is what makes us uniquely capable of guiding clients through the myriad of legal issues involved with any new or ongoing development.