Your Advisory Fees and 1031 Exchanges

Topics: ,1031 Exchanges/DSTs blog-post

More and more, fiduciaries are turning to private real estate to diversify their clients’ portfolios, provide an alternative source of income, generate non-correlated return profiles, and offer tax benefits.

The Delaware statutory trust (DST) is often used in 1031 exchanges and can be a compelling tool for RIAs working with clients seeking to defer capital gains from their real estate holdings.  

DSTs offer investors multiple benefits, such as:

  • Real estate ownership without the day-to-day management
  • Access to institutional-quality property
  • Ability to diversify both by geography and by property type 

Utilizing this important investment strategy, you can provide a value-add wealth enhancement service and distinguish your fiduciary practice from the many financial planning firms in the marketplace.  But how should you be compensated?

The Fee Question

Many RIAs considering the addition of DSTs to their practice have questions about their professional fees.  RIA firms come in all sizes and disciplines, as do client fee structures written into a client advisory agreement.  While the methods we discuss here may seem like something you have heard about in the past, we recommend you seek legal counsel and compliance advice to determine which method best suits your practice.1

Broken down into two parts, let’s begin to explore various compensation structures when advising on DSTs.

RIA Fees and DSTs Part 1: Three Common Options

  1. AUM and AUA
  2. Hourly
  3. Flat Fees
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1. AUM and AUA 

A percentage of assets under management is the most common structure for RIA fees. This approach allows advisors to align their interests with that of their client and deliver guidance on a broad range of investment opportunities.  Thus, advisors can more efficiently manage their client’s entire investment portfolio, potentially increasing their overall compensation as a clients’ assets increase as a result of better financial management.

An RIA may oversee client assets on a discretionary basis, and such assets are generally considered to be Assets Under Management (AUM). An RIA may also work with a client on a non-discretionary basis, and such assets are considered to be Assets Under Advisement (AUA). While fees for both approaches are generally asset-based, AUM fees are may be higher than AUA fees, reflecting the additional ongoing work and responsibility.

For advisors overseeing a client’s total financial picture, combining AUM and AUA fees is common approach. When discussing advisory services with clients wishing to invest in DSTs, these are some of the services most commonly provided:

  • Due diligence trips - property visits
  • Review of quarterly reports
  • Attendance on sponsor update calls, webinars, or meetings
  • Performance reviews: quarterly, semi-annual, or annual
  • Obtaining tax documents and coordinating with CPAs

 

In a typical approach, clients are invoiced and pay the RIA directly or through a brokerage account. If the DST investment is held on a major Custodial Platform, like Charles Schwab, your fees may be able to be deducted in the manner your clients are accustomed to. 

 

2. Hourly Fees

Some RIAs charge hourly fees for specific professional services, or for services provided to investors that do not have AUM with the RIA. The hourly rate is stated in the advisory agreement and would indicate a per hour rate for a list of services like those mentioned above.  Clients are invoiced and pay the RIA directly or through a brokerage account.

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3. One-Time or Flat Fee

An RIA may perform DST due diligence and analysis on a project-by-project basis, with fees sometimes ranging from $5,000 to $10,000 or more. The fee may vary due to the size and complexity of the investment.  Larger deals may involve more work and thus higher project fees. 

Some RIAs may combine the flat fee with an hourly due diligence fee, in order to compensate for more time-consuming projects.

 

RIA Fees and DSTs Part 2: Professional Fees from the DST

Some advisors may desire to earn fees payable out of the distributions earned by the client or from a Qualified Intermediary (QI).   Receiving such fees has important compliance implications. There are two fee approaches in this category:

  1. Monthly advisory fee from DST sponsor
  2. Professional fee at closing through the QI
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1. Monthly Advisory Fee Payable from Distributions 

With this approach, the RIA collects a monthly advisory fee through a signed investor Letter of Instruction (LOI). The investor instructs the DST to pay the RIA a portion of the monthly distributions when issued to the investor. 

Caution: The SEC and state regulators may consider this to be a commission or excessive compensation if paid to the advisor over an extended period. Be sure to seek counsel prior to using this method.

2. Professional Fee at Closing 

With this approach, the RIA requests an advisory or due diligence fee at closing to be paid by the Qualified Intermediary (QI), which is responsible for holding client funds to comply with 1031 exchange rules.

Caution: This approach is controversial and may have tax consequences to your client. Many QIs will only disburse funds to the DST or to the investor to avoid creating a taxable event under applicable tax law.  Be sure to seek counsel prior to using this method.

Legal, Compliance, and Your Choices 

It is essential to evaluate these different approaches, discuss them with your legal and compliance teams, and select what is most suitable for your clients.

The good news is that you have more than one choice. You can customize your services and fees to your specific approach to 1031 exchanges, DSTs, and private real estate investing.

 

Want a full view of ALL client assets? Here's a natural first step.

 

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