If you’re new to the world of real estate investment, understanding the roles of General Partners (GPs) and Limited Partners (LPs) is crucial. Let’s break it down in a friendly and straightforward way.
How it all started
In the 1960s and 1970s, real estate syndication started gaining popularity in the US. This era saw the emergence of tax-sheltered real estate investments, offering investors income from properties along with tax benefits from owning real estate. During this time, GPs became more structured, with sponsors handling everything from finding deals to managing properties.
The Tax Reform Act of 1986 made significant changes to real estate by removing many tax advantages that had previously attracted investors to syndications. Yet, GPs continued evolving by focusing on adding value through strategic property management and enhancements. The 1990s and 2000s witnessed the growth of real estate private equity funds, where GPs oversaw large capital pools from institutional investors and high-net-worth individuals.
What are GPs and LPs?
General Partner (GP): The General Partner, also known as the sponsor or syndicator, is the active manager in a real estate syndication. GPs are responsible for:
Finding and vetting deals: GPs are responsible for identifying potential real estate investment opportunities. This involves searching for properties that meet specific investment criteria and performing thorough due diligence. Due diligence includes inspecting the property, reviewing financial records, assessing market conditions, and conducting risk analyses to ensure the investment’s viability.
Organizing legal and financial aspects: Once a potential property is identified, GPs take charge of organizing the legal and financial aspects of the deal. This involves setting up the partnership structure, which can include forming a Limited Liability Company (LLC) or a Limited Partnership (LP) to facilitate the investment. GPs also manage the preparation of legal documentation, such as offering memorandums, subscription agreements, and partnership agreements. Additionally, GPs arrange for financing, which may involve securing mortgages or other types of loans, and ensuring that all financial transactions are properly documented and compliant with regulations.
Managing the investment: From acquisition to eventual sale, GPs handle the day-to-day management of the property. This includes overseeing property management activities, such as tenant relations, maintenance, and rent collection. GPs may also be responsible for implementing value-add strategies, such as renovations or improvements, to increase the property’s value and profitability. Throughout the investment period, GPs monitor the financial performance of the property, prepare regular reports for investors, and ensure that the investment remains aligned with the overall business plan.
Being a GP is akin to running a business, involving significant effort, expertise, and risk management.
Limited Partner (LP): Limited Partners are passive investors who provide the capital necessary for acquiring the property. Their main responsibilities include:
Providing capital: LPs invest money into the syndication.
Performing initial due diligence: LPs must vet the GPs and understand the deal before investing. Here’s a video where Adrian from Cash Flow Portal shares tips on what questions to ask GPs before investing in a deal:
LPs enjoy limited liability, meaning they are not responsible for the debts or legal issues of the property beyond their investment.
Liability
General Partners: GPs have unlimited liability, meaning they are responsible for all aspects of the investment, including legal issues, debt obligations, and overall property management. This high level of responsibility entails significant risk.
Limited Partners: LPs have limited liability, protecting them from any legal or financial repercussions beyond their initial investment. This makes it a safer, albeit more passive, role.
Common structures in commercial real estate investing
Real estate investments can be structured in various ways. Here are the most common structures:
Real Estate Investment Trust (REIT)
Limited Liability Company (LLC)
Limited Partnership (LP)
Syndication deals are usually structured as either limited liability companies or limited partnerships. In syndication, GPs and LPs come together to purchase a property that would be difficult to acquire individually. The combined efforts of GPs and LPs make larger deals possible, benefiting everyone involved. Syndication also opens up various investment opportunities, allowing investors to navigate capital markets effectively and pursue both LP and GP roles for additional protections.
How syndication works
In a syndication, multiple investors pool their money to buy and manage a property. Here’s a quick rundown of the roles:
LPs: Provide the capital. In real estate syndication, a Limited Partner usually serves as a passive investor, contributing funds to the project without assuming the risks or responsibilities of active management.
GPs: Manage the project, handle the paperwork, guarantee the loan, ensure the property is profitable, and oversee property management.
For instance, LPs might include family offices, private equity firms, or individual investors. These investors might not have the time, expertise, or desire to manage a property but still want to invest in real estate. By partnering with GPs, they can own a share of the property without the hassle of managing it. GPs and LPs play crucial roles in commercial real estate, with GPs handling the operational aspects and LPs providing the necessary capital.
Importance of general partners and limited partners
LPs bring the necessary funds, while GPs bring expertise and management skills. In commercial real estate investing, GPs are responsible for managing the investments and making strategic decisions to ensure profitable outcomes.
Passive investors, or LPs, provide capital to the fund and expect investment returns without being actively involved in the management or control of the business. This collaboration allows for significant real estate acquisitions and profitable outcomes.
GP Team structure
Like most teams, the most common way to track the duties and responsibilities of GPs in a syndication team is through a hierarchy. Let’s start from the top and work our way down.
Lead Sponsor: The head of the team, responsible for ensuring everyone else does their jobs. The lead sponsor has complete oversight of the entire project and is often the most experienced member of the team.
Co-Sponsors:The rest of the GP team, each co-sponsor has a specific role but can assist others if needed. The different roles are:
Acquisitions: Responsible for finding, vetting, and underwriting deals. They create relationships with brokers, lenders, and property managers to find off-market deals.
Loan Guarantor or Key Principal (KP): Ensures the team meets lender requirements, often staking their balance sheet for a fee or partnership percentage.
Capital Raiser: Brings in the remaining capital necessary to close the deal, screens the deal and the GP team, and ensures investors’ capital is wisely invested.
Asset Manager: Manages the property through the property manager, implements the business plan, tracks day-to-day operations, and creates reports. They are often called the “Boots on the Ground” for their proximity to the property.
GP Team roles
Acquisitions: Vital for securing deals and building relationships that lead to profitable investments.
Key Principal: Critical for meeting financial and liquidity requirements, often compensated for their unique role.
Capital Raiser: Arguably the most important member to a passive investor, ensuring capital is raised and invested wisely.
Asset Manager: The most crucial member of the GP team, responsible for executing the business plan and ensuring the profitability of the investment.
Watch Adrian from Cash Flow Portal explain GP Team structure in detail:
Financial Returns
General Partners: GPs can invest their own money into the deal but primarily earn through the sponsor’s promote (also known as carried interest). This is a share of the profits that GPs receive after LPs get their preferred return. Additionally, GPs may earn various fees, including:
Asset management fees. They are a part of the compensation structure for GPs, calculated as a percentage of the capital committed by LPs to cover operational costs such as salaries and office space.
Acquisition fee. A standard acquisition fee is usually 2% but can range from 1% to 5% of the purchase price, with often a higher % for smaller assets.
Disposition fees. They are paid when the property sells. Disposition fees are less common than acquisition fees.
Refinance fees. These are paid during the closing of the loan.
These fees help cover the operational costs of managing the investment.
Return metrics
Cash on Cash Return: Measures the return on capital invested, calculated as Cash Flow / Capital Invested.
Internal Rate of Return (IRR): A sophisticated metric that accounts for the time value of money, considering the entire project’s cash flows and liquidity events.
Equity waterfall structure
The equity waterfall structure determines how profits are distributed among investors and typically includes tiers or hurdles to incentivize GP performance.
Watch Adrian explaining equity waterfalls in this video:
Cash on Cash hurdle + Promote example:
LPs are entitled to an 8% cash-on-cash return before any profit splits.
After the hurdle is met, GPs receive their promote, e.g., 20% of the profits.
IRR Hurdle waterfall example:
Tier 1: LPs receive a 7% IRR preferred return.
Tier 2: Profits are split 80% to LPs and 20% to GPs until LPs achieve a 15% IRR.
Tier 3: Thereafter, profits are split 60% to LPs and 40% to GPs.
Typical deal structure
Limited Partners: LPs typically earn returns through profit split and preferred returns.
80/20 Split: LPs receive 80% of the profits, and GPs receive 20%. This means that from the profit generated, 80% goes to the LPs and 20% to the GPs, as long as a preferred return is met.
Preferred Return: This is the first payout to LPs before GPs receive their share. It ensures LPs are prioritized in the profit distribution. For instance, if there’s a 6-8% preferred return, LPs get their 6-8% before any profits are shared with GPs. Carried interest is then allocated to GPs as a reward for successfully managing the fund’s investments.
Why preferred return and carried interest matter
The preferred return aligns with the interests of GPs and LPs. It motivates GPs to ensure the property performs well because they only get paid after the LPs have received their preferred return. This setup benefits LPs by securing their investment and encouraging GPs to maximize profitability. Additionally, GPs work diligently to secure financing from limited partners, ensuring the property has the necessary financial backing to succeed.
The exit strategy
When the property is sold, the profits are again split according to the agreed percentages. For example, if there’s $10 million in profits at exit, LPs would get $8 million (80%) and GPs $2 million (20%). If the preferred return wasn’t met during the holding period, a catch-up provision might be used to ensure LPs receive their due before profits are divided.
In a commercial real estate deal, the GP spearheads all investment activities on behalf of the passive LPs, who benefit from greater deal exposure and less personal liability without requiring direct real estate experience.
Real-life example
Office building investment
In 2018, a GP identified a lucrative opportunity to acquire and renovate a downtown office building in Chicago valued at $25 million. The GP raised $20 million from LPs, which included institutional investors and high-net-worth individuals. The GP managed the extensive renovation project and successfully secured high-quality tenants, resulting in a 30% increase in the building’s market value by 2023. Throughout the holding period, LPs received an 8% preferred return annually. Upon selling the property in 2023 for $32.5 million, LPs earned substantial returns, with profits split 80/20 between LPs and GPs, respectively. The GP’s strategic planning and active management were instrumental in maximizing investor returns.
Conclusion
Understanding the difference between GPs and LPs is fundamental for investing in real estate. The distinction between general partners and limited partners is crucial as GPs handle the heavy lifting of managing the property, while LPs provide the necessary capital. The roles highlight that GPs are actively involved in the management and decision-making processes, whereas LPs are passive investors with limited control. Together, they create a powerful team capable of successfully acquiring and managing large real estate investments.
For more insights and detailed discussions on real estate investing, check out our YouTube channel and other articles.
Alexandra is a Community Manager at Cash Flow Portal. She writes blog posts, demos, guides and shares tips and tricks for running a successful syndication business.
