WHAT TO EXPECT AS A LIMITED PARTNER IN A REAL ESTATE SYNDICATION
What is a limited partnership in a real estate syndication?
The best way to answer that question is to understand the two parties involved in a typical real estate syndication. You have the General Partners (GPs) also known as the real estate syndicator or deal sponsor and the Limited Partners (LPs) also known as the passive investors or equity partners.
There is a group of people (individual investors), the GPs and LPs who come together to pool their resources to purchase real estate investment opportunities and form a real estate partnership to invest in a commercial property.
We’ll continue to cover some basics of real estate syndication throughout this article as we cover the logistics of being a limited partner in a syndication structure.
What is a General Partner or General Partnership?
The general partners operate and manage the investment. When we talk about a real estate syndication investment, we are often talking about an apartment building community or a medical office building, or an industrial warehouse facility – large, expensive commercial properties.
The general partnership does all of the work on behalf of the limited partnership. The general partners are responsible for everything related to the asset from identifying the opportunity, overseeing the acquisition, developing and implementing the business plan, distributing profits, overseeing the property manager or property management company, and managing the liquidation or the sale of the property.
The general partners of the real estate syndication do all of the heavy lifting…they do it all.
A general partnership should always be vetted thoroughly by a potential investor before a commitment to a particular investment is made.
What is a Limited Partner or Limited Partnership?
Most real estate investors understand the benefit of real estate investing and the incredible ways it can build wealth, generate cash flow and contribute to one’s net worth in extraordinary ways. Additionally, most people know that real estate deals have a high barrier to entry. A high barrier to entry is realized even more when it comes to acquiring commercial real estate such as large-scale apartment buildings. An acquisition of that scale is almost impossible to achieve without a property syndication structure. However, a great way to solve that problem is to invest in a real estate syndication deal with other investors.
Let’s take an example. If we were to buy a large apartment building community for say $100 million, then usually the lender would require that we bring in 25% to 30% of the purchase price ($25M – $30M) in the form of equity. Then the lender provides the remainder of the purchase price in the form of debt on the property.
Most people don’t have $25-$30M lying around to put toward purchasing a large apartment community. This is where a limited partnership comes in. A real estate syndication is the pooling of resources among a group of investors (both the general partners and the limited partners) so that the group can collectively purchase an investment property that would otherwise be unattainable to purchase individually.
Limited Partnership Roles & Liability
The limited investors contribute most of the required equity capital needed to purchase the asset. The general partnership should also be contributing its own funds as a portion of the equity requirement.
The general partnership is responsible for obtaining the loan to fund the remainder. The good news for limited partners is that the loan is neither the responsibility of the limited partners nor the liability of the limited partners. The liability of the limited partners is limited to their initial capital, nothing more.
As a passive investment, the limited partners do not actively partake in ANY day-to-day operations or decisions. Those tasks are left up to the general partnership. As we discussed, the responsibilities of the GPs are vast in a real estate syndicate.
How Are Limited Partnerships Structured?
The role of a passive real estate investor is just that – it is a passive investment with the limited partner taking a passive role in a real estate project such as a multifamily syndication. Limited partners receive passive income distributions and a portion of the equity. The amount limited partners receive from cash flow distributions and their portion of the equity when the asset sells directly correlates to their initial investment.
All of the logistics of the real estate deal including how the investment is structured will be in the private placement memorandum (PPM) within a subscription agreement. A PPM is just one of a few legal documents that potential investors need to review. All investors must attest that they have read and understood the PPM before signing.
We won’t go into how the returns are structured in a real estate syndication such as a straight split structure or a waterfall structure, but you can learn more about syndication structures here.
The PPM provides important information such as:
- General company information
- The expectations between both parties and of both parties
- The number of shares and the price of those shares
- The rights of the investors
- Terms under which investors can terminate before completion
- Nomination of a board
- Confidentiality provisions
- Investor distributions – how and when paid out
Distributions are usually paid out to investors on a monthly or quarterly basis if a limited partner is investing in commercial real estate syndications.
What Can Limited Partners Invest in With Real Estate Syndications?
Limited partners can invest in a variety of commercial real estate assets such as:
- Apartment Communities
- Storage Facilities
- Office Buildings
- Strip Mall Centers
- Student Housing
- Medical Centers
- Mobile Home Parks
Potential Risks of Being a Limited Partner
As with any investment, there is always some level of risk. Real estate syndications are no exceptions. Your investment in real estate syndication is illiquid and can be illiquid for a certain amount of time such as 5, 6, or 7 years (or longer) depending on the terms of the agreement. You cannot sell your shares of the investment as you can with investments in the stock market, so that is one downside for some investors; liquidity.
A real estate syndication and the success of that syndication is almost wholly based on the expertise of the general partnership. That’s why it’s critical for limited partners to do their due diligence to protect their hard-earned money and vet a syndication sponsor thoroughly before investing in a passive real estate investment.
That is probably one of the most important roles of a limited partner is to adequately vet the deal sponsor.
Remember, as a passive investor in a real estate syndication you do not have any say in the management of that asset so you are relying solely on the abilities, expertise, experience, and track record of that syndicator.
Benefits of Being a Limited Partner
There are significant benefits for a limited partner investing passively in a real estate syndication. Foremost, as a limited partner, your risk is only limited to your investment capital, as mentioned earlier.
Also, you don’t have to do any work, as a passive investor, to become a part of a real estate syndication.
Additionally, by investing in a real estate syndication, you can generate passive income and have full control over your life. Passive income generated through a real estate portfolio allows you to live freely and allows you financial freedom. If you are an active investor, you don’t have these same freedoms.
There are also tax advantages to being a limited partner in a real estate syndication. There is depreciation and accelerated depreciation and even carryover losses if you qualify. These tax benefits can greatly reduce your overall tax burden.
Another great benefit you get when you invest in real estate of any kind is the diversification that it can provide for your investment portfolio.
And last but not least, you don’t have to have any real estate knowledge or expertise to be a passive investor in a real estate syndication.
There You Have It!
Real estate syndications can be an amazing investment type for an investor looking to have passive income and equity in real estate while also seeking the potential tax benefits that real estate can provide to investors.
There’s a reason why the wealthiest investors in the world have the healthiest real estate portfolios.
A quick note: we are not tax or financial advisors. We always recommend that you speak to your advisors before making any financial decisions.
Until next time…Earn Passively & Live Abundantly!
Ready to Learn More?
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