How Limited Partnerships Work for Commercial Real Estate Investors
In many cases, commercial real estate investments are structured as real estate limited partnerships (RELPs). A RELP will generally consist of a general partner (GP) and multiple limited partners (LPs). The GP, who is financially responsible for the investment, is often a real estate developer or property manager, while the LPs are typically passive investors who only contribute capital to the project. This type of investment is referred to as a real estate syndication. In the vast majority of cases, LPs will not be liable for any losses or liabilities beyond the amount of money they initially invested.
Unlike investors who place money in stocks or bonds, LPs in a RELP cannot easily liquidate their funds-- in most cases, the money will not be available until the property itself has been sold. Many real estate limited partnerships have a target date for when they will sell a property, though this may change based on market conditions. In addition, in most cases, limited partners in a RELP need to be accredited investors, which, in the U.S., means that they have a minimum net worth of $1 million, (not including their primary residence), or, have a minimum income of $200,000/year for the last two years (or a combined $300,000 for married couples).
Real Estate Limited Partnerships vs. Limited Liability Companies (LLCs)
Limited partnerships are one way that a real estate syndication can be structured, with another common method being an LLC, or limited liability company. Unlike an LP, which only provides liability protection to limited partners, an LLC provides legal protection to all its members. Plus, while an LP generally needs to consist of individuals, the members of an LLC can typically be individuals, partnerships, or other LLCs themselves, though this may vary on a state-by-state basis. However, since LLCs do not generally possess one general partner who can make decisions for the entity, the LLC decision-making process can be somewhat more time-consuming and complex.
RELPs and Waterfall/Promote Structures
In a real estate syndication set up as a RELP, profits are generally calculated using what’s called a waterfall and promote structure, in which the GP will receive an additional percentage of the profits, referred to as a “promote,” should the investment reach a certain level of profitability. For instance, if a GP has placed 10% of the equity in the property, they might receive 10% of the profits up to 8%, after which they might receive 15% of any profits over and above 8%. In this case, 8% would be referred to as a “hurdle.” A project may have multiple hurdles. This type of structure incentivizes the GP to make the project as profitable as possible, which, in the end, benefits both the GP and the LPs.