Limited partnerships in commercial real estate are growing in popularity as new opportunities arise, inflation continues, and many investors realize the potential of structuring relationships to purchase assets. Commercial real estate is an expensive undertaking. However, limited partnerships offer a unique avenue for green investors or those who aren’t willing to manage their investment in commercial assets.
What Are Limited Partnerships for Real Estate?
A real estate limited partnership, or RELP for short, is a kind of real estate investment that pools multiple investors in order to purchase or develop real estate.
The structure includes:
- A general partner who oversees the investment and assumes liability
- The limited partners who are passive investors
Typically, limited partnerships for real estate are leveraged for larger projects that require significant capital. Multiple investors come together to combine their resources and strike deals that might otherwise be impossible as solo ventures.
Private investors for commercial real estate are specifically drawn to these partnerships as there is something to be gained from both the general and limited partnering perspectives.
An investor who offers experience with investment management may not have the funds to secure significant commercial assets. A wide pool of combined limited partners may have the funds but not the management experience or desire to oversee day-to-day operations.
Together, there lies the opportunity for general partners to join with limited partners to secure commercial real estate and achieve success on their investment.
A Private Real Estate Investor’s Blueprint to Limited Partnerships
The structure of limited partnerships for real estate depends on the partnership agreement itself. This means that there is a great deal of variety in these agreements, especially when it comes to commercial investments. With that being said, there are some basic formats that remain stagnant and make up the blueprint for limited partnership status.
As mentioned, a general partner and limited partners are the two major players. While each type of partner has equity in the agreement, the contributions, responsibilities, and liabilities are vastly different. Similarly, the returns are also distributed differently. Let’s explore.
The General Partner (GP)
The general partner is responsible for establishing and maintaining the partnership. They will typically handle the transaction, financing, and management of the commercial real estate investment. Oftentimes, especially with larger limited partnerships and institutional funds, a fund manager or management company is employed to manage day-to-day fund administration.
More often than not, a general partner will establish a separate entity to act as the partner in the agreement. This is to protect their assets and allow further opportunity in the limited partnership.
Equity in the partnership can differ greatly from one LP to the next. Generally, it sits between 20%-30%. Some general partners manage the property themselves and may charge a management fee. While not all GPs will charge fees in the partnerships, they often earn money through:
- Acquisition fee: 1% to 5%
- Asset management fee: 1% to 3% annually
- Refinance fee: 1% to 3% of the loan amount
- Loan guarantee fee: 0.5% to 3.5% of the original loan amount
- Construction management fee: 5% to 10% of the renovation budget
- Disposition fee: 1% to 2% of the sale price
Limited Partners (LP)
Passive investors who provide capital to the partnership to earn ROI are known as limited partners. Limited partners have limited liability in the commercial real estate investment and almost no involvement in the daily minutia of the investment.
They’re what’s known as “silent partners.” In some partnerships, limited partners have voting rights (typically on major decisions only) depending on the agreement. These decisions may include refinancing, capital expenditures, and managing significant financial issues.
Limited partners are not allowed to spend more than 500 hours in a year on the operational activities of a limited partnership. If this amount is exceeded, they risk losing their liability protection and limited partner status.
Now that we’ve covered the basic structure of limited partnerships for real estate let’s explore how profits are distributed.
Distributions can vary greatly depending on the partnership agreement, but there are some foundational elements depending on the type of commercial real estate:
- For an income property, profits are shared at routine intervals.
- For a development that is to be sold or refinanced, the profits are shared when the deal is executed.
It’s not uncommon for limited partnerships for real estate to include a preferred return for limited partners, which means that LPs must receive minimum returns before GPs can obtain their profits.
How Are Limited Partnerships Financed?
Commercial real estate investments will require some kind of financing support. General partners are responsible for acquiring, signing off on, and offering the guarantee for the loan unless they get a nonrecourse loan.
This means that a general partner will have to get approved for the loan based on their experience, history, and creditworthiness.
What About Taxes?
You may be surprised to find out that limited partnerships for real estate don’t pay taxes. Well, not in the traditional sense. There are many tax benefits for commercial real estate investments this way.
Net gains or losses are considered pass-through income for each partner. That means that private investors for commercial real estate will need the following:
- File form 1065, which reports net income or losses after deductions
- Schedule K-1, which indicates the income received throughout the year from the commercial real estate investment partnership
Why Participate in Limited Partnerships For Real Estate?
Private investors for commercial real estate looking to participate in a limited partnership have much to gain. There are incredible opportunities and benefits for both general and limited partners.
For General Partners
- Invest in massive deals by pooling funds from limited partners
- Added equity for managing the deal
- Income from various fees
For Limited Partners
- Limited liability
- Passive investment as a silent partner
- Commercial real estate tax benefits
Limited partnerships have been around for decades. They offer a unique avenue for pooling funding and obtaining commercial real estate with benefits to both general and limited partners. Finding partners can be tricky, but with the right tools and resources, you’ll open doors to real estate investment options and significant returns.