The potential payoff for an investor in a real estate acquisition or development opportunity is substantial. Of course, this also means they’re on the hook for any losses and must know their stuff regarding investing. To pool resources, divide up risks, and make the most of the knowledge of our most reliable employees, investment firms form several partnerships with different types of developers. This way, they can provide their investors with high-quality assets while keeping expenses and risk levels low.
Partnerships are widely favored by both small and large investors in commercial real estate due to their tax advantages and legal security. While there are a wide variety of partnerships, we will discuss the two that see the most action on our projects: limited partnerships (LPs) and general partnerships (GPs). We will explain the purpose of each position and how they are utilized.
Duties and Dangers of General and Limited Partners
The General Partner (GP):
Site selection and preliminary property layout are common components of this phase. They do everything from buying the land to getting the necessary permits and permits for building on the site before beginning construction. While the GP’s initial investment is smaller (usually between 5 and 20 percent), it occurs earlier in the project’s lifecycle, when the risks are higher. As the project’s sponsor, it is their responsibility to make the groundwork ready for construction. Legal, architectural, and other costs add up quickly, and the whole thing might take anything from six months to several years. A contract may fall through at that time.
When done correctly, GP investments generate a disproportionately larger percentage of profits than LP investments since this early investment comprises more uncertainty and risk than later phases.
The Limited Partner (LP):
After all the pre-development work is done, it usually provides funding between 80% and 95% of the total required equity. In exchange, limited partners (LPs) are usually given the final say over any important investment choices. When a property is sold or refinanced and which companies are hired for leasing and management are decisions the LP makes. The LP is also responsible for setting budgets and allocating funds for major construction initiatives.
There is less danger associated with LP investments than with GP ones. So, in a successful enterprise, GPs will take home a larger percentage of the earnings than LPs will. There are situations when certain limited partners (LPs) receive return preference over general partner (GP) investors up to a certain total return or internal rate of return (IRR). Up to an IRR of about 10%, general partners and limited partners (LPs) normally receive a pari passu (Latin meaning “in equal proportion”) return on their capital investments. Then, as the project reaches different levels of profitability, the GP receives a growing percentage of the profit in the form of a “waterfall” across incentive hurdles.
The Purposes Behind LP, GP, and Co-GP Functions
The Fund partners with a seasoned sponsor to provide equity in this 310-unit property as co-general and joint venture limited partners. The growth of that GP is assured. In contrast, “hybrid” co-general partners contribute to pre-development costs and share in the associated risk.
There are a few reasons why firms play the role of general partner:
- Supply a higher-margin capital at an initial stage of a transaction.
They need to make a sizable investment whenever they encounter a promising opportunity. As a co-general partner, they are eligible for a larger portion of the deal’s profits due to their involvement.
- It offers an abundance of opportunities to pursue.
Since they provide sponsors with general partner capital through programmatic relationships, the sponsors have agreed to make available investment options for limited partners. Because of the early involvement, they are in the best position to evaluate the opportunity as the LP and decide whether or not to take part.
- Through experience, it can add value.
They are simultaneously working on other projects across the nation. Therefore, they contribute market knowledge and design expertise when they function as co-general partners in a transaction. It includes how to deploy technology, which wood frame closet storage is more attractive and delivers a higher return, and whether or not to construct more junior one-bedroom apartments with a home office nook for those who work from home. Due to the early arrival, they impact crucial parts of the project.
- Maintain a lean workforce and low overhead.
Having the capacity to operate as a co-general partner has allowed them to get more transactions without employing in-house developers. As a result, the investors incur fewer expenses, improving their net return.
Concentrating On Investments Increases Profits
Taking a long-term view, firms have decided they do not want to be a typical development company. Investment management is all they do. In this way, they ensure that their shared interests are being represented. Using their expertise in market fundamentals, operations, risk management, asset management, and property management fees, they negotiate all aspects of development with the sponsor. It is just another aspect in which they excel beyond the competition.
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