Investing in commercial real estate can be an exciting and lucrative endeavor. There are several ways to go about it, including investing in a REIT, or a real estate mutual fund, which lets a variety of investors partake in large real estate deals and financing. For those who want to make direct real estate investments, however, but don’t have the time or connections to successfully make that happen, working with a general partner is a good option. Commercial real estate investing can be complicated to navigate for a new investor. Working through an entity like a general partnership or limited partnership is often a good way to ease into the industry.
In commercial real estate investing, a general partner is a person or a team in charge of a real estate deal or private equity fund from its inception on through to the end.
A general partner in commercial real estate might be a real estate development firm, a corporation or a property manager with years of experience. General partners, also referred to as “sponsors” or “GPs,” take an active role in real estate deals. They own the property and they handle all components of the transaction as well as operations. General partners are responsible for finding investment opportunities through their network and raising capital for deals from outside investors, who are also known as limited partners or LPs LPs contribute equity financing in exchange for an investment return. GPs sign loan guarantees and they execute most decisions about the fund or the deal “GPs are really the boss of everything,” said Greg Hallman, a senior lecturer in finance at the University of Texas at Austin. “They do the work and make the decisions. A limited partner isn’t allowed to participate in the decision-making process. That’s what keeps their liability limited.”
Out of all the types of joint venture, a GP-LP real estate partnership is structured with a sponsor leading multiple investors (aka LPs) who combine their funds to buy or to develop real estate. An advantage of pooling funds through a real estate partnership entity option is that investors are often able to participate in a deal they likely would not have been able to access on their own. The general partner has management experience and manages the deal or investments, assuming unlimited liability for the project. Meanwhile, limited partners function as passive investors. They may not have management experience or deep connections in the industry, and they prefer not to have to focus on day-to-day tasks and operations. GPs generate investment ideas or themes and source deals. For example, a smaller fund might buy an inexpensive apartment complex and fix it up, asking $100,00 of LPs to get into the fund. A larger GP could invest in 50 apartment complexes across the Southeastern part of the United States, requiring an investment of $5 million each from institutional investors. GPs approach limited partners with these investment opportunities and raise funds from investors to go toward the deal or deals they’ve sourced. Generally, GPs running a private equity fund then spend a year or two investing the money they’ve raised in different projects as part of the limited partnership. Then, they typically hold onto the projects in the fund for anywhere from five to eight years or more, Hallman said. Funds typically have a 7-to-10-year life span. Afterward, the GP will sell. That’s when LPs get their money back, hopefully profiting from the venture. “The first two years, the GP generally does a lot of work trying to find the right investments,” Hallman said.
While being a GP isn’t for the faint of heart, there are plenty of general partnership advantages that make being a GP worthwhile.
GPs who make smart investments can make a good deal of profit. GPs are paid based on assets under management (AUM) and based on the performance of the investments they make. The AUM management fee might hover around 1.5 -2% on AUM until the money is invested. Then, it could drop to 1% of assets under management once funds have been invested. GP compensation contracts then specify the rate of return a GP earns once the minimum acceptable rate of return has been achieved for investors. This performance payment is sometimes called the GP’s “carried interest”, or more simply, the “carry,” or in real estate, the return component is called the “promoted interest,” or simply the “promote.” For example, a GP compensation contract might say a GP gets 20% of the returns earned over an 8% hurdle rate. The hurdle rate is typically referred to as the “preferred return,” or more simply, the “pref.” Taken together, the GP contract in a typical private equity deal is called a “pref-promote structure” or “waterfall.”
In a GP-LP business entity, GPs dictate all of the investment and sales decisions. Many GPs thrive on developing relationships within the industry and on researching and finding exciting investment opportunities for LPs to invest in. GPs can create investment themes and strategies that are unique to them and require creativity and analytical skills.
As a GP, you have a real opportunity to make investors a significant amount of money. Successful GPs specialize in certain areas and then become well-known in the industry for their deal-making. They’re often sought after by LPs and by others in the industry for their knowledge and their expertise.
General partners in commercial real estate have a variety of responsibilities across the deal-making process. These duties include:
GPs should always have their finger on the pulse of the industry, with knowledge of deal trends. GPs must dedicate a significant amount of time to creating and nurturing a vast network of professionals across the real estate sector so they’re constantly up-to-date on trends and the latest developments.
GPs are responsible for choosing the best real estate investment deals, negotiating investments with the best possible terms, and then correctly choosing the right time to sell to maximize profits for all limited partners, all while managing expenses and expectations.
The best GPs get in touch with LPs early on in the investment process to gauge interest. GPs need to know how to find the best LPs for a variety of deals, how to create pitch decks and presentations, and how to effectively communicate with potential LPs interested in participating in a deal.
After finding the best deals and securing joint venture equity, GPs are responsible for securing the best possible terms on a real estate investment to the benefit of all LPs. LPs may have a variety of preferences and goals, and good GPs can navigate these while achieving solid results for all investors involved.
Part of a GPs job is to handle property management — though most hire an onsite property manager that reports to the GP firm — all bookkeeping and accounting, including making sure limited partners receive the necessary tax documentation on time, and that cash flow is positive. Large GPs often have sophisticated investor portals or platforms that help them in managing the day-to-day operations.
More often than not, the advantages of working with a general partner far outweigh the disadvantages.
Successful GPs have developed a vast network in the industry and are often clued in to the best deals ahead of others. They “get good deal flow.” Often, an investor may not have sufficient funds to participate in an attractive deal on their own. But, by pooling their funds with other like-minded LPs and working with a GP, they can invest in deals they otherwise would never have had access to.
In a RELP, or real estate limited partnership, LPs involvement in deals when working through a limited partnership structure is, well, limited. In this type of arrangement, the GP takes on all liability should something go wrong with a deal. Essentially, the LP is not liable.
LPs who find themselves working with successful, hard-working GPs with a knack for deal-making can earn significant passive returns. By partnering with a GP, these returns come at no effort to LPs because LPs are not involved in the day-to-day management decisions of the deal or fund.
Hallman recommended that real estate investors looking for a good general partner to work with in commercial real estate prioritize communication. Does the GP have an investor portal? How will they communicate with you throughout the investment process? Many LPs are connected with GPs through word of mouth and personal recommendation. LPs should be selective about who they invest with. They should know a GP is trustworthy and that others have worked with him or her successfully and had a good experience. Look into their track record, past deals and who invested in those deals. Start by talking to friends in the industry or real estate agents you know. “GPs have a lot of power,” Hallman said. “Once you put your money in, you have very little say about what’s going on. The onus is on you. You really have to do your homework.”
Working with a general partner as a limited investor is one way to invest in commercial real estate, and it can be a profitable one for both GPs and LPs. When investigating how to form a general partnership, know that becoming a GP requires hard work and carries with it a good deal of responsibility. LPs looking for a GP to work with should be sure to do plenty of their own research before committing to a GP-LP relationship.
