The Path To Wealth Without The Work

Understanding how limited partnerships operate allows you to build wealth without the work. A limited partner real estate structure is a popular way for investors to combine their resources, knowledge, and capital to scale their real estate investments.  With the right partnership structure, we create opportunities otherwise not available..

What is a real estate limited partnership?  A real estate limited partnership (LP) is a type of real estate investment where multiple investors pool their money to purchase or develop real estate. The LP is made of  general partners (GP) who find the deal,  manage the investment and assume the liability.  The limited partners are  passive investors who provide equity to fund the deal.  An investor with management experience that secures a deal on a great investment property, but with limited funds, can partner with investors with the capital.  These limited partner investors may not have the management experience or may just want to invest in a deal without having to worry about the day-to-day operations.  LPs are common structures for real estate syndication and equity crowdfunding.

How is a real estate limited partnership structured?    Both LPs and GPs have equity in limited partnership deals, but the contribution, responsibilities, and liabilities are different between the two. The investment returns are also distributed differently between the two in most cases.

1. General partner (GP):  The general partner is responsible for setting up the partnership, handling the transaction, securing the financing, and managing the investment. The general partner is usually the one who finds the deal, and typically invests some level of equity in the project (i.e., 5%).  

2. Limited partners (LP):  The limited partners in a real estate limited partnership are the passive investors. They contribute capital to the partnership to earn a return on their investment. These partners benefit from having limited liability in the investment.  The limited partners have little to no involvement in the daily operations of the investment (silent partner), but have 24/7 access to the General Partners for any questions or feedback. They're considered "silent partners." 

How are distributions handled?  Profits are distributed among partners based on how the partnership agreement is structured. Profits will be shared at regular intervals if the partnership has invested in an income property. It's common for a real estate limited partnership to offer a preferred return to the limited partners. This means that the limited partners have to receive a minimum return on their investment before the general partner can share in the profits.  There are a number of ways this profit split can be structured. It's often structured in a way that gives the general partner more incentive to increase the profits by offering a larger split as the return increases. This split may start out as 70% to the limited partners and 30% to the general partner and increase to 50/50 if the total return hits a certain milestone.  A simple example of a preferred return structure:

• Preferred return: 6%

• If the total return during a period is 5.5%, all of the profit will be paid to the limited partners.

• If the total return during a period is 7%, then 6% will be paid to the limited partners and the other 1% will be split between the general partner and limited partners according to their agreement (i.e., 70% to the LP’s and 30% to the GP’s in the above example).

This is great but what about Uncle Sam’s cut? The partnership is required to file Form 1065, which reports the net income or losses after all deductions. The partnership is required to provide each partner with a schedule K-1, which shows the income they received throughout the year. LP investors are able to enjoy the same tax benefits as if they were investing in real estate on their own. Depreciation and interest expense can be deducted to reduce each partner's tax liability.

Brass Tax, what are my benefits and risks?  There are many benefits, as well as risks, with a LP for both the general partner as well as for the limited partners as outlined below:

General Partners:

• BENEFITS

1. The ability to invest in larger deals by partnering with other investors

2. Sweat equity

3. Income from asset management fees

• RISKS

1. Capital invested

2. Liable for loan

3. Personal assets

Limited Partners:

• BENEFITS

1. Liability limited to the amount invested

2. Passive investment

3. Real estate tax benefits

4. Pass-through entity

5. Preferred return

6. Real Property diversifies and balances your investment portfolio, inflation protection, equity accumulation, and higher returns

7. There may be additional benefits to investing in a partnership as a limited partner depending on the exact terms of the partnership agreement.

• RISKS

1. Capital invested

2. General Partner trust

3. Investments aren't liquid