Demystifying Real Estate Limited Partnerships and the Role of Sponsors

What are Real Estate Limited Partnerships?

Real Estate Limited Partnerships are vehicles that Sponsors set up to invest in real estate.

Real Estate Limited Partnerships can be set up as a Limited Partnership (“LP”) or a Limited Liability Company (“LLC”).  Investors invest in the entity that will be acquiring the asset, which is the essence of Real Estate Limited Partnerships.  The entity that the investors invest in then owns the property directly.

What is a Real Estate Sponsor?

Sponsors are real estate investors who acquire, own, and manage real estate.  Sponsors set up Real Estate Limited Partnership to acquire a property, finance the property, manage operations, and raise capital from investors who want to invest in a particular deal.

What is the Role of a Sponsor in Real Estate Limited Partnerships?

The Sponsor is responsible for finding deals, analyzing deals, doing due diligence on deal terms, and engaging with third parties to coordinate property Inspections for appraisers and over vendors.

Sponsors are also responsible for sourcing debt capital for the property.  They also do the initial underwriting and analysis related to closing the loan.  Sponsors are responsible for finding and vetting limited partners/members to invest in the entity that will buy the property.  Sponsors ensure that all of the documentation is prepared properly with the private placement memorandum, the subscription agreement, and that the bank accounts are set up to receive the investment capital from the investors.  

Real Estate Sponsors are then responsible for the property operations at that particular property, which includes overseeing the property management, accounting, finance and tax matters at the property.

Once the property is owned, Sponsors are responsible for implementing a renovation strategy or a capex strategy and they are responsible for overseeing the leasing of a property either on their own or through a broker.

At the end of the day, Sponsors are involved with every facet of the business related to real estate investments.

What are some benefits of Real Estate Limited Partnerships?

Real Estate Limited Partnerships can be fantastic vehicles for both the Sponsor and for the investors.  

For the Sponsor, a major benefit is that Sponsors can identify and acquire more deals.  If a Sponsor was investing in deals on their own, there would likely be a time when the Sponsor did not have enough capital to continue with an aggressive investment strategy.  By bringing on co-investors, Sponsors are able to raise the capital for the various investments from investors who can share in the cash flow and profits from the real estate investment.

By having co-investors, Sponsors also benefit because Sponsors charge fees for acquiring, managing, and financing the property that the entity owning the property pays to the Sponsor.  And one further benefit is that the Sponsor earns upside through a financial promote when the property performs above a certain level for the investors.  

Investors benefit from  Real Estate Limited Partnerships because they are able to get diversification by investing in multiple asset types in various geographies with multiple Sponsors.  Through Real Estate Limited Partnerships, investors also gain access to deals that they may have never seen or otherwise known about that they now have the ability to earn passive flow and profits from.  Real Estate Limited Partnerships typically also have smaller investment minimums, so investors are able to spread their net worth around while obtaining diversification for their capital.

Real Estate Limited Partnerships can also be advantageous from a tax standpoint because while Preferred Returns are taxed at ordinary income tax levels, the capital gains are taxed at a lower level for long term investments. As such, you can have long term capital gains tax rates as low as 15% depending on your personal situation.

Real Estate Limited Partnerships also benefit from depreciation, which reduces the taxable income that an investment group may have to pay on a property. Also, depreciation, oftentimes in the early years can shelter all the income, which means that the property will have positive cash flow, but the income may be fully or partially sheltered by depreciation.  This would enable you, as the investor, to have a tax neutral situation or you could have a taxable loss at the property.  What a situation – cash flow positive at the property and tax loss for income tax purposes.  

Another way that Real Estate Limited Partnerships can be beneficial is upon a property refinance. Oftentimes, it is possible to do either full or partial cash out refinances that have no impact on the tax liabilities of the partnership or the individual.  There are many times when Sponsors are working on a large cash out refinance while they are also looking for additional properties to invest in using the cash out refinance proceeds.  The cash out refinance proceeds can be reinvested in another cash flowing deal with upside.

Yet another benefit of Real Estate Limited Partnerships is that Real Estate Limited Partnerships also have the ability to be tax deferred upon a sale.  Therefore, it is possible in the US to do a 1031 exchange, which gives investors the ability to defer taxes for a longer time period if you roll the proceeds from the sale into another property.  That means that you can defer taxes due from the sale during the ownership period of the new property and you can continue to benefit from the tax advantages related to 1031s because you can continue doing 1031 exchanges on properties each time that you sell an asset.

Not everyone utilizes 1031s.  Sometimes, you hear Sponsors say that they would rather sell an asset, pay the taxes, and then move onto another deal that has no time pressure.  That way, there is no issue with long term capital gains or depreciation recapture.

Another benefit of Real Estate Limited Partnerships is that investors, generally speaking, do not have the wherewithal to invest and manage good quality assets at scale. Many of the most successful real estate investors are passive real estate investors, and these passive real estate investors find good Sponsors to invest with that they know, like, and trust.

Investors can spread their risk around by asset type, geography, and also by Sponsor.  Many real estate investors are also investing in various countries to get diversification through different economies and potentially even to different currencies.  Currently, we are invested in nine countries.  We have exposure to five different currencies.

My diversification strategy is always to get exposure to different asset types, geographies, Sponsors, and currently.  I have investments in multifamily, industrial, residential, cold storage, office, retail, mixed-use, and hotels currently.  

I’m a big believer in diversification of your finances and of your portfolio, and believe that a balanced Real Estate Limited Partnership strategy investing with multiple, reputable Sponsors is your best avenue for long term passive cash flow and net worth growth.

Let’s continue growing our cash flow and net worth together!

– Robert

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