The Role of Real Estate Limited Partnerships in a Diversified Portfolio 

Real Estate Limited Partnerships should be an important part of both a diversified overall investment strategy and of a diversified real estate portfolio specifically.  Obtaining a diversified portfolio is something that many investors strive for.   

Many investors are also seeking alpha, which means that they are looking for a return on investment over the market return or a market index.  Alpha can be considered the active return.  Real estate investing can be a consistent provider of alpha, as Investopedia reported that a diversified real estate investment portfolio returned over 10.6% over the past 20 years while stocks averaged 8.6%.    

Goals of investing in Real Estate Limited Partnerships 

A primary goal of mine when investing in Real Estate Limited Partnerships is to preserve capital invested in a deal.  Real estate is a physical asset.  Over time, values should increase, but they do not always go up, so I am concerned with cost basis.  Cost basis is the amount you pay for a property when you acquire the asset.  If it costs $200 per square foot to build a similar property in your market and you can buy a property for $150 per square foot, you have some comfort that it will be challenging for developers to build new product to compete with your property.  

Another goal of mine when investing in Real Estate Limited Partnerships is to obtain the most cash flow possible for each investment and to create the highest risk adjusted return possible through a combination of cash-on-cash returns and profit.  Guardrail Finance looks for opportunities with good in-place cash flow that also provide growth or profit potential through value-add strategies and through tax benefits. 

Four ways to build diversification with Real Estate Limited Partnerships 

Guardrail Finance proposes four ways that are of the utmost importance in building a diversified real estate portfolio.   

The first way Guardrail Finance proposes to create a diversified portfolio is based on asset type.  Not all real estate performs the same in every market.  While multifamily has had a fantastic run over the last 20 years, commercial real estate and certain submarkets of commercial real estate, like industrial or office have also had great run-ups, and have yielded very high risk adjusted returns.  It’s important to make a concerted effort to not only invest in one asset class.  And the way to do that is to not only invest on your own, but to also invest with other sponsors who have strong performance in a particular asset class that you might not. 

Another way to build a diversified real estate portfolio is by investing in various geographic regions.  Investing in one market (or MSA) can be detrimental to your overall returns, especially if that market ends up having local law changes or takes a big economic hit due to a company closing down in that vicinity or if that market has population and/or job out migration.  For that reason, it’s wise to combine both asset diversification and geographic diversification into your portfolio.  

A third way that you need to have geographic or diversification in your real estate portfolio is by investing with multiple sponsors.  I take an approach where I not only invest on my own, but I also invest with other Sponsors.  I invest with other Sponsors in asset classes and/or markets that I know and also invest in.  I also invest with other Sponsors in asset classes that I may know but in geographies where I don’t have direct experience.  And I invest with other Sponsors in markets that I don’t have direct experience in and in asset classes that I don’t invest in directly.   

A fourth way that Real Estate Limited Partnerships play an important role in a diversified portfolio is through foreign currency.  If you have the inclination to invest in markets outside your home country, you have the benefit of not only investing in markets with geographical differences, but also with economic differences.  The economic drivers in another country are often times different than the economic drivers in your home country.  Having these currency, geographic, and economic differences can bolster your returns over time.  Investing in real estate outside of your home country can also aid in preservation of capital, as there are some markets especially when you think of major European cities that have been able to hold value for centuries.   

Benefits of investing in Real Estate Limited Partnerships 

Indirect investments can provide opportunities to defer or negate capital gains taxes through Opportunity Zones, which were created as part of the 2017 IRS Tax changes.  Through Opportunity Zone fund investments, you can create a situation where you can reduce your taxes over time solely through the investment.   

In addition to looking at factors like that, Real Estate Limited Partnerships offer you the ability to create positive cash flow without having to do much more than the initial analysis on the deal, the Sponsor, and the geographic location.  Real Estate Limited Partnerships also give you exposure to investments outside of the financial markets, which generally have a lower correlation to the stock market.  This is an added layer of asset diversification.  If the stock market drops, it does not necessarily mean that your real estate earnings will also be reduced.  That’s not always the case if you are invested in REITs, which have more correlation to the stock market.   

As a limited partners or when you are a limited member in an LLC, you will have less liquidity than when investing in the stock market, but you are less correlated to the financial markets as a whole and you have a better chance to receive both higher preferred returns and higher overall returns over time than you would receive from the stock market.   

Real Estate Limited Partnerships offer the benefit of flexibility compared to direct real estate investment.  Real Estate Limited Partnership offer the benefits of being able to invest smaller amounts of money into a wider range of deals with a wider range of Sponsors and in a wider range of geographic areas to help you obtain optimal diversification. 

Real Estate Limited Partnerships allow you to sprinkle your net worth around a number of deals in various markets. 

When you invest on your own directly, you end up being responsible for the real estate, the financing, the operations, and both the gains and losses.   

It is imperative to diversify into multiple Real Estate Limited Partnerships.  You should be able to yield cash-on-cash returns in the 5% to 8% range, IRRs in the 10% to 15% range, and equity multiples in the 1.50x to 2.00x over the course of five years.   

In many instances, investing in passive real estate deals gives that opportunity for cash flow and capital growth without having to do much of the work.  This can be a better option for investors who want exposure to real estate without having to make the day-to-day decisions while still giving the investor the ability to make choices in the investments that they want to be invested in. 

When investing in REITs, you choose a company and a management team, but you don’t have control over their operational costs and you don’t have control over the assets that they invest in, which often times makes REITs harder to value.  Some of these REITs may invest in tertiary markets and take risks that you would not normally take.  REITs can also place higher amounts of debt at the property level than you are comfortable with and the REITs could even be putting debt at the entity level, which may not be aligned with the investors’ interests. 

With Real Estate Limited Partnerships, you make a choice to invest in a particular asset in a particular geographic region with a particular Sponsor.  Investing in single asset entities gives you choice.  The investment is one that you believe in based on the business plan, property, location, and Sponsor.   

And over time, if you sprinkle your net worth around a number of deals that you believe in, you have a better chance to grow your passive cash flow and increase your net worth. 

Downside of Real Estate Limited Partnership 

There are multiple downsides of Real Estate Limited Partnerships.   

The first downside of Real Estate Limited Partnerships is that your investment is illiquid.  You make an investment and you are in the investment until the Sponsor decides to sell the asset.  

The second downside of Real Estate Limited Partnerships is that your preferred return is based on ordinary income tax rate.   

The third downside of Real Estate Limited Partnerships is that you cannot always make a choice about whether you will defer taxes.  Once you sell the property, you will be subject to long term capital gains as long as you hold the property for investment for longer than a year, but if a Sponsor decides that they just want to sell the asset and finalize the investment, then the limited partners generally do not get to defer taxes if they would otherwise prefer to do so. 


Real Estate Limited Partnerships are an important avenue for your diversification.  Furthermore, real estate is an important asset to allocate your net worth into to obtain a diversified portfolio.  Whether the majority of your investments are in stocks, bonds, venture capital, or even with your business that you may own, it is necessary to have exposure to real estate in various asset types, various geographies, and with various sponsors.  Otherwise, you are doing yourself a disservice in creating a diversified portfolio with exposure to multiple asset types. 

Your allocation to real estate is going to be different than other investor’s allocations based on your preferences.   

I am heavily invested in multifamily although my concentration in commercial real estate is substantial and growing.  In addition to multifamily, I invest in industrial, mixed-use service office and service retail, triple net (NNN) properties, high-tech office space, parking garages and self-storage.  Another area that I invest in is high-yield debt instruments with lower loan-to-value ratios as an investment strategy for preservation of capital and for a higher risk-adjusted returns. 

Regardless of how much real estate you ultimately invest in, it is wise to have exposure to real estate with a broad mix of asset types and classes, geographies, and with multiple Sponsors.   

Until next time, let’s continue growing our cash flow and next worth together! 

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