Co-Founder and Managing Partner of Disrupt Equity. To learn more about our multi-family investment opportunities, visit our website.
When investing in real estate, everyone has a role in the project that is critical to its success—whether that’s the person finding the deal, the investors, or even the company finding tenants. Two major roles of a real estate deal are the LPs and the GPs. What do LP and GP stand for? Let’s see how these roles work together to make real estate deals possible!
What do LP and GP stand for?
The definitions of these terms are simple:
LP stands for limited partner. GP stands for general partner. General partners can also be referred to as sponsors in the real estate sector or the sponsor team.
Both roles are essential to establish a real estate syndication agreement. One takes care of the equity and the other does all the work, including finding a potential deal, raising capital and bringing it to a close.
What is a general partner?
The general partner(s) of a real estate deal are the “brain” of the operation. They are the ones driving the deal from start to finish.
General partners typically deal with:
- Finding the property.
- Increase capital.
- Arranging the financing.
- Hiring and collaborating with suppliers.
- Make daily decisions about investment strategy.
- Sale of the building after some time (usually five to ten years).
The general partners are the ones who make sure the deal works, and as such, when entering into a real estate transaction, you need to trust and trust the GPs!
What is a limited partner?
A limited partner has one job and one job alone: Providing investment money.
Correct! All limited partners do is provide some of the equity financing needed to make the deal work.
If something goes wrong with the real estate deal, the GPs will be in trouble, not the limited partners. They merely offer an investment of capital in exchange for shares in the building.
In return for their investment, limited partners receive a good return, and they also get a share of the sale when the general partners sell the building for a profit in the future.
How does this work in commercial real estate?
To illustrate how GPs and LPs work together in commercial real estate, let’s look at an example of a multi-family real estate agreement. Suppose a family doctor sees a $10 million apartment building that seems like a great investment opportunity. The general partner will prepare a prospectus and information to raise capital from LPs. This prospectus will contain the expected return, the risks and the strategy for the investment.
Once the general partner has raised enough money to acquire the commercial asset, they will buy the building, organize the property management and once the business plan is executed, eventually sell the property, take out the original loan and distribute the income to the investors.
Along the way, the GP will pay out rent (passive income) to investors as a form of return. They will also handle all tenant contracts and other decisions along the way.
What do the LPs and GPs usually earn?
Limited partners put in money and receive cash flow returns and a final lump sum payment at the end, representing their share of the building’s sales proceeds.
Let’s assume an LP has $100,000 invested in the apartment building above it. Suppose the investment yields 8% cash-on-cash annually and the GP decides to keep the building for five years. In this example, the investor would make $8,000 per year for five years, totaling $40,000. Suppose the building is sold for $12 million after all the renovations, and to keep it simple, let’s assume the loan amount is still $8 million. The total proceeds from the sale would be $4 million, and the investor’s share would be $200,000. The LP would then receive a total of $240,000 of their original $100,000 investment, which equates to a profit of $140,000 or a total ROI of approximately 19% per year.
When it comes to returning GPs, GPs get a fee for driving the transaction through various fees during the purchase and ownership of the property. The four most common fees are:
- Acquisition: 1%-2% of deal size, or somewhere between $100,000 and $200,000 in the example above.
- Management: 3%-6% of the gross income of the property per year.
- Asset management: 1%-2% of the total invested capital.
- disposition: 1%-2% of the sale price of the property.
Finally, in addition to cash-on-cash returns and appreciation, one of the incredible benefits for LP investors is the tax benefits. Any depreciation that occurs on the property is passed on to LP investors in the form of K-1s. Many of the projects target a 30%-50% tax amortization in the first year of investment.
Both LPs and GPs are necessary for a successful real estate deal. The general partner does most of the work and research. The limited partners, on the other hand, invest the money and have limited liability and input in any decision-making process.
Whether you choose a limited partner or a general partner, now is the best time to start. Commercial real estate is one of the best investments out there.