In a typical syndication real estate deal, there are two primary classes of ownership shares. These are the limited partner (LP) shares and the general partner (GP) shares. The GP shares on a real estate deal are awarded to the investors who are putting the deal together and providing the sweat equity. The limited partner shares are given based on capital that has been placed into the deal. A lot of questions go into understanding the structure of a deal and whether it favors the LP or GP investors. While both investors should benefit from a well executed real estate deal, here are a few indicators that show the GPs concern for the LPs interest in a given syndication.
Is there a preferred return or waterfall structure?
A preferred return is a promise to LP investors for the first returns provided from cash flow in a syndication. Although this can be any amount, 6%-7% is typical in today's market depending on the quantity of cash flow generated from the deal. A preferred return is a great indicator that the GP team is concerned for the returns provided to LPs. It is important to ensure that in the event a preferred return is not met with cash flow on a given deal, that it will be paid out first from the profit at sale. A waterfall return structure is for the split between GPs and LPs after the preferred return is paid out. A typical initial split is in the range of 70/30 to 80/20 (once again depending on the projected returns on a given project). A waterfall will change that split once a return slightly higher than projected is reached to perhaps a 50/50 split. This means the larger split up front to LP investors places their interests first while the waterfall split encourages high performance from the GP team who is rewarded for going above and beyond.
Are the GPs also invested in the deal?
Quantifying an exact amount that GPs should invest as LPs in a given deal can be difficult since so many variables come into play depending on the deal size, lender liquidity requirements and other factors. However, ensuring that some or all of the GPs have money invested in a deal is another great indicator that they will have the best interest of the LPs in mind.
Is the deal "fee heavy?"
In the world of commercial real estate, a seller is normally represented by a broker while the buyer is left to represent themselves in placing an offer on a property and getting the deal to the finish line. This process takes an enormous amount of time and expense and it is therefore normal to see an acquisition fee for the GP team in the deal structure. Additionally, a nominal asset management fee is also common for the task of executing the business plan by working with the property manger. This is especially true in a tight market where minimal cash flow is often left for GP investors once a preferred return is paid out. While the specific amounts for the fees may vary depending on the project, comparing various deals in a given market and understanding the GPs reasoning for setting a certain fee structure can help to determine if the fee structure is fair for both parties. While other fees are sometimes used and justifiable on syndications, these are the two most common and reconciling additional fees on a deal can be done in a similar manner.
There are many important considerations when evaluating a multifamily deal and we make it our mission to careful vet each of these items. If you would like to learn more about passively investing in multifamily, please set up a meeting with us through our Calendly link and subscribe to our weekly blog here.
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