What are reasonable LP terms for a CRE deal?

Question

My question is: What are reasonable terms for an LP in a commercial / multifamily investment that I can draft up and have my CPA and lawyer review? I don't want to come to the table empty handed. In order to fund both deals, I will need to bring on limited partners. I want to make sure that the terms are reasonably enticing for an LP to invest with me, but not take over all profit and leave me out.

The deals:

I am under contract on two commercial properties; 1. 11,000sq/ft lot with a rundown building currently standing - I plan to tear it down and build a 17,000-20,000 sq/ft 4-story mix-use commercial stores on ground floor and 18 units on the 3 floors above, and 2. Buy a 13 acre run down old mill property which has 10 developable acres and an operating 6 unit dry storage warehouse and small 1,500 sq/ft office building.

Property 1: Purchase is $275,000 and construction costs are expected to be just shy of $6M.

Property 2: Purchase is $1.5M for all 13 acres which includes the warehouse, 6 unit office space, and 10 developable acres. I have no current development plans in place yet - I'd be looking to either sell off the 10 developable acres  and keep the warehouse and 3 acres to build a few SFH myself or partner with venture capital to develop the 10 acres it for me - while my equity in that deal would be the land itself.

I plan on investing $350K split between both deals - unsure yet how I want to allocate that capital.

Nick Belsky · Answer

@Zach Herbert-Burns

I am literally going to copy and paste a flyer from one of my PE lenders.  This is pretty common for what I am seeing in any LP or JV deal right now.

JV Interest Preferred Equity, no recorded lien, no hard pay, no maturityInvestment Size $1 to 30 millionSponsor Capital 10% of total capitalizationTypical Waterfall Cash Flow:1. First, to pay debt service2. Next, to pay an ~8.5% cumulative compounded preferred return3. Next, to pay sponsor an ~8.5% cumulative compounded return4. Then excess cash distributed ~2/3 to sponsor, ~1/3 to LP Transactions:1. First, to repayment of senior debt2. Next, return of LP equity with a >8.5% IRR lookback3. Next, return of sponsor equity with a >8.5% IRR lookback4. Then, ~2/3 to sponsor, ~1/3 to LPTerm Sponsor and LP exit option via buy/sell Targeted holding period typically 3 - 5 years, flexibility for longer hold periodsCovenants Approval on all major decisionsTransfer rights under mortgageRight to retain participation interest if repaid via refinance

JV Interest

Preferred Equity, no recorded lien, no hard pay, no maturity

Investment Size

$1 to 30 million

Sponsor Capital

10% of total capitalization

Typical Waterfall

Cash Flow:1. First, to pay debt service2. Next, to pay an ~8.5% cumulative compounded preferred return3. Next, to pay sponsor an ~8.5% cumulative compounded return4. Then excess cash distributed ~2/3 to sponsor, ~1/3 to LP Transactions:1. First, to repayment of senior debt2. Next, return of LP equity with a >8.5% IRR lookback3. Next, return of sponsor equity with a >8.5% IRR lookback4. Then, ~2/3 to sponsor, ~1/3 to LP

Term

Sponsor and LP exit option via buy/sell Targeted holding period typically 3 - 5 years, flexibility for longer hold periods

Covenants

Approval on all major decisionsTransfer rights under mortgageRight to retain participation interest if repaid via refinance

Zach Herbert-Burns · Answer

@MasonLiu,

Thanks for your input! So if I'm understanding you correctly, the 1-2% management fee is based off a % of the NOI, and then once I take a management fee, the LP will receive their 10-12% preferred fee as a portion of monthly NOI and will receive an additional 15-20% above that if/when we exit if there is a profitable capital gain upon the sale?  I will be developing in an Opportunity zone - so my minimum hold period to realize the tax savings on capital gains is 10 years. Would you recommend a fund term of 15 years, for example, if I plan to sell right at the 10 year mark? What is a good strategy to pay back LPs if I plan to hold for 20+ years?

Mason Liu · Answer

Here are some potential terms you could consider:

Management Fee: 1-2% (just to make sure you get paid for your efforts)

Preferred Return and Incentive Fee: 15-20% incentive fee over 10-12% preferred return to LPs (this is so you get rewarded after LPs get a certain rate of return upon exit. Since this sounds like a longer term deal, I do think it is important to provide some preferred return to give LPs incentive to invest with you)

Distributions: No firm timeline on distributions, but would be allocated once cash flow occurs

Fund term: give yourself much more time than your expected exit. If you are able to exit early and provide a return to LPs, I'm sure they will be happy. Problem is if you the market conditions do not allow for your original exit timeline and you can't wait and are forced to exit at unfavorable conditions.