The Secret of Preferred Returns for Passive Income - A Real Example

Are you intrigued by real estate investments but prefer a hands-off approach? Do you want to earn money while you sleep, similar to investing in mutual funds or stocks, but in the realm of real estate? If so, you're in luck because I'm going to share a real estate secret that can help passive investors like you align your interests with general partners or sponsors and operators.

The Passive Investor's Dilemma

Many investors are attracted to real estate for its potential returns but are hesitant to get involved in the day-to-day operations of property management, fixing plumbing issues, or collecting rent. They want a real estate investment that's as simple to analyze and deploy as investing in traditional assets like mutual funds or stocks. Fortunately, there's a smart way to achieve this by structuring your real estate investments in a way that aligns everyone's interests.  Recently, I shared this and more on my podcast: 

The Alignment of Interests

The key question for passive investors is how to ensure their interests align with those of general partners or sponsors, often referred to as operators. Motivation plays a vital role in this alignment. As a limited partner (the passive investor), your primary motivation is to recoup your capital as quickly as possible so you can reinvest and grow your wealth. Conversely, the general partner's motivation is to generate good returns for investors while building their portfolio and business. To bridge this gap, a smart strategy is to implement something called a "preferred return."  

The Power of Preferred Returns

A preferred return is a powerful tool to ensure that everyone's interests are aligned in a real estate investment. It sets a specific percentage return that must be achieved before any profit-sharing begins. Here's how it works:

Example Scenario:

Let's say you're investing $100,000 in a real estate project with a 50-50 profit-sharing agreement between you (the limited partner) and the general partner. However, you've negotiated an 8% preferred return.

The Breakdown:

• The property generates $10,000 in annual cash flow.
• Before profit-sharing, the investor is entitled to an 8% return on their $100,000 investment, which amounts to $8,000. This money is paid to the investor first.
• After satisfying the preferred return, the remaining $2,000 in cash flow is then split 50-50 between the limited partner and the general partner.

In this scenario, the general partner has a strong incentive to complete the renovation, lease up the property, and execute the business plan as quickly as possible. Why? Because until the investor receives their preferred return, the general partner only makes $1,000 (50% of the remaining $2,000), whereas they could potentially earn $5,000 (50% of the entire $10,000) once the preferred return is met.

Conclusion

If you're considering investing in real estate through a syndicator or operator, it's crucial to insist on a preferred return structure. This ensures that your interests as a passive investor are aligned with those of the general partner. It motivates the general partner to work diligently to meet your preferred return, ultimately benefiting both parties.

So, remember the power of the preferred return when structuring your real estate investments. It's the smartest way to ensure that you and your investment partner are on the same page, working together to maximize returns. By implementing this strategy, you can make your real estate investments as hands-off as you desire while still reaping the rewards.

Take Care, 

Ryan 

PS - to discuss passive income real estate opportunities, go to: https://linktr.ee/serviocapital