How is a Passive Investment Structured?

A passive real estate investment typically refers to an investment in which the investor does not actively participate in the day-to-day management of the property. Instead, the investor typically contributes capital to a real estate investment vehicle that is managed by a professional real estate manager.

One of the most common passive investment structures is a syndication. A syndication involves a group of investors pooling their capital to purchase a property. The syndicate is typically managed by a sponsor, also known as a manager, who is responsible for finding the property, negotiating the purchase, and managing the asset. The investors receive a share of the profits based on their contribution to the syndicate.

The sponsor is typically know as a General Partner, or GP, and the passive investors are referred to as a Limited Partner, or LP.

Here are some common offering terms that an investor may expect:

1. 1. Equity

Limited Partners can expect to receive 70-80% of the equity in exchange for providing a majority of the capital necessary for a syndication. When equity distributions are made (the profits), Limited Partners will typically receive 70-80% of the equity distributions.

1. 2. “The Pref” - Preferred return

In addition to being entitled to a pro rata share of the profits, Limited Partners are also entitled to a preferred return typically between 6-8%. Preferred returns are usually measured against a Limited Partner’s investment. For example, if a Limited Partner invested $100,000 and there was a 7% preferred return, the Limited Partner is entitled to receive a $7,000 preferred return.

This preferred return must be paid before the equity distributions are paid, meaning that a Limited Partner must receive a 6-8% return on investment before a General Partner is entitled to any equity distribution.

1. 3. Fees

General Partners typically do a majority of, or all of, the required work in a syndication. This includes sourcing the deal, forming the syndication entity, putting the deal together by facilitating the Limited Partner investments and retaining a lawyer to handle the necessary SEC paperwork, conducting thorough due diligence including environmental due diligence, obtaining bank financing, managing renovations, implementing systems and processes at the property, and managing the property. In addition to investing capital into a deal like a Limited Partner, General Partners also pay for the earnest money deposit – which is typically 1-2% of the purchase price – legal fees to form the syndication, and due diligence fees. General Partners also own all of the liability in a syndication, by, for example, providing personal guaranties to banks in exchange for financing.

In exchange, General Partners generally are assigned 20-30% of the equity and collect fees. These fees often include an acquisition fee, asset management fee, and disposition fee. An acquisition fee is generally 1-2% of the purchase price, asset management is 1-2% of the gross income, and disposition is 1% of the eventual sale price when the syndication ends. These fees help to cover some acquisition costs and property management costs.

1. 4. Distributions

Distributions can be scheduled monthly, quarterly (most common), or some other semi-regular scheduled time as agreed upon.

1. 5. Liability

Limited Partners typically have no liability and are not responsible for the day-to-day management of the property. General Partners often own 100% of the liability and use their personal credit and issue personal guaranties, as necessary, to facilitate the property acquisition.

1. 6. Paperwork

Because a syndication is a security, it is monitored by the SEC. The SEC requires that Limited Partners sign syndication documents, such as a Private Placement Memorandum and Operating Agreement. These will be prepared by an SEC attorney retained by the General Partners.

1. 7. Minimum Investments

Most syndications have a $50,000 minimum investment.