Hey All,
Wanted to provide a quick glossary of key terms relevant to Real Estate Syndication deals and their definitions. These are important to understand when evaluating the high level details of a syndication deal from the stancepoint of a LP (Limited Partner AKA passive investor). Prior to me starting my current job which is heavily involved in evaluating syndication deals, I knew little to none of these terms, so I figure it may help some people out!
General Partner (GP): The manager responsible for running an investment fund. If you created your own syndication, you are the GP.
Limited Partner (LP): An investor who contributes capital to a fund but has limited involvement in its management. If you invest in someone else's syndication, you are a LP
Accredited Investor (AI): An individual or entity that meets specific financial criteria, allowing them to participate in certain investment opportunities, often with higher risk and potential returns. Refer to this link directly from the SEC on eligibility
Qualified Purchaser (QP) : A specific type of accredited investor who meets additional financial thresholds, enabling them to invest in private funds and other restricted investment vehicles. This link provides an overview of the QP definition
Management Fee: A fee charged by the fund manager to cover operational and administrative expenses associated with managing an investment fund. Typically we can see Private REITS charge anywhere between 1-2.5% for a management fee.
Preferred Return: A predetermined minimum return on investment that limited partners (LPs) receive before the general partner can share in the profits. For example, if the preferred return is 8%, the GPs cannot collect any incentive fee until the LPs get 8%.
Incentive Fee: Also known as a performance fee or carried interest, it is a share of the profits earned by the general partner of an investment fund, typically calculated as a percentage of the fund's profits. For example, if the inventive fee is "12.5% over 8% preferred return", that means that once the fund has achieved an 8% return for the LPs, any subsequent profit can be shared by the GPs (they will get 12.5% of all subsequent profits).
Catch-up Fee: A provision in a fund's structure that allows the general partner to receive a higher share of profits after the limited partners have received a specified return. This favors GPs if the fund achieves the preferred return for the LPs. For example, if the incentive fee and preferred return are 12.5% over 8%, but there is a catch-up fee of 100% until the GP gets 8% return, this means that once the LPs get 8% from the fund, they will not get any additional profits until the GPs get 8% as well since they have a catch-up provision of 100% until 8%. After that, they get 12.5% of profits while LPs get 87.5%.
Clawback Provision: A contractual arrangement allowing the general partner to reclaim distributed profits from limited partners in specific circumstances. It allows the general partner to reclaim previously distributed profits from the limited partners under certain circumstances. Typically, a clawback provision comes into effect when the fund's overall performance falls short of meeting certain predetermined benchmarks or when there is an overpayment of carried interest to the general partner. IE: If a fund has a minimum performance requirement of 8% IRR and a incentive fee of 20%, but only achieved a 6% IRR, they GPs would not be entitled to 20% of profits and would have to give a portion of it back to the LPs. This aligns GPs and LPs.
Hurdle Rate: The minimum rate of return that an investment must exceed before the general partner can receive incentive fees. Also knowns as Preferred Return, but important to know as there is a Soft & Hard Hurdle.
Soft Hurdle: A hurdle rate that only applies to a portion of the fund's profits, typically calculated after the preferred return has been achieved. IE: for 12.5% over 8%, GPs only get 12.5% of profits , not including any of the 8% that the LPs received first.
Hard Hurdle: A hurdle rate that applies to the entire fund's profits, including both the preferred return and the general partner's share. This is more favorable to GPs and less so to LPs.
Placement Fee: A fee charged by the fund manager to compensate brokers or placement agents for securing capital commitments from investors. Can range from 0-5%.
Liquidity: The ease with which an investment can be converted into cash without significantly affecting its price. If a fund term is 10 years, you may not have liquidity beyond the distributions you get paid until the end of the term.
Onshore and Offshore Funding: Refers to the location of the investment fund and its investors. Onshore funding involves investors and funds domiciled within the same country, while offshore funding involves investors and funds based in different countries. You'll see this in larger private REITs where they stipulate if they allow offshore
Distributions: Payments made to investors from the profits generated by the investment fund. Important to note that REIT distributions are often tax-advantaged due to REIT status and/or also return of capital (ROC)
Fund Term: The specified duration or lifespan of an investment fund, typically ranging from several years to a decade or more. Also important to read the fund details as sometimes GPs will include a provision that allows them to extend at their discretion for a certain number of years.
Target Fund Size: The predetermined amount of capital that the fund aims to raise from investors.
General Partner Commitment: The capital contribution made by the general partner to the investment fund, demonstrating their alignment of interest with limited partners. It is important to note whether the GPs are substantially committed as this shows they have skin in the game as well.
IRR (Internal Rate of Return): A measure used to evaluate the profitability of an investment by calculating the discount rate that equates the present value of cash inflows and outflows. In short, it is a measure of profitability...the higher the better. You can look at previous funds from the GPs and evaluate their IRRs to see what type of return they have been able to achieve. Also important to note whether the IRR is net or
MOIC (Multiple on Invested Capital): The ratio of the total distributions received by investors, including at fund termination, to the total capital they initially invested. This is more common in Private Equity but can show up in some Private REIT deals.
DPI (Distributions to Paid-In Capital): A metric that shows the proportion of capital that has been returned to investors relative to the capital they have contributed. This is more common in Private Equity.
TVPI (Total Value to Paid-In Capital): The ratio of the total value of the fund's investments plus any remaining unrealized value to the capital contributed by investors. This is more common in Private Equity.
RVPI (Residual Value to Paid-In Capital): The ratio of the unrealized value of the fund's investments to the capital contributed by investors. This is more common in Private Equity deals.
I hope this glossary helps! Let me know if you'd like clarification on any term or definition, or would just like to talk shop on Private REITs (or any alternative investment for that matter).
