Strategies and Partnership Structures in Commercial Real Estate

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The seemingly endless strategies and partnership structures available to investors in commercial real estate can feel overwhelming. Fortunately, you can model your potential partnership structures on paper before signing any dotted lines.

If you want to model hypothetical commercial real estate projects, you will need to build upon clear and defined assumptions. These are some of the considerations you should include in your project model.

Investment Summary

  1. Building size, useable space.
  2. Parking spaces, amenities.
  3. Construction or rehabilitation timeframe.
  4. Timeframe for analysis (and exit).

Valuation

  1. Market cap rate for comparable properties in the region.
  2. Forecast growth in cap rate.
  3. Expected cap rate at exit.

Development Assumptions

  1. Land cost with entitlement.
  2. Hard construction/rehab costs with 5% contingency.
  3. Soft costs with 5% contingency.
  4. Leasing costs.
  5. Real estate development timeline.

Financing

  1. Interest rate
  2. Loan type
  3. Origination and other loan fees

Other items you need to consider are operating expenses, vacancy rates, and rent roll income.

Last but not least, the equity split between limited and general partners (often 90/10 LP/GP), the Promote (a financial interest provided to the investment manager as an incentive to maximize performance, payable once the investors have received back their entire initial capital contributions and achieved certain profit thresholds), and the preferred rate of return (the preference given to a certain class of equity partners when distributing available cash flow).

Partnership With a Real Estate Agent, and Other Provisions

A provision in a real estate partnership agreement authorizing a partner who is a real estate agent to retain commissions on partnership property bought and sold by that partner would be an example of a type or category of activity that is not manifestly unreasonable.

Likewise, a provision in a general partnership agreement or joint venture agreement enabling partners to buy or sell real property on their own accounts, without prior disclosure to the other partners or first offering it to the partnership, would be considered a valid activity of individual partners.

Partnership agreements frequently contain provisions releasing a partner from liability for actions done in good faith, so that personal assets are not at risk.

Detailed agreements can specifically list activities that would not constitute gross negligence or willful misconduct. However, language which absolves partners of intentional misconduct would probably be deemed unreasonable in court, and could possibly result in unlimited liability for the willfully negligent party.

Master Limited Partnerships

This type of ownership vehicle is especially common in real estate or oil and gas ventures. It’s usually created by “rolling up”, or “buying up”, existing limited partnerships that own property.

For example, a real estate entrepreneur could syndicate 30 properties over a 10 year span of time, with each one a separate limited partnership. All could then be marketed and sold together as one large entity, a master limited partnership.

By the way, 30 is very close to the magic number of 35. When you want to sell to more than 35 investors, you’ll need approval from the SEC and/or state securities agencies, as that’s the threshold for registration requirements and regulation as a public offering.

The Passive Investor in Partnerships

If you don’t want to manage your commercial real estate investment, because you lack either the skills, time or desire, you can form a general partnership with someone who does have the skillset for managing property, ideally a qualified and experienced real estate syndicator who will devote the time and expertise in managing the property for profit. When you contribute money, but not effort, you are a passive investor.

The Real Estate Limited Partnership (RELP)

When two or more investors pool their money to invest in the purchase, development and/or leasing of real property, and they form a limited partnership, one general partner typically assumes full liability (normally mitigated by insurance), with the limited partners liable only up to the amount they contribute.

An active real estate partnership could consist of two investors in a portfolio of single-family rentals.

RELPs file information return and don’t pay taxes directly. Net income or losses are passed along to investors, who are responsible for tax reporting.

RELPs are marketed with detailed partnership agreements that define the terms of the entity and the overall investment opportunity. HNWI (high net worth individuals) and institutional investors are the most frequent participants in this type of endeavor and are in fact often appreciative of losses that can offset other income.

Most RELPs will start with the narrowly defined focus of a neighborhood shopping center, commercial office building, or an industrial park; perhaps with warehouses and data centers.
There can be flexibility for various business activities within the portfolio. A RELP might undertake direct investment in real estate properties, credit issuance for real estate borrowers, proportional capital investments, or participation in a collaborative business deal.

Your Partnership. Your Strategy.

Before drafting your partnership agreement, make sure you’ve run your own numbers and that you trust your partners. Make sure you’re all on board with your chosen strategy. The more work you put in now, the less likely you are to fail.

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