Private equity real estate investment firms buy properties in one of three ways, all of which can have an impact on investment performance.
They can own the property outright, like buying a house; be active investors in a day-to-day decision-making role; or serve as majority stakeholder, retaining major decision rights on issues such as a sale, financing and the budget, while leaving day-to-day operations to a partner.
All three purchasing options — as a direct buyer, general partner or limited partner, respectively — have different financial requirements, profitability outcomes and demands on company resources.
Generally speaking, given the substantial amount of money required to acquire commercial real estate, smaller firms often serve as the general partner because this role requires the least capital. Meanwhile, larger firms are often direct buyers and limited partners.
Origin is uniquely positioned to participate in all three roles, although we prefer to serve as a direct buyer or general partner, given our collective experience and track record of turning around properties. Here is a more in-depth breakdown of these roles.
Direct Buyer: Given the substantial capital and expertise required to operate commercial real estate, there are high barriers to entry as direct buyers. These challenges are amplified when trying to build a diversified portfolio of investments, especially when they require further capital for tenant improvements, leasing commissions or renovations.
Direct buyers own and operate the asset outright. As such, they can make swift and opportunistic decisions as they have no outside partners to consult.
At Origin, we look to invest as a direct buyer of properties valued between $10 million and $30 million and then hire third-party leasing and management firms to execute our improvement plans.
General Partner: Partnerships make bigger investments practical. Even pension funds and other institutional investors seek to limit risks and gain expertise by combining resources with other investors.
We invest in projects between $30 million and $50 million as a general partner. Such a building price is often out of reach for small, regional real estate investors but often overlooked by insurance companies, REITs, pension funds and other institutions.
Acting as what’s called an operator or general partner, we can partner with these larger companies, and not only invest alongside them but provide asset management services as well.
In exchange for managing the asset, there is generally an economic incentive, called a “promoted interest” for the general partner to manage the property well.
This “promoted interest” is attained through a negotiated structure that works something like this:
If a general partner invests 10 percent of the capital required in an investment and the limited partner invests 90 percent, both partners get their respective investment back at the time of the sale of the property plus an 8 percent to 10 percent return on the investment.
At that point, if there are profits still to be distributed, the general partner may get 30 percent of the remaining pot of money and the limited partner may get 70 percent, even though they initially invested 10 percent and 90 percent, respectively.
This increased share of the pot for the general partner is called a “promote,” which, in turn, dilutes slightly the overall return of the limited partner.
Limited Partner: Finally, we can serve as a limited partner.
Limited partners don’t have day-to-day involvement or control of the business plan, but, given that they generally represent the largest portion of the invested capital in any one deal, they are granted special rights and legal controls.
For instance, the limited partner dictates when the property is sold or refinanced and which firms are retained for leasing and management. The limited partner also has controls over setting budgets and determining how much is spent on capital projects.
Occasionally we invest as both a limited partner and co-general partner in a property. In this scenario, we get to control both the major decisions and also have some impact on day-to-day operations. We also get to share in a portion of the “promote” with the co-general partner, which effectively offsets any dilution that we would have if we were solely the limited partner.