How We Use Limited and General Partnerships in our Real Estate Funds
An investor in a real estate acquisition or development opportunity can reap big rewards if their investment pays off. But they also shoulder all the risks and responsibilities, and need to be an expert in all aspects of investment. At Origin, we structure a variety of partnerships with developers to share resources, limit and distribute risks, and leverage the expertise of our trusted colleagues. One way we do that is through limited partnerships in real estate investments. Another is through general partnerships. By using these approaches, we deliver high-quality assets, control costs, mitigate risks and ensure that investment returns are maximized.
Real estate investors, individual partners and large pension funds alike prefer using partnerships with real estate investments given the tax efficiencies and legal protections provided. And while there are several types, we’ll focus on the two that we use the most on our projects: limited partnerships (LPs) and general partnerships (GPs). We’ll define how each role functions and explain how we employ them.
In two of our open Funds, Growth Fund IV and QOZ (Qualified Opportunity Zone) Fund II, we invest our capital in ground-up multifamily projects that require tens of millions of dollars. These real estate investment partnerships involve LPs and GPs, which play complementary roles in each phase of the development, from funding and acquisition through construction and management. We usually play a limited partner role, but we have found many advantages in operating as a co-GP as well.
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General and Limited Partners: Responsibilities and Risks
The general partner (GP) typically identifies the site to build on and conceptualizes the layout of the site and property to be built. They acquire the land, execute pre-development zoning, entitlements and site work, and provide construction and development services. The GP invests less capital—typically 5% to 20%—but they invest earlier, in the riskier phase of the project. Their job as sponsor is to get the project shovel ready. That process is expensive, involving legal, architectural and other fees, and it can take from six months to several years. During that time, the deal may fail.
Because this early investment entails more uncertainty and risk than later phases, partnership agreements from a GP earn a disproportionately higher share of profits than LP investments when executed successfully.
The limited partner (LP) typically provides capital—anywhere from 80% to 95% of the total required equity—to the development project after some or all pre-development tasks are complete. In exchange, LPs typically control or have veto rights over all major investment decisions. For instance, the LP dictates when the property sells or is refinanced, and which firms to use for leasing and management. The LP also controls the budgets and determines how much to spend on capital projects.
LP investments incur less risk than GP investments. So LPs typically earn a lower relative share of profits than GPs in a successful project. In rare cases, some LPs get priority on a project’s returns ahead of GP investors up to a pre-determined total return or internal rate of return (IRR). More typically, both GPs and LPs earn what is called a pari passu (Latin for “in equal proportion”) return on their invested capital up to say, a 9% to 10% IRR. Then, a waterfall is provided over incentive hurdles that provides a disproportionate share of profit to the GP as the project reaches various levels of profitability.
Why We Play LP, GP and Co-GP Roles in Real Estate Properties
One of our Growth Fund IV deals is a single-family rental development outside Austin, Texas, called Preserve at Star Ranch. For this 310-unit property, we are providing co-GP and joint-venture LP equity alongside an experienced sponsor partner. That GP will be the real estate development firm. But in this “hybrid” co-GP role, we fund some pre-development expenses and take on some of the risk alongside them.
We act as a general partner for several reasons:
We can provide higher-margin capital earlier in a deal. When we find a good deal, we want to put a meaningful amount of money into it. Operating as a co-GP allows us to get a disproportionate share of the upside for putting the deal together.
We can tap into a pipeline of opportunities. We have programmatic relationships with sponsors contractually obligated to offer us LP investment opportunities because we are providing them with GP capital. And because we have been assisting early on, we are in the best position to decide whether to participate as the LP.
We can add value by offering expertise. We are working on many projects simultaneously across the country. So, when we act as co-GP in a deal, we bring market intelligence and design input. That’s everything from how to deploy technology, which wood frame closet shelving is more attractive and offers a better return, or whether to build more junior one-bedroom apartments with an office nook for people who work from home. Because we are coming in early, we have input on key aspects of the project.
We can keep our team and operating costs lean. Our ability to act as a co-GP helps us win more deals without in-house developers. That results in lower fees and costs for our investors and, ultimately, produces a higher net return. That’s why we are trying to create more of these types of partnerships for Growth Fund IV.
Focusing on Partnership Agreements Maximizes Our Returns
As a firm, we have made the strategic decision not to be a traditional development firm. We focus exclusively on investment management. That’s important because we represent our collective interests during the process. We negotiate every aspect of a development with the sponsor using our deep understanding of market fundamentals, operations, risk management, asset management and property management fees. It’s another way we outperform the competition.