This article is part of our passive investors guide on real estate syndications, available here.
Maximizing resources while shielding against liability is the golden balance in real estate. You’ll hear a real estate limited partnership (RELP) referenced when researching how to structure the way you operate your investment at the entity level. It’s the path that many investors take. What is a real estate limited partnership? That’s what we’ll cover in this article.
Key Takeaways
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A real estate limited partnership is a setup where multiple investors pool resources together to purchase, lease, or develop a real estate project. A RELP must have at least one limited partner paired with at least one general partner (GP).
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The LP is the limited partner in a real estate partnership. Their primary duty is to contribute capital to an income-generating project. LPs can choose to either be passive or active partners.
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In a passive partnership, the LP simply collects income in proportion to their investment from a property managed entirely by the general partner(s).
What is a Real Estate Limited Partnership?
A real estate limited partnership is a setup where multiple investors pool resources together to purchase, lease, or develop a real estate project. A RELP must have at least one limited partner paired with at least one general partner (GP).
RELPs are attractive because they give investors access to properties they wouldn’t be able to obtain on their own. Next, we’ll take you through the role of the limited partner in a real estate limited partnership.
What is LP in Real Estate?
The LP is the limited partner in a real estate partnership. Their primary duty is to contribute capital to an income-generating project. LPs can choose to either be passive or active partners. In an active real estate partnership, the LP will be actively involved with all aspects of the investment. In a passive partnership, the LP simply collects income in proportion to their investment from a property managed entirely by the general partner(s).
The role of LP is best understood in the context of the part of the GP. A GP takes on unlimited personal liability for the investments made and is usually but not always a real estate development firm. By contrast, the limited partner is only responsible for the amount they’ve invested and are often “silent partners.” This protects the LP’s personal assets from exposure to losses.
Next, let’s clear up the common confusion over RELP vs REIT.
RELP vs REIT
A real estate investment trust (REIT) is a company that owns and operates income-producing properties, often high-value commercial properties. While they work similarly, RELPs and REITs aren’t identical in business structure. Exclusivity is a significant factor. While RELPs are considered private equity funds, REITs are publicly listed. As a result, REIT shares are much easier to buy and sell.
Generally, RELPs are intended for high-net-worth individuals capable of meeting income and minimum investment thresholds. By contrast, REIT shares are considered affordable for the average person.
Returns are also handled slightly differently. While REITs are considered ongoing entities that offer continual income, most RELPs have an individualized real estate partnership agreement that clarifies everything from generating annual income to providing a big payday when a property is sold. Next, we’ll run through the pros and cons of RELPs.
The Pros and Cons of a RELP
“Real estate is a traditional hedge against inflation because it has tremendous intrinsic value as a tangible holding of limited supply,” according to Forbes. While most people know that real estate is an intelligent asset class, many would-be investors can’t develop the capital needed to own significant property. This is why a RELP looks like an easy choice.
The advantages of RELPs can make them attractive to people entering the real estate world for the first time. However, the “easy entry” can feel stifling after a while if your property goals aren’t aligned with the RELP you choose. Here’s a breakdown of the pros and cons.
Pros of a Limited Real Estate Partnership
- Higher Returns: Partnerships generally allow for higher returns because you’re pooling resources with other investors to own part of high-value property. In addition, general partners are heavily invested in ensuring that RELP properties are run impeccably because they hold unlimited personal liability.
- Networking and Collaboration: RELPs tap into the hive investor mind. When you invest in a RELP, you’re working with other investors and real estate professionals with experience from many different market pockets. It’s an excellent strategy for making informed, well-rounded decisions based on the expertise of many.
- Flexibility: RELPs offer opportunities to invest in many different properties for strong portfolio diversification. RELP investing provides a better shield than solo real estate investing because you don’t have to pour all your resources into a single property in the hopes that you selected the right property in the right market to avoid losses. Being a partial investor in a more considerable property can free up personal capital to allow you to invest in several properties with reduced risk.
- Tax Benefits: Flexible pass-through distributions can help entities retain more of their profits using a loophole that stops double taxation at the corporate rate by only taxing members’ income.
Cons of a Limited Real Estate Partnership:
- Restricted Liquidity: RELP returns aren’t always liquid. This will vary based on your particular investment because general partners have specific investment goals. While some RELPs are focused on generating immediate passive income, others are structured to gain long-term value for a future payday.
- Differing Investment Goals: This potential drawback piggybacks on the previous one. Limited partners are locked into the investment strategy chosen by the larger group. That means that you don’t have the option to pivot the investment strategy based on what’s happening in your own personal financial portfolio.
- There’s No Guarantee That Effort Matches Returns: If you’re in an active partnership, there’s no guarantee that the amount of effort you put in will generate returns that match your effort. This is where researching the effort needed to operate a property is vital for deciding the real return on investment.
Next, we’ll help you balance the pros and cons of your investing life by reviewing the things to consider before joining a limited partnership.
Consider the Following Before You Join a Limited Partnership
You have to join the right limited partnership to get the desired results. Here are the core considerations for joining any real estate partnership:
- Make sure there’s a plan that delegates duties for capital, tasks, contacts, and skills.
- Verify that all partners share the same goals using a shared business philosophy.
- Verify that partners are on the same timeline for buying, holding, and selling.
While RELPs don’t offer complete control, they do offer a level of personal control that makes them great for diversifying against stocks. Experts say you should keep a small allocation for commodities, real estate, and cash in case stocks and bonds fall in tandem.
Next, we’ll show you why RELPs shouldn’t be viewed the same as stocks, even though they need to accompany them in your portfolio.
Why You Should Generally Be in It for the Long Haul With RELPs
While a RELP doesn’t lock you in for life, it also doesn’t provide the same freedom to “change your mind” as stocks. While conditions vary by agreement, it may not be possible to resell your real estate investment partnership quickly if you suddenly need to liquify your assets. That means you can’t count a RELP as an investment you can cash out in a pinch.
Selling a RELP Property
When the decision is made to sell a RELP property, active partners will activate the sale. The profits are then shared among all partners for the percentage each partner is entitled to based on the size of their initial investment.
We’ll finish off with some common questions about real estate partnerships.
Frequently Asked Questions About Real Estate Partnerships
Limited partners invest money to purchase an investment property as a group. The involvement in day-to-day operations varies based on your decision to choose an active or passive partnership. Limited partners occupy a hands-on role that allows them to collect passive income without any duties.
While general partners take on the bulk of the liability for an investment, limited partners are only responsible for the portion they’ve invested.
Real Estate Limited Partnerships in Commercial Real Estate- Conclusion
A limited real estate partnership offers a way to enter high-end real estate investment opportunities without taking a significant personal risk. It’s how many investors build up robust real estate investments that generate multiple streams of passive income without any hands-on work. Join the investor club at Willowdale Equity to get access to passive, private value-add multifamily investment opportunities across the southeastern United States.
Sources:
- Forbes, “3 Alternative Investments To Hedge Against Inflation“
- U.S News & World Report, “Why Diversification Is Important in Investing”
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