What is LP and GP in Private Commercial Real Estate Investing?

Part of Real Estate Syndication: The Passive Investors Guide

Table of Contents

1. What is LP and GP?
2. What is LP Investment?
3. Why Is LP Investing Beneficial?
4. Frequently Asked Questions About LP’s and GP’s
5. LP and GP in Private Real Estate- Conclusion

It’s one of those early questions that can help aspiring investors decide where to pivot their energies. In this article, I’ll cover what you need to know to understand these two roles in a limited liability partnership and in real estate syndications.

What is LP and GP?

Private equity real estate transactions tied to funds and syndications are structured using two rules for its members, a general partner (GP) and a limited partner (LP). You can describe these roles as being both opposite and complementary. The formal definition of what a GP means in finance sits in partnership law.

The GP is the driving force of property investment. The general partner handles all aspects of managing properties, performing due diligence, underwriting, serving tenants, managing partnership tax obligations, and paying out cash distributions. They also take on most of the liability associated with a partnership. There are also benefits to being a general partner, like earning a management fee and carried interest. Of course, when interacting with investors, financers, clients, or the IRS, general partners are also the face of a partnership.

Rather than managing the operations of the real estate project, the limited partner provides a capital contribution to help fund the project and in return, would see some level of upside in the deal’s performance. For many investors who lead busy lives with full-time jobs, a limited partner role is the best way to get into the commercial real estate investing world without having to reinvent their lives entirely. 

There’s essentially no time commitment to being a limited partner investor aside from the initial due diligence that the LP would perform to make sure they believe in the business plan and that this is the right investment opportunity for them. 

Next, I’ll go deeper into what LP investment looks like in real-world settings to show why passive income through real estate is becoming a popular option among people looking to diversify away from stock-only portfolios.

What is LP Investment?

LP investment is a form of passive investment that comes with a heavy shield against liability. It is considered a much “neater” way to invest in real estate compared to becoming a single landlord. Historically, the only way an average person could invest in real estate was to find a suitable property in as hot a market as you could afford. Next, you’d pour money and energy into fixing the property to make it habitable for tenants. 

This begins the never-ending cycle of constantly attracting quality tenants, collecting rent, making upgrades to the property, and being on call whenever tenants need assistance. In addition to it becoming your full-time job, being a landlord means you have most of your invested capital committed in a single property in the best market you can afford on your own.

The capital pooled by LPs flows up to entities like a real estate GP fund on the sponsor side, and the sponsor's role and responsibilities are what determine how that capital actually performs.

Why Is LP Investing Beneficial?

LP investing is beneficial because it opens up investment opportunities that would be impossible for a single investor who isn’t already a multi, multi, multi-millionaire. Next, we’ll cover some unique benefits of using partnerships to invest in commercial and multifamily properties.

1.) Access to Better Properties

LP investing channels into the power of the collective investor to get “normal” people into highly lucrative markets by owning parts of revenue-generating, appreciating properties. Moreover, the properties available to you as an LP investor have already been carefully vetted based on market fundamentals, area demographics, interest rate and cap rate sensitivity, and risk vs. reward. Only after that can an opportunity be deemed lucrative and risk-adjusted.

GPs use their extensive channels to analyze market data and work with select brokers to source quality properties with targeted future growth potential. This is a far cry from the “shot in the dark” approach for buying any affordable property that comes on the market used by most first-time property investors.

Ultimately, amateur investors get access to professional analysis when they become part of a partnership. The legal mechanics of who owns the property in a syndication sit inside that partnership structure.

2.) Protection Against Inflation

Americans are currently being rocked by inflation. The tight market makes it harder for single investors to snatch up quality properties. LP investors get an advantage because they get to join the “big fish” in the pond when it comes to making offers and doing quality deals with real future value.

While inflation creates a mess for both single investors and renters, LP investors get to ride out the storm on two fronts. In addition to having buying power due to strength in numbers, they also enjoy the benefits of rising rents to keep pace with inflation. That can make rental income a more dependable income stream than W-2 income, contractor income, or stocks.

The tight housing market is also causing more and more people to “stay put” in rentals instead of jumping into houses of their own in some markets. Property investors can have access to long-term, stable tenants instead of incurring losses from recurring vacancies.

3.) Risk Diversification

LP investing can be a shelter against a turbulent stock market. When times get rough, institutional investors like private equity firms, hedge, and pension funds begin to look toward tangible assets with potential for appreciation. Real estate is always a default investment strategy because shelter is a core human need and is generally among the last cuts people make in their budget when their disposable income is constrained. While variables can make a stock irrelevant overnight, homes and buildings will still serve the same purposes they did before a bad day on the stock market.

While many people continue investing in stocks when diverting some of their capital to real estate, the diversification angle makes LP investing attractive. In an LP investment position, you aren’t pouring unpredictable amounts of your own money into keeping up with a property every month, which means you have more predictable capital to invest into stocks for extraordinary diversification between real estate and stocks based on their risk tolerance.

4.) Tax Benefits

Limited partners enjoy unique tax benefits that allow them to share in all the “paper losses” from the property to offset gains. One of the things that few people outside of the investment world know is that property investing doesn’t just generate an income solely through rent.

While owning a profitable rental property can set a person up for living entirely off of passive income, the tax benefits of investing in commercial real estate assets like multifamily are the bedrock of how many become independently wealthy. Some high active earning individuals simply invest in large commercial real estate assets to lower their tax burden. They do this by leveraging the large depreciation that can be utilized through accelerating “paper losses” in the first year of commercial property ownership.

For savvy property investors, there are also options for using a real estate professional loophole to use losses from an investment property to offset earned income from W-2 work, independent contractor work, and other income sources.

5.) Consistent Dividends

The “passive” part of passive investment means checks show up regularly. Real estate partnerships pay out monthly or quarterly cash distributions that provide LPs with predictable passive revenue streams. Next, I’ll cover some of people’s most common questions about LPs and GPs. Some larger deals also use a co-GP structure where multiple sponsors team up on a single transaction.

Frequently Asked Questions About LP’s and GP’s

LP and GP in Private Real Estate- Conclusion

LP investments represent some of the most flexible and advantageous investment conditions available. While GPs handle all management tasks associated with generating profits from a property, LPs can enjoy the peace of mind that comes with consistent cash distributions with very low liability.

LP investing provides both the access and freedom to pour capital into multiple projects without trying to “live off” a single make-or-break property for investors seeking a way to invest in much larger or multiple properties. The underlying real estate syndication structure that codifies these LP/GP roles is worth understanding before committing capital.

Sources:

1. ABC 17, “Home prices rise along with inflation“
2. CNBC, “How to figure out how much risk you can handle when you start investing in the stock market“