Make sure you understand if you are in a General Partnership or a Limited Partnership.  The General Partner (also known as the “sponsor”) is responsible for day-to-day operations of the real estate investment and is typically personally liable for the payment of any debt.  The General Partner (abbreviated as GP) is the active partner.  The Limited Partner (abbreviated as LP) is the passive partner and typically is not personally liable for any debt on the real estate project.  Normally the LP does not have any say in managing a real estate project although there are certain times when there are specific limits on what the GP can do without the LP’s consent.  As previously mentioned, it is important for the LPs to be sure that the GP has made a cash investment (skin in the game) in the real estate project.  This GP investment can typically range from 5% to 20% of the total capital investment.  The higher the skin in the game, the safer it is for the LPs.

Here are some important terms that apply to the “deal” between the GP and the LPs:  Preferred Return:  In many real estate partnerships the GP must pay the LPS a minimum return (sometimes called an interest rate) of between 8% to 12% before the GP gets a share of the profit made from the sale of the real property involved in this hypothetical partnership. This is an important way the GP can incentivize their investors to put their cash into a deal. Without a preferred return a partnership becomes much more of a risk to the Limited Partners.  GP Fees:  Frequently a GP requests various fees for their management of the real estate project.  These fees are in addition to the GP’s share of the profit made when the investment sells.  Here are some of the fees that a GP may request:  Acquisition fee of 1% to 3% of the purchase price of the asset.  Management fee which is an annual fee paid to the GP – typically between 1% to 2% for their work in managing the property. Disposition fee:  This is a less common fee but one that may be seen in certain partnerships.

What kind of protection can LPs receive in a partnership?  There is a procedure known as a “clawback” which helps protect the Limited Partner.  If a General Partner is paid a significant amount of the fees shown above before the partnership is finalized and the asset sold – it is possible that the asset may be sold at a loss or at an amount less than the required preferred return.  The clawback simply means that the LPs have a right to demand the GP pay back to the partnership any of the fees they have received before the partnership is dissolved if the LPs did not receive the amount of money they were quarantined as a preferred return in the partnership agreement.  Although rarely used, the clawback provision offers some protection to the LPs if a deal does not live up to its promised return.  The other protection that can be built into the Limited Partnership documentation is giving the LPs the right to force a change in control in the management of the partnership.  This provision can be invoked in the event of very poor performance, fraud or other bad acts done by the GP.  This does not happen often but is necessary if and when the partnership is mismanaged and is a right the LPs should attempt to include in the documentation of the original partnership.

If you have a property in need of a facelift or complete overhaul, contact Montegra at 303-377-4181 for more information about our private capital loan programs.