How to Become an LP

Have you ever run into roadblocks or barriers to entry when considering investing in real estate? Does your busy life or work schedule limit your ability to invest in flipping houses or other active investing strategies that seem to take a lot of time?

If so, have you considered “passive” investing? Becoming a limited partner could be the solution for you.

A passive investor is usually called an “LP” or Limited Partner. LPs typically invest in the equity portion of the deal (the amount needed to close on the property beyond the loan amount, including capital expenditures and fees). LPs are not active in managing the day-to-day responsibilities of a property or fund, so very little time is required.

Investopedia defines an LP as “a part-owner of a company whose liability for the firm’s debts cannot exceed an individual’s amount invested in the company. Limited partners are often called ‘silent partners.’

The term “limited” typically refers to their legal status in venture capital funds or private equity funds— or in this article, a real estate syndication deal or fund–which consists of multiple commercial and/or multifamily assets producing monthly cashflow.

Ultimately, LPs are partners in the fund but with limited rights and limited obligations. These limited obligations can be a great position for busy professionals looking for a solid return with little time input.

Limited Partners are people or entities not interested in controlling the deal. Some investors want to think about accessing their investment or receiving updates about the status of the properties or funds. In contrast, others will ask a ton of questions, have the desire to be involved because they’d like to learn, and of course– many are seeking updates quite often. Sometimes these variables can depend on the sophistication or experience level of the investor.

Now that you understand the basics of Limited Partners, how do you become one? It starts with finding the right “General Partners,” also known as a “GP” or deal sponsor– and asking them questions to determine whether investing with them is the right fit.

If a sponsor is raising capital with little to no experience in the asset class they are currently raising equity for, it could be a red flag. It’s best to invest with a team who knows what they are doing; your hard-earned money will be in safer hands.

First, when talking to the GPs, the strategy for the investment should include a clear:

– Asset Class

– Geographic Focus

– Company and Market Data

– Development or Renovation Plan

– Financial Projections

– Exit Strategy

For example: let’s say you have some working capital (as little as $500 to invest) and you’ve done some basic research on the topic and sponsors you think could be candidates to vet. Next, you will want to ask more specific questions.

Here is a short list of questions you could ask to ensure you feel comfortable investing:

What is the sponsor team’s track record?

Have they invested in this asset class before?

Have they been involved in previous private placements (SEC syndications)? If so, what is their success rate, and what did those deals yield to investors?

Do they have financial statements or investor reports they can share from prior deals?

What is the deal sponsor’s background?

What is their educational and professional background?

What is the specialty of each team member?

Does someone specialize in analyzing deals, legal/SEC transactions, financial, property or asset management, or investor relations?

What is the objective and strategy of the business plan for the fund?

Are they focused on cash flow, appreciation, asset preservation, or a combination of those factors?

Ensure the sponsor team has a clear, defined strategy in a targeted asset segment:

Does management communicate this strategy? Is it focused? Investors should avoid broad, vague, unfocused, and speculative approaches.

What are the principal financial projections and terms surrounding the venture?

Do you have proformas?

What’s the acquisition fee?

What are the total costs for capital expenditures?

Will it be leveraged? How much? And what are the loan terms?

What’s the cap rate at acquisition? What’s the projected cap rate at the time of disposition?

What’s the projected first-year cash-on-cash return? The average annual return? The IRR?

How often can we expect distributions?

How will management be compensated?

Will you or any affiliated companies receive periodic or per-transaction fees?

What is your profit split of cash flow from operations?

What is your profit split of cash flow from dispositions?

What is the exit strategy?

How long should I expect my investment capital to be locked up?

How should I expect a return on my capital?

Will there be a refinance or sale?

What are the business, market, and financial risks of this opportunity?

Avoid open-ended exit strategies. Expect a defined exit with little flexibility to allow for disposition at the optimal time. Also, in an ideal world, the General Partners should only be compensated if they’re successfully executing the business plan for the property or fund. In other words, they should only get paid if you get paid. That’s not to say that acquisition or management fees are bad – in fact, it’s very common– and is how sponsors/GPs are incentivized to structure the deals upfront. Deal sponsors often have to spend thousands of dollars looking for and structuring deals, hiring attorneys, travel, due diligence, and more–and the deals don’t always pan out. Just make sure the fees are reasonable. Both the acquisition and management fees should be in the range of 1% – 3%.

Beware of the risk-free pitch. There’s no such thing. Make sure management recognizes the risks and has a plan for mitigating those risks. In fact, legal disclaimers and complete transparency and disclosure are a legal must.

Ensure that the payout and distribution structure of the opportunity aligns with your own investment goals and objectives. Are you more interested in a long-term return and payoff from appreciation? What about cashflow with a consistent return? Or are you interested in a mix of both? Make sure the fund’s business strategy aligns with your financial goals.

You should be ready to invest when you can understand these questions and interpret the deal sponsors’ answers! You won’t always have to get this deep or granular, but these are questions some of the most seasoned LP investors ask. Plus, it’s your money, so knowing what you are doing is a good idea.

Above all else, you should keep your goals and objectives in mind when investing. If they align with the deal or fund, it should be a great fit.

In summary, get to know the team and their ability to execute the plan, the offering, and how well it aligns with your life and goals–and then get to work investing as an LP! And it always helps to invest with a team you know, like, and trust! This is why Active Duty Passive Income created ADPI Capital. If you’re looking for another way to invest in vetted deals, definitely check out the offerings and information at: https://www.ADPICapital.com