Is Being a Limited Partner Right for You?
If you’re like most investors, you realize the wealth-building power of real estate, but you don’t know where to start. This is where limited partnerships serve a critical education role.
A limited partner is an investor who wants to invest in real estate but does not want the hassle that comes from dealing with tenants, overseeing construction projects, executing a business plan, and so on.
Sometimes, investors take on greater responsibility move on to the operational side of the business as a general partner, but more often, they remain a limited partner. It’s important to note that even though the responsibility of vetting and performing a deal falls on the shoulders of the investor, once invested, a limited partner becomes part of larger community of limited partners in that deal. It’s also important to remember that the money is pooled together by the operator from many limited partners—and without them, fewer investors would be able to reap the benefits of commercial real estate. As you can see, this is a very important role!
The Advantages of Being a Limited Partner
There are four main advantages to being a limited partner.
- Limited liability
- Leveraging time
- Limited recourse
A limited partner’s role ends after capitalizing the project. Limited partners DO NOT maintain an active role in the deal afterwards; likewise, their liabilities and risks are generally limited to their investment contribution to the deal.
To understand how this works, let’s look at how a typical syndication is constructed:
Generally, when a property is acquired, a new LLC is formed, comprised of the general partners and limited partners. If you invest $50,000 as a limited partner into the real estate project, and later the LLC that owns that property is sued for millions of dollars in damages, the plaintiff can’t go after your additional assets to try to cover their settlement. However, this doesn’t mean that your $50,000 isn’t in jeopardy because of the lawsuit: If the lawsuit forces the LLC into insolvency, the limited partners may lose their entire investment. However, these circumstances are rare and show the benefits of the word “limited” in limited partner.
Most working professionals prefer investing as limited partners because they do not have the time and resources it takes to purchase and operate large commercial real estate properties.
However, what some investors may be surprised to learn is that some general partners are actually limited partners in other operators’ deals.
The reason is simple: Most operators have a set bandwidth of how many deals their team can handle at any given time. By investing in other operators’ deals, that bandwidth is increased exponentially. Plus, their own operating knowledge allows them to more quickly evaluate a deal. So it doesn’t matter if you are a professional doctor or a professional apartment building operator; you can leverage other operators’ time and bandwidth to build your net worth.
Many newer investors are also surprised to learn that the debt needed to purchase a large commercial real estate actually offers better terms and rates than smaller residential deals. In fact, there’s a joke in the syndication world that it’s easier to get a $5 million loan than a $50,000 loan. Besides better rates, the debt is usually provided by “agency” providers Fannie Mae and Freddie Mac, which are government-backed agencies with a mandate to provide liquidity and stability to the housing markets.
The loans provided by these agencies have recourse provisions that are very favorable to both the limited and general partners. For the limited investor, the most they can lose is their investment amount. For the general partner, they are also shielded from recourse unless fraud or “bad acts” are found usually referred to as the “bad boy carveout.” Otherwise, limited partners get to enjoy limited recourse and, to some extent, the general partners do, as well.
All of this should be done prior to investing the money because once the wire is sent, the limited partner becomes 100% passive. This means no legendary tenant stories, evictions, or contractor problems. If the deal goes well, you share in the profits—not the headaches.
The Disadvantages of Being a Limited Partner
There is one key disadvantage in this scenario, and that is lack of control. Therefore, some investors still choose to buy and self-manage single-family rentals vs. investing in syndications, even though the pros are overwhelmingly in favor of investing in a syndication. However, there are some investors who do not want to risk investing in someone else’s deal. If that approach resonates with you, there’s nothing wrong with that—as long as you’ve educated yourself on all of the options.
A final word: Being honest up front is important because the last thing a general partner wants or needs is an unsure limited partner in any deal. This would not only be bad for the general partner but for the other limited partners, as well.
So Is It Right for You?
Only you will know if becoming a limited partner is right for you. When I speak to investors, I usually know within a minute or two of our introduction calls.
Busy professionals who earn a great living and love what they do usually want nothing to do with finding or operating a deal. This makes them a great fit to become a limited partner.
On the other hand, investors who want more involvement in decision-making usually have trouble giving up control and may not have the ideal personality to invest passively. In most cases, a limited partner can still grab the attention of an operator and provide suggestions, but the operator is not obligated in any way to follow through with those suggestions unless they find them worthwhile and accretive to the bottom line. If their input is not implemented, the limited partner needs to be able to quickly move on and not take offense because at the end of the day, they entrusted the operator to operate.
Disclaimer: The information presented in this article is for informational purposes only and does not constitute professional financial or investment advice. The author does not make any guarantees or promises as to the results that may be obtained from it. You should never make any investment decision without first consulting with your own financial advisor and conducting your own research and due diligence. Even though the author has made reasonable efforts to ensure that the contents of this book were correct at press time, the author disclaims all liability in the event that any information, commentary, analysis, opinions, advice and/or recommendations contained in this article result in any investment or other losses. Your use of the information in this article is at your own risk.