A real estate limited partnership is like a private fund that lets you profit passively from large property investments
real estatelimited partnership ( RELP) is a private investment that pools investors' funds to buy, develop, and sell properties.
- During their lifespan, RELPs may furnish a regular income, but mainly pay profits at the end when their properties sell.
- Although they offer high returns, RELPs also come with considerable risks, and investors can't easily unload them.
Real estate can be an excellent addition to your investments, not only for its own potential for appreciation and income but also for the diversification it brings to a portfolio. There are plenty of ways to gain real estate exposure: You could invest in a rental property or a commercial building, or fix-up and flip a house.
But what happens if you want to invest in real estate but don't want the hassles of the day-to-day management or the landlord duties? Cue the real estate limited partnership (RELP), which lets you pool your money with other investors to buy, lease, and ultimately sell buildings. You passively own these properties - but you actively participate in the profits.
Because it's a form of private equity, RELPs may not be as well-known as, say, publicly traded real estate stocks or investment trusts (REITs). Here's what to know if you might want to partner up.
What is a RELP?
A real estate limited partnership, or RELP, is a legal entity formed to invest in real estate ventures. The structure allows investors to combine their resources to purchase and develop properties they couldn't afford or manage on their own.
Like most limited partnerships, RELPs are a private investment - that is, their shares do not trade on stock exchanges. You buy in when the RELP is formed; sometimes ownership stakes become available after the original offering, as well.
A RELP is meant to last for a finite number of years. During its lifetime, it functions like a little company: It forms a business plan, and then identifies properties to purchase and/or develop, manage, and finally sell off. Profits are distributed along the way. After the holdings are all dispatched, the partnership dissolves.
There's no standard term for RELPs. "Limited partnerships exist for varying durations, from months to decades, based on the business plan with the target investments," says Tom Blake, founder of Flexible, a tech-enabled real estate company that offers bespoke real estate transactions. Typically, though, RELPs run from seven to 12 years.
Most limited partnerships also have investment minimums: generally, $2,000 or above and often substantially more. With RELPs, the minimum "buy-in" for investors often can be anywhere from $100,000 to a few million, depending on the number and size of the real estate purchases.
Who are the partners in a RELP?
Every RELP has a general partner and limited partners. Each type of partner has an equity stake, but their contributions, responsibilities, and liabilities vary - and their returns are distributed differently, as well.
The general partner (GP) can be an individual, but it's usually an entity, such as a real estate development firm. The GP is usually an experienced real estate manager who acquires or develops properties on the partnership's behalf.
It's the GP's responsibility to set up the partnership, secure the financing, and manage the investments. They bear unlimited liability for the partnership's debts and obligations (like mortgages or loans).
In return for all this heavy lifting, the GP receives an ownership stake in the partnership. They also earn money through fees charged to the partnership - for anything from acquiring properties to selling them, and for management along the way. Similar to a mutual fund's expense ratio, the management costs alone can range from 5% to 10% annually.
The limited partners (LPs) are the investors the GP rounds up. After contributing their capital, they are silent partners, pretty much, relying on the expertise (and judgment) of the GP. They generally have a hands-off role in the daily operations - in fact, they're required to.
What's the attraction, then? Well, along with high returns, there's their limited liability. Limited partners have an ownership stake in the real estate, but "the partnership holds title to the real property, so the individuals do not have to be listed as direct owners," Blake explains.
That means they bear little responsibility for incurred loans or expenses or costs. They can't be sued. The brunt for those obligations is borne by the GP and the partnership itself. LPs' liability - and potential loss - is limited to the total amount of their investment.
What do RELPs invest in?
When it comes to RELPs, "all real estate assets are fair game," says Blake. "Single-family homes, multi-family homes, retail, industrial, office, hospitality, land, you name it." Some RELPs invest in dozens of properties, some in only a few, or even one. Often, they specialize in a particular type of property - say, historic rehabs or office buildings. They might invest heavily in commercial property loans or mortgages, too.
How are RELP profits distributed?
Depending on their focus, RELPs can generate an annual cash flow from rents or loan interest for investors. Usually, though, the payoff comes from selling the appreciated properties, usually in the RELP's later years.
Ultimately, all profits are shared between the GP and the LP - while it varies a lot, 30% (GP) and 70% (LPs) is a typical split. In many RELPs, the limited partners must receive a specified minimum return on their investments before the GP shares in any of the profits. GPs often get a bonus if the properties register a particularly large gain.
RELP profits are distributed to the partners based on their ownership percentage.
The benefits of RELPs
As with any investments, there are pros and cons to real estate limited partnerships. Some of the advantages include:
- Economies of scale. By combining resources, investors can invest in larger (and potentially more profitable) real estate deals than they could ever afford on their own.
- Tax savings. RELPs are structured as pass-through entities, meaning the RELP doesn't pay any taxes on its income. So the income and losses from the partnership pass through to each investor and are claimed on their income tax returns at individual, not corporate, rates. More money for you, potentially - or a bigger deduction. Each partner receives a K-1 form that details their share of income/losses for that year.
- Little work and liability. Though they're property owners, limited partners don't take part in daily management, and are shielded from unexpected costs and debts.
- Potential for high returns. RELP investors might look for overall annualized returns that range between 5% and 14%, depending on the type of property. In boom years, they've realized as much as 20% or 30% profit on their properties.
The risks of RELPs
If you're interested in a real estate investment partnership, be sure to consider these risks:
- Lack of liquidity. RELPs are usually long-term investments, and it may be impossible to find someone to buy a limited partner interest. You typically have to wait until the property is sold and profits are shared to get your money back.
- No guarantees. The real estate market fluctuates. Project costs can go over budget. Some RELPs may have trouble getting the zoning approvals and government permits they need. This can delay or even squash projects and negatively impact returns.
- Trust issues. The general partner has control over the partnership's business operations. That means limited partners have to put their trust in the GP and hope for the best.
RELPs vs. REITs
RELPs have some elements in common with another popular vehicle, real estate investment trusts (REITs). Both hold a portfolio of properties. Both offer a tax-advantaged, passive way to own real estate: Investors are free from management decisions - they sit back and wait for the gains (hopefully) to roll in.
But RELPs and REITs differ in many fundamental ways:
- Clientele: RELPs have high minimum investments and are generally targeted at high net worth individuals or accredited investors who meet certain income and net worth requirements. But anyone can invest in a
REIT, and shares are often priced in the $10-50 range.
- Public/private status: RELPs are private equity funds, where REITs are publicly listed and traded daily on stock exchanges. That makes REITs much easier to buy and sell than RELPs, and their pricing more transparent.
- Returns: REITs are perpetual entities that provide an ongoing income. RELPs tend to be finite arrangements: While they may provide some annual income, the big payoff comes from profits when properties are sold. "They can outperform REITs, sometimes by a wide margin," Blake says.
The financial takeaway
Real estate limited partnerships let investors pool their resources to buy and develop real estate. For general partners, RELPs provide income and access to capital needed to fund larger projects and deals. Meanwhile, limited partners can invest in real estate and earn passive returns without the day-to-day responsibilities of ownership.
But passivity cuts both ways. Limited partners are pretty dependent on the skills and management abilities of the GPs. Their liability is limited, but they can still lose their entire investment.
RELPs are completely exposed to the ups and downs of the real estate market. And If a partnership owns only a few properties of a particular kind, its potential for loss is even more concentrated.
RELPs typically yield relatively high returns when compared to other real estate investing options; however, these returns do come at a higher risk. Investors need to have a tolerance for that, as well as the patience to wait for returns and to have their money tied up in the meanwhile.
Related Coverage in Investing:
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Financial planners say not everyone is cut out to be a landlord, but there's another option if you still want to invest in real estate
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