How Do We Align Interests in Our Real Estate Syndications?

In a real estate syndication, the general partner (GP) and the limited partners (LPs) each have different roles. The GP typically invests a small minority of the equity but takes on a more active role in acquiring and financing the property and making day-to-day management decisions, while the LP’s invests the vast bulk of the equity but is typically much more passive and limited to providing capital.

Because the LPs are investing the vast bulk of the equity, but at the same time they have very little control over the day-to-day operations, it is critically important to make sure the terms of the investment align the interests of the GP with those of the LPs as closely as possible. When the interests of the general partner and limited partners are not properly aligned, it can lead to misunderstandings, conflicts, and potentially suboptimal investment returns.

Investors Should Always Come First

As a GP, we take an “investor first” approach to structuring and managing real estate investment partnerships because we always invest alongside our limited partners, and we never take cash fees at closing. As a GP, one of our first objectives is to have a high conviction investment thesis on a certain asset or market. Once we do this, it’s easy to invest alongside our LPs in a substantial and meaningful manner. In fact, we much prefer-long term equity to cash fees at closing.

In most cases, we invest at least 5-10% of the equity required to purchase an asset, and we often invest more. We also act as the Key Principle by providing certain limited personal guarantees that may be required by mortgage lenders. Each of these deliberate decision helps put us on the same side of the table as our investors, and they are crucial steps in aligning our economic interests with those of our LPs.

We Are Not a Fee-Driven Sponsor

In addition to contributing meaningful equity to each investment and providing certain guarantees to our lenders, we also restrict the amount of our fees. We never extract cash fees at closing, and we do not not charge refinancing or disposition fees.

We do this deliberately to because it helps our partners understand that we’re always on their side of the table. We’ve been in business since 2006, and our profitability has always been driven by the quality of our investment decisions, not by charging excessive, unnecessary or punitive fees.

Waterfalls Are Important. They Must be Fair and Equitable

We also work diligently, deliberately and thoughtfully to tailor a waterfall structure that will help de-risk the investment for our LPs. I have written a separate post on waterfalls that goes into much more detail on how these structures work, but in essence a waterfall formally governs the allocation of property cash flows, and a properly designed waterfall should de-risk the investment for the LP’s by putting LPs first in line for cash receipts.

The waterfall accomplishes this in several ways. The first is through a Preferred Return structure which effectively gives the LPs a priority claim on all property cash flows before the GP can receive its share of any distributions. Our waterfalls also prioritize 100% return of original capital to the LPs prior to allowing any GP claim on profits from a sale or refinancing.

Our goal in designing any waterfall structure is to create a clear and equitable allocation of profits that properly reflects the level of risk involved. In addition, we make best efforts to create waterfall structures that will not interfere with rational economic decision making with respect to the asset. For example, if the LPs would be better off by refinancing the asset and holding it longer term, the waterfall should not be compelling the GP to sell it.

Transparency May be Even More Important

Finally, we recently invested in Juniper Square’s investor portal solution, which we believe is the gold standard for investor portal design and capabilities. This solution provides investors with 24/7 access to investment information and performance, as well as electronic payments and signature capabilities, and a secure digital file cabinet for documents and reports. Juniper Square has helped us increase our level of communication and transparency, and we are hopeful that this investment will be another key piece of our multi-faceted efforts to create an alignment of GP/LP interests that is as strong as it can possibly be.