The structure of commercial real estate syndications begins with the business setup. Most syndications form an LLC (Limited Liability Company) or an LP (Limited Partnership) to hold the property.
Both business models establish a general partner (GP) to acquire and manage the property and limited partners (LP) who contribute capital as passive investors. Limited partners are not liable for debts, limiting risk to the financial contribution.
General partners actively manage the entire process. They locate a suitable property, secure financing, work with passive investors to raise capital, finalize the deal, and manage the asset until the exit. Ownership typically lasts three to five years.
Limited partners receive monthly or quarterly distributions based on the preferred return during ownership. The bulk of the return of capital comes at the exit when the general partners sell or refinance the property.
Most compensation structures are weighted toward passive investors. General partners build fees into the project to compensate for their time, expertise, and risk. Standard fees charged to cover the costs of activities associated with buying and managing the property include the following:
- Acquisition fees, also known as a “raise” fee, are based on the amount of capital contributed by investors or the property’s price. The cost generally ranges from 1 to 5% of the deal.
- Asset management fee compensates general partners for management duties and covers tax and legal requirements. Prices typically range between 1 and 3% of the total investment.
- Promote fee covers the cost of sponsoring the project. General partners get paid if the deal produces returns above a predetermined threshold.
- Refinance fee may be in place if the strategic plan includes a refinance. The charges cover the cost of obtaining a new loan and are often 1 to 3%.
- Disposition fee covers the sales and marketing efforts required to sell the property.
Ownership percentage affects the compensation structures, which lay out the distributions to each party during ownership. Below are common structures used to reward both general and limited partners.
A Straight Split is the simplest payout structure and divides cash flow and capital gains based on the percentage of ownership.
Preferred Return pays investors a certain percentage of profits before the general partner receives a share. A cumulative preferred return allows the GP to start distributions at some future date but must catch up on accrued returns before slitting remaining profits.
Once the GP meets the preferred return threshold, compensation follows a split payout structure. For example, the deal may offer an 80/20 or 70/30 split. Meaning investors receive 70 or 80% of returns above the preferred Return, and the GP gets the remaining 20 or 30 percent.
Waterfall Distributions allow uneven payments and are customized based on tiers. It is the most complex compensation structure.
- The Return of capital (ROC) requires passive investors to receive their initial capital investment before the sponsor gets any dividends.
- Preferred Return is distributed after the repayment of the initial capital investment.
- GP catch-up gives the general partner a significant portion of gains until they receive a certain percentage of the profits.
- Carried interest is a predetermined percentage allocated between the GP and passive investors after meeting the previous benchmarks.
McKee Capital Group currently uses the preferred return compensation structure with an 8% return to limited partners before the profit split. This structure delivers distribution payments throughout the hold period creating cash flow for investors while paying the bulk of the return at the end of the hold period.
To learn more about investing with McKee Capital Group, watch our introductory video here.