I’m going to give you a breakdown of how basic real estate private equity firms are structured. I run Bolt Storage, a private equity company focused on self-storage properties. We raise money from outside investors, otherwise known as limited partners (LPs), to buy real estate and put together deals. I’m a general partner (GP), otherwise known as a sponsor, and I secure the deals and manage our properties.
As the GP, I have a team of employees. My goal is to make money for myself, my team, and my investors. When we buy properties we typically put some of our own money in the deal as an act of good faith, called the co-invest. As money comes in from the deal, it gets split out between the LP and the GP based on the deal structure. Usually, LPs are guaranteed a return up to a certain percentage before the GP gets any money, called the preferred return or “pref”. An 8 pref means that if an LP invested $100K, they’ll get the first $8K of profit before any goes to the sponsor.
After the pref hurdle is met, money is divided up based on the deal’s promote. The promote is the percentage of returns beyond the hurdle that goes to the GP. Ideally, the deal goes so well that the GP sees a share of profits beyond the pref hurdle. At Bolt Storage, this is often a 50% promote, meaning we get 50% of all profits after the pref hurdle is met. This incentivizes a sponsor to chase upside deals, because they only get paid after the preferred return is hit.
As a sponsor, we also charge fees for the work we do, which vary by the type of deal. Acquisition fees are used to fund the acquisition team within Bolt Storage, and are a percentage of the total acquisition price. We have assets under management (AUM) fee, which is a percentage of the deal capital per year, to account for the work that it takes to manage investors, send money to the right places, keep the books, and send out investor reports. There’s a management fee, which accounts for the cost of managing the property itself, like handling maintenance, snow removal, and customer collections.
Our goal is to maximize our profitability but also make deals look appetizing for investors through key metrics. The most important is often the internal rate of return (IRR), which measures the total return once the deal is finally complete. How much money did the investor receive vs what they invested, and how long did it take? Investors also like to measure the multiple on invested capital. 3X means your money tripled in the span of a deal, 2 means it doubled, etc.
Deal structure all depends on the market for capital. If capital is easy to get, if tons of investors want to get in on real estate, you can be aggressive on your terms. If capital isn’t easy to get, the investors get to call the shots. There are other factors to consider like how reputable the management team is, how appealing the deal looks, whether the sponsor is co-signed on the debt, and so on.
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