Ep 82: Real Estate Private Equity 101

I want to get you a breakdown of how basic real estate private equity firms, including my company Bolt Storage, operate and structure their deals. The high-level view is that my company is continuously on the search for self-storage facilities to acquire, and we raise money from investors who become our limited partners (LPs) to pay for these deals, while I act as the general partner (GP), or sponsor.

As the GP, I have the whole team at Bolt Storage under me, and my goal is to make money for both the LPs and myself. I have to put some money into every deal, called the co-invest, along with what the LPs contribute. My co-invest secures me common shares of the deal, while LPs get preferred shares, which means that LPs get the first cut of profits and money doesn’t flow out to me until we hit certain milestones.

These milestones, called waterfalls, begin with the preferred return. If a deal is structured on 8 pref (8% preferred return), that means 8% of all yield on an annual basis gets paid to the LPs. If LPs invest $100K on 8 pref, the first $8K in profit goes to the investor.

After the preferred return, the promote is the percentage of returns beyond the waterfall that I, the GP, am entitled to. In many deals, I take a 50% promote, meaning I get 50% of the profits above the waterfall. This is a pretty aggressive mark, and on riskier deals the promote can shrink down to around 20% instead. With this type of structure, the GP is incentivized to chase high-upside deals, because they only get paid on what is made beyond the pref.

In addition to the promote, the GP will make money on fees through each transaction. Everything that the GP does costs money, starting with finding and acquiring the property. Acquisition fees range from almost 0% up to 3.5% of the acquisition price, and this goes to the work needed to find and close the deal. Assets under management (AUM) fees range from 1% to 2.5% of total investor capital being managed, which is generally in the millions. This helps us manage our investors, send money to the right places, file taxes, and prepare investor reporting. Management fees are simple fees for handling the management of a property, such as daily maintenance and upkeep.

So how do you structure a deal, landing on the pref, the promote, the acquisition fee, and all other considerations? It all depends on the market for capital. If getting capital is easy and investors are throwing money at you, you can get aggressive with your terms and take a higher promote or lower pref. If investors are scared and capital is hard to come by, you need to be more lenient. It also depends on how much you’re co-investing, whether you’re cosigning on the debt, how good the deal looks on paper, and how much the investors trust your management. Investors will take lower returns if they see a deal as less risky, and vice versa.

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I started the Sweaty Startup in December of 2018 because I believe the Shark Tank and Tech Crunch culture is ruining the real spirit of low-risk entrepreneurship.