Episode 3: How Real Estate Private Equity Works

Is real estate a good investment? The short answer is, yes! Now, when it comes to structuring a real estate private equity deal, there are some details that need to be considered. Here, I talk about how a real estate private equity firm is structured and give you some more good, need to know terminology.

Generally speaking, there are two key sets of players with these kinds of agreements: General Partners (GPs) and Limited Partners (LPs), and in a nutshell, GPs raise money from outside investors–LPs–and are in charge of organizing the details. The GPs goal is to make money for both the LPs and themselves, and there are a variety of ways to accomplish this.

Now, a big thing to keep in mind is what is termed as Waterfalls. Basically, this is an overflow of money that comes in from a private equity deal and there when it comes to dividing money for the deal, there are provisions stipulating where this overflow of cash goes: between the common shares and the preferred equity (LPs). In a preferred return this is like an interest rate promised to the LPs, because after all, they are the ones that fronted a bulk of the capital to begin with. Once that is met, The Promote is what goes to the GP.

There are a lot of ways to structure a single deal, and knowing the difference between low risk and high risk deals is vital when organizing one, and fees are a major consideration. From Asset Under Management (AUM) fees to Acquisition and Disposition Fees all of these generally go to the GP to help them set up the deal for success. Structuring any deal really depends on the market and how aggressive or risky a specific deal is, which will also determine co-investing and debt sponsorship.

Three Key Takeaways

  1. The key players are the General Partners (GP) and Limited Partners (LP). As the organizer of the deal, the GP is responsible for finding where the money to structure it comes from, and that’s where the LPs come in. Both sets of players are entitled to a return on their investment, but with that being said, there are a variety of factors to consider to make this happen.
  2. There’s not one single way to structure these deals. It all depends on the market, the financial risk involved, and how easy (or not) it is to have access to capital. Factors of debt and co-investing must also be considered when creating private equity and real estate investment strategies. 
  3. Keep in mind the fees and returns involved in a deal. From AUM fees to Preferred Returns, the money is going in all sorts of different directions. Make sure you know where the money flows before, during and after any deal is struck.

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About Me

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.