Passive Investor Profit Sharing

6 Replies

Hi everyone,

Im thinking about bringing on passive investors for future real estate deals, but I haven’t been able to find great resources that cover common real estate profit sharing, fee, and capital structure techniques for small time investors.

I imagine this can vary drastically from deal to deal, but I know other industries have standard fee structures. For example, hedge funds, venture capital funds, and private equity funds typically use the 2 and 20 structure. They charge investors 2% of assets under management for management fees each year and 20% of an investors return made on their investment over an agreed upon preferred return.

A 2 and 20 structure doesn’t seem like it would yield much more money for smaller investments. What are some typical profit sharing, fee, and capital structures for smaller investments (e.g. 8-12 unit multifamily properties) that you have heard of?

Greatly appreciate any insight or direction. Please feel free to ask clarifying questions if anything is unclear. Thank you!

@Shane Shaddox

Typically whenever passive investors that bring equity to a deal are involved, you're entering the world of syndications. Hence would need to work with securities attorney to draft the legal agreement (aka PPM) to do that. If your deals are smaller as you mentioned (8-12 units), it may be cost effective to consider JV option. However in such case, all of your partners in a deal would have to be active, in other words have some sort of task to perform.

In terms of the fees and payouts, every deal is different. You'd have to go through a number of scenarios and discussions with your group of investors to find an alignment with them and a fair compensation for your services.

Reading a few books on syndications will help as well: "best ever syndication book" and "it's a whole new business".

@Shane Shaddox , for that size of deal the costs of setting up a syndicate are likely prohibitive. Why not go with a joint venture or simple partnership? You can adjust the split of the returns any way you want. A very basic example would be a 50/50 split between two partners, one of whom brings the money and the other who finds and manages the deal. Good luck!

Search out "syndication" and you will find a ton of resources. 

Splits can vary greatly and are all based on the sponsor, the investors and the deal

A typical deal will have the following:

1-3% acquisition fee on the purchase price

1-3% asset management fee on the gross collected revenue

60-80% of the equity is given to the limited partners (investors)

4-8% preferred return paid to the investors

The above is a very simple explanation - you should consult a securities attorney. I have a few articles that may help you along your journey. 

https://www.biggerpockets.com/member-blogs/10145/83067-limited-partner-s-guide-to-investing-in-the-right-deal

https://www.biggerpockets.com/member-blogs/10145/73373-opm-how-to-syndicate-with-success

https://www.biggerpockets.com/member-blogs/10145/72118-syndication-the-ins-and-outs-of-real-estate-syndication

@Shane Shaddox Some great recommendations here. So I will just follow up with, typical deals with partnerships and investors fit into two basic categories. Equity or Debt Financing.

Equity being, the partnership shares in ownership of the property for both upside and downside. These can be structured any which way, much explained above. Splits with preferred returns are common here.

Debt financing being, the partnership is split with equity being with one owner/owners for updside and downside while the other owner/owners simply get a return based on the amount borrowed. Hard money lenders or even traditional financing are a good example of this, but in this case its simply private investors in a partnership agreement/llc achieving a return.

Here is a good explanation and video by Matt Faircloth on both types of financing.

@Shane Shaddox great recommendations by everyone here; Todd Dexheimer is correct, the splits can vary quite a bit, depending on the deal and sponsors.

 Another book, it's old, but good.  "Principles of Real Estate Syndication", by Samuel K. Freshman.  Generally, your legal bills are higher in the beginning when creating a PPM, but if you set up a fund structure where you are continually adding properties, they tend to be lower for each property added.