GP LP Structure
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Understanding the popular GP LP Structure in commercial real estate

In the realm of real estate investments, navigating the complexities of funding and partnership structures is crucial for investors aiming to maximize their returns while mitigating risks. Among the various investment structures, the General Partner (GP) and Limited Partner (LP) setup stands out as a popular and effective model. Read more about the GP LP Structure below.

What is a GP LP Structure?

The GP/LP structure is a form of limited partnership specifically designed for real estate investments. It comprises two key parties: the General Partner (GP) and the Limited Partners (LPs).

It all starts with the General Partner (GP). The GP is the driving force behind the investment, responsible for managing the day-to-day operations of the real estate project. This includes finding investment opportunities, securing financing, managing properties, and ultimately, steering the project towards its financial goals. GPs typically invest a smaller portion of the capital but take on a more significant risk, including liability for the partnership’s debts.

What is a Limited Partner (LP)?

LPs are investors who provide the bulk of the capital required for the real estate project. Their role is primarily passive, with their involvement limited to financial contributions. LPs enjoy limited liability, meaning their risk is capped at the amount of their investment, and they are not responsible for the partnership’s debts beyond this.

How does it work? 

The GP LP structure operates under a partnership agreement that details the investment terms, distribution of profits, management fees, and the roles and responsibilities of each party. The process typically unfolds as follows:

Formation: The GP identifies a real estate investment opportunity and forms a limited partnership to pool capital from LPs.

Investment: LPs contribute the majority of the capital, while the GP may also invest a smaller amount to have a stake in the project.

Management: The GP undertakes the management of the investment, from development or renovation to operation and maintenance, aiming to add value to the property.

Distribution: Profits generated from the real estate project are distributed according to the pre-agreed terms in the partnership agreement. Typically, LPs receive a preferred return on their investment before profits are shared according to the negotiated split.

At Covercy, we believe that integrated banking services are key to maximizing a GP LP structure. With integrated banking, GPs can collect capital commitments from LPs via instant ACH debit with the click of a button. Similarly, LPs can simply click a button to invest in a new deal, moving funds seamlessly from their bank account to the asset.

Because of Covercy’s partnership with leading banks, all capital transferred and held with Covercy is eligible for high-interest earning, driving even more profit for both the GP and LP involved in the deal.

GP LP Structure
Advantages & Benefits

Risk Mitigation

Limited Partners (LPs) enjoy a unique position where their liability is confined to the amount of capital they have invested. This means that an LP’s assets remain protected if the investment does not perform as expected or if the partnership faces legal challenges. This limited liability feature acts as a safeguard, encouraging individuals and institutions to invest in real estate projects without the fear of risking more than their initial investment.

Expert Management

General Partners (GPs) bring a wealth of experience and expertise to the table, often having a deep understanding of the real estate market, from identifying potential investment opportunities to executing complex development projects. This level of professional management allows Limited Partners to adopt a passive investment stance, relying on the GP to make day-to-day decisions and navigate the intricacies of the real estate market. LPs benefit from the GP’s expertise in selecting properties, managing construction or renovations, overseeing property management, and ultimately driving the project toward financial success.

Capital Efficiency

The GP LP structure facilitates the aggregation of funds from a diverse group of investors, enabling the pursuit of larger, more ambitious real estate projects that individual investors might not be able to finance alone. This collective investment effort not only broadens the scope of potential projects but also diversifies risk across a larger asset base. The ability to gather significant capital resources under one umbrella enhances the partnership’s buying power, potentially leading to better investment terms, greater leverage in negotiations, and access to high-value properties that promise higher returns.

Incentive Alignment

One of the foundational benefits of the GP LP structure is the alignment of interests between the General Partner and Limited Partners. GPs are typically compensated through a combination of management fees and a share of the profits (carried interest), which means their financial success is directly tied to the performance of the real estate project. This setup motivates GPs to perform at their best, ensuring that the property is managed efficiently, costs are kept in check, and strategies are implemented to maximize returns. This alignment of incentives creates a partnership dynamic where both GPs and LPs are focused on the same goal: the success and profitability of the investment.

The Importance of the Distribution Waterfall

The distribution waterfall is a fundamental element in structuring a GP/LP deal, as it dictates how cash flows from the investment are distributed among the partners.

Impact of the Distribution Waterfall on Deal Success

Alignment of Interests: A well-structured distribution waterfall ensures that the financial interests of the GP and LPs are aligned. By setting clear benchmarks for performance-based payouts, it motivates the GP to meet or exceed these targets to achieve higher compensation, while also ensuring that LPs receive returns commensurate with their investment risk.

Incentive for Performance: The waterfall typically includes provisions for a preferred return to LPs, which is a minimum annual return on their investment before the GP can participate in the profits. This structure prioritizes investor returns, thereby incentivizing the GP to optimize the performance of the investment to reach these thresholds.

Risk and Reward Balance: A carefully designed waterfall can balance risk and reward effectively between GPs and LPs. Since GPs often receive a significant portion of their compensation through carried interest (a share of the profits), they are motivated to manage the investment wisely, enhancing the deal’s overall success potential.

distribution waterfall spreadsheet

Learning to Create
a Distribution Waterfall

Start with Education

Industry Literature and Courses: Many real estate investment books, online courses, and seminars cover the basics of structuring investment deals, including the nuances of distribution waterfalls. Starting with these resources can provide a foundational understanding.

Software and Tools: Various real estate financial modeling software and Excel templates are available that can help in understanding and designing distribution waterfalls. These tools often come with examples and can simulate different scenarios. Covercy software includes completely Customisable distribution waterfall models for every GP customer and an experienced support team to help GPs run a variety of scenarios depending on the deal structure.

Modeling Different Scenarios: Using financial modeling, a GP can simulate various investment outcomes and see how different waterfall structures impact the distribution of returns. This exercise helps in understanding the sensitivity of returns to different performance thresholds.

For a first-time GP, building this knowledge base and consulting with experienced professionals are key steps toward structuring a deal that is attractive to LPs and successful in the long term.

distribution waterfall spreadsheet

Understanding Key GP LP Structure Components

A GP LP co-investment deal involves intricate financial mechanisms. While there is no end to the learning involved in real estate investing, below are some key terms every GP should know before he or she embarks on creating a GP LP structure for their next real estate project.

Capital Call

A capital call is a request made by the GP to the LPs for a portion of the committed funds to be paid into the partnership. Capital calls are typically made to cover investment acquisitions, operational expenses, or additional capital requirements for the project. They are governed by the terms set out in the partnership agreement, which detail the timing, amount, and conditions under which capital calls can be made. Failure of an LP to meet a capital call can lead to penalties, dilution of interest, or forfeiture of their investment position.

hurdle rate - gp lp structure

Clawback Provision

A clawback provision is a contractual clause included in the GP LP structure that entitles LPs to reclaim part of the GP’s previously distributed carried interest. This scenario occurs if future losses mean that the GP has received more in distributions than the agreed-upon share. The clawback is designed to ensure that over the life of the investment, the GP receives only the portion of profits that aligns with the agreed performance thresholds and profit-sharing ratio after all investments have been liquidated and final distributions made.

Hurdle Rate

The hurdle rate, often synonymous with the preferred return in a real estate investment context, is the minimum annualized rate of return that the LPs are entitled to receive before the GP can participate in the profits. This rate acts as a performance threshold that the investment must exceed for the GP to begin receiving a share of the profits (carried interest). The hurdle rate is crucial for aligning the GP’s incentive with the LPs’ expectations, ensuring that the GP is motivated to exceed this minimum performance benchmark.

Waterfall Structure Tiers

The waterfall structure tiers represent the sequential order in which profits are distributed among the GP and LPs according to predefined benchmarks within the distribution waterfall. Each tier corresponds to achieving specific financial milestones, such as the return of capital, payment of the preferred return, and various levels of profit-sharing between the GP and LPs based on the investment’s performance. The tiers are designed to ensure that financial rewards are distributed in a manner that reflects the level of risk undertaken and the value created by each party. Advanced structures may include multiple tiers to more finely tune the distribution of returns based on surpassing certain internal rates of return (IRRs) or other performance metrics.

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