Limited Partnership (LP)

Limited Partnership Definition

A limited partnership is a business structure often used in investment real estate. It involves one partner whose liability is limited by their invested capital and another partner whose liability extends beyond their monetary investment[1].

REtipster does not provide legal advice. The information in this article can be impacted by many unique variables. Always consult with a qualified legal professional before taking action.

What is a Limited Partnership?

A limited partnership consists of two or more partners: the general partner (GP) and the limited partner(s).

limited partnership

The general partner actively manages the entity’s operations and has unlimited personal liability for the partnership’s debt.

The limited partners are “silent” partners and do not participate in business operations. Their liability is limited up to the amount of their personal contribution to the partnership.

All states except Louisiana recognize and oversee limited partnerships under the Uniform Limited Partnership Act[2]. Partners must register their partnership with the Secretary of State and obtain any licenses required by the state.

Limited Partnership vs. Limited Liability Partnership

In a limited partnership, only the general partner has operational control over the business’s activities, while only the limited partners have personal liability protections.

In a limited liability partnership (LLP)[3], all partners participate in the organization’s management, with each having limited personal liability.

Professional services companies such as law, accounting, and architectural firms often use LLPs. On the other hand, investors use LPs for investment purposes.

Limited Partnership vs. Joint Venture

The general partner typically oversees all business operations in a limited partnership; the other partners have little or no operational control[4]. Limited partnerships may also have a fixed-term lifespan that repays the principal to silent partners at a predetermined maturity date.

limited partnership puzzle

By contrast, a joint venture is a type of general partnership where each partner is actively involved in the business operations. They share equally in the organizations’ profits, responsibilities, and debts. Joint ventures are usually time-limited and created to accomplish a particular goal, such as developing a parcel of land.

Limited Partnership vs. LLC

A limited partnership requires at least two individuals to form, in contrast to a limited liability company (LLC), which requires at least one. All members of an LLC have personal liability protection against the debts of the business, but they also have the right to participate in its management.

It is common for the general partner in a limited partnership to create an LLC to provide a layer of protection against the liabilities of the partnership. Thus the limited partnership agreement is between the general partner’s LLC and the limited partners in the LP.

What Is a Real Estate Limited Partnership (RELP)?

A real estate limited partnership is an organizational structure that allows a group of investors to pool their resources to purchase, develop, and/or lease real property. In a RELP, the general partner is typically a property management or development corporation. Meanwhile, the silent partners are outside investors who put up capital in exchange for returns.

limited partnership group

Real estate limited partnerships are popular vehicles for real estate syndication and equity crowdfunding.

In this partnership, the general partner has a vested interest in the partnership. They usually receive an additional equity stake in exchange for organizing and overseeing the real estate deal. The GP also earns money through fees charged to the partnership, including acquisition fees, asset management fees, and construction management fees. They also hold decision-making authority over the day-to-day management of the business.

By contrast, the limited partners have little to no influence or involvement in the partnership’s operations. In some partnership agreements, limited partners may have voting rights for major decisions, however.

Limited partners receive pass-through dividends and annual income from the partnership. In most cases, the limited partners’ investments are committed for a specified period; they cannot “cash-out” at will.

How Does a RELP Distribute Profits?

Profits are distributed according to the terms of the partnership agreement. In most cases, however, limited partners get preferred returns, meaning the silent investors get a minimum return on investment before the general partner is paid.

Some limited partnerships have a tiered profit-sharing structure to incentivize the GP. For example, 75% of profits may be allocated to the limited partners and 25% to the general partner up to a certain return benchmark. Returns above this benchmark are split 50-50 between the limited partners and the GP.

Limited partnerships are not taxed at the partnership level. Instead, gains and losses are passed through to the individual investors and reported on their tax returns.

Financing a Real Estate Limited Partnership Deal

If the partnership uses leverage to finance a real estate deal, the general partner is responsible for obtaining and guaranteeing the loan. The lender will evaluate creditworthiness based on the GP’s financial status.

Ideally, the general partner aims to secure enough outside investment to lower the project’s loan-to-value ratio and obtain a non-recourse loan. Less leverage also benefits investors because equity provides a buffer in the event the real estate market declines. Lower debt payments also offer protection against periods of low occupancy.

Pros and Cons of a Real Estate Limited Partnership

The LP structure is advantageous for both the GP and the limited partners for many reasons.

Pros for the general partner:

  • They receive equity in exchange for creating and overseeing the real estate deal.
  • They earn additional income through management and other fees.

Pros for limited partners:

  • Their liability is limited to the amount invested in the partnership.
  • Preferred returns mean limited partners get paid before the GP.
  • Limited partnerships are a passive investment for silent partners.
  • Investors enjoy real estate tax benefits and the benefits associated with a pass-through entity.

There are risks in all real estate investments, however. All partners share some risks, while others are unique to the general partner in a limited partnership.

Cons for the general partner:

Their personal assets outside investments in the partnership are at risk if the partnership defaults on its obligations.
They may not get a share of profits unless return benchmarks are met.

Cons for limited partners:

  • They can lose the entire amount of their initial investment.
  • They have no control over the business operations; they are solely dependent on the expertise of the general partner to generate profits.
  • LPs are an illiquid investment, which means capital is at risk throughout the entire investment timeline unless another limited partner is interested in purchasing the interest.

Takeaways

Limited partnerships have been a preferred vehicle for real estate investments for a long time. However, they are just one of many options for investing in real estate. Consider the different organizational structures in light of individual investing goals, style, and risk tolerance before entering an investment partnership.

Sources

  1. Friedman, Jack P., Harris, Jack C., Lindeman, J. Bruce. Dictionary of Real Estate Terms (Barron’s Business Dictionaries) (p. 445). Barrons Educational Series.
  2. The Business Professor. (2019.) Uniform Limited Partnership Act – Definition. Retrieved from https://thebusinessprofessor.com/lesson/uniform-limited-partnership-act-definition/
  3. Entrepreneur. (n.d.) Limited Liability Partnership. Retrieved from https://www.entrepreneur.com/encyclopedia/limited-liability-partnership
  4. Law Depot. (n.d.) Partnership Agreement FAQ – United States. Retrieved from https://www.lawdepot.com/law-library/faq/partnership-agreement-faq-united-states/

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