GP vs LP: A Comparison Guide For Real Estate Investors
Defining GP and LP
General partners (GPs) and limited partners (LPs) are the principal parties in a joint-venture (JV) equity investment or real estate syndication. The GP is the managing entity of the investment, while LPs are passive investors. The common GP vs. LP legal structure establishes voting rights, legal remedies, and profit-sharing provisions between them. This dynamic is prevalent in both private equity and real estate investing.
GP vs. LP Considerations for Accredited Investors
When investing in real estate, understanding the roles of GPs and LPs is crucial. These terms refer to different positions within the capital stack, ranging from senior and mezzanine debt to preferred and common equity. Investors seeking leveraged returns and potential upside often look to invest in common equity, typically bifurcated between equity investors or LPs and real estate sponsors or GPs. GPs actively manage and operate the investment, while LPs contribute capital passively.
The Role of an LP
LP investors in equity investments assume a limited share of risk and, consequently, a limited share of potential profits compared to GP investors. LPs are not liable for debt and are exempt from much of the legal risk inherent in a real estate project. However, the GP is entitled to a proportionally greater share of profits due to their active management role.
Key Takeaways
- Symbiotic Relationship: LP/GP structures create a symbiotic relationship between equity investors.
- Co-GP Opportunities: These funds offer passive investors the chance to share in the sponsor’s profit potential without managing the asset daily.
- Appeal of GP Participation: This is particularly attractive where there is significant upside potential, such as in value-add or opportunistic business plans.
Responsibilities of GPs and LPs
| LP | GP |
| Passive Investor (Contribute capital) | Operator (Source deals, structure investments, execute business plan) |
| 20-80% of the total equity | 5-20% of total equity (often called “Sponsor Carry”) |
| HNW-investors, family offices, private equity, SPV agglomerates of accredited investors | Real Estate Investment Company, Developers, and financial institutions |
| May vote on important decisions; in some cases has no voting rights | In the driver’s seat; provides day-to-day management |
In the traditional LP-GP structure, LPs provide the capital, while GPs manage the operations. This structure aligns the interests of both parties, as the GP uses their expertise to manage the project, and LPs benefit from the investment without being involved in day-to-day operations.
GP vs. LP Compensation Structures
A typical GP/LP distribution structure, known as a “waterfall,” outlines how profits are shared. Here’s a simple explanation:
- Preferred Return: 100% distribution to all equity investors (LP and GP) pro-rata until they receive an 8% preferred return.
- Return of Capital: 100% distribution to all equity investors (LP and GP) pro-rata until they receive their capital contribution back.
- Catch-up for Sponsor: 100% distribution to the GP until they receive 25% of all profits distributed in the first step.
- Split at Hurdle Rate: 70% to all equity investors (LP and GP) pro-rata, and 30% to the GP until LPs achieve a 13% internal rate of return (IRR).
- Ongoing Profits: 60% to all equity investors (LP and GP) pro-rata, and 40% to the GP.
This structure incentivizes the GP to maximize returns because they receive a larger share of profits after specific performance hurdles are met, a concept known as the “Sponsor Promote.”
Understanding the Waterfall and Sponsor Promote
The “waterfall” structure ensures that GPs (sponsors) are motivated to run the investment at peak performance. As the project achieves higher returns, GPs earn a larger share of the profits. This “Sponsor Promote” means that although GPs might only contribute 5-20% of the equity, they can receive a much greater portion of the profits if the project is successful.
Pros and Cons of GP vs. LP Roles
GP Pros
- Higher potential returns: Direct stake in ownership and management.
- More control: Hands-on decision-making role.
GP Cons
- Increased risk and liability: Personally liable for debts or legal issues.
- Time commitment: Significant time investment required.
- Capital requirements: Substantial upfront capital needed.
LP Pros
- Passive income: Earn income without managing operations.
- Limited liability: Liability limited to the initial investment.
- Diversification: Can invest in various projects.
LP Cons
- Lower return potential: Smaller share of profits compared to GPs.
- Lack of control: Minimal influence over management decisions.
Investing Alongside the GP
Co-GP structures allow passive investors to share in the economics of the GP without handling day-to-day management. These structures are beneficial in value-add and opportunistic investment strategies, where the potential upside is significant.
The Stream Group Approach
The Stream Group carefully vets sponsors and negotiates on behalf of our investors, ensuring access to a diverse array of high-quality real estate investments. By prioritizing GP and co-GP positions, we aim to provide better control over outcomes and enhance capital stewardship for our investors.
Frequently Asked Questions
Do GP or LP investments offer better returns? GP positions generally offer higher returns due to the incentive structure but come with more risk and responsibility.
Between GP vs. LP, which is the better investment? For most investors, LP positions are more feasible due to the extensive responsibilities and liabilities of a GP. LP positions allow investors to participate passively while sharing in the profits.
How do I know if a GP/LP structure is fair? Consider the underwritten target net return. Significant promotes should be justified by the complexity and risk of the project. Always ask questions to understand the structure fully.
Get Started with The Stream Group
Explore GP and LP investment opportunities with The Stream Group. Register today and discover how our strategic approach can enhance your real estate portfolio.
Timothy Shaw
Timothy Shaw is a Founding Partner at The Stream Group. Leveraging his broad experience in real estate, he provides strategic guidance and advisory support. His background includes multifamily syndications, distressed asset acquisition, and serving as a licensed real estate salesperson in Ohio. At The Stream Group, Tim focuses on ownership and investment strategies, ensuring the firm’s long-term growth and vision.
Before his real estate career, Tim served as a lieutenant in the fire department. His career in public safety allowed him the opportunity to serve in many roles, including: firefighter, flight paramedic, hazardous materials technician, and certified fire safety inspector. This background instilled a deep commitment to service and integrity, values he brings to his work with investors, tenants, and team members.
A graduate of the University of Cincinnati with a degree in Fire Science Engineering, Tim is dedicated to creating an environment where systems and data drive success. He admires Warren Buffett’s investment philosophy: “When others are greedy be scared, when others are scared be greedy.”
Tim is married with two children and enjoys traveling with his wife. They spend their free time at their second home on Amelia Island.