How Are Profits Distributed in Real Estate Syndication?

In real estate syndication, profits are distributed based on the agreed-upon structure between the general partner (GP) and limited partners (LP). Typically, profit-sharing is divided through preferred returns, followed by an equity split. The general partner oversees the deal and management, while limited partners provide the capital. Understanding how profits flow in a syndication deal is crucial to ensure you know when and how you’ll receive returns.

Key Takeaways:

• Preferred returns give limited partners priority in receiving profits before the general partner.
• After preferred returns, profits are split based on a pre-determined equity split, often 70/30 or 80/20.
• Distributions can come from cash flow during the hold period and capital gains when the property is sold or refinanced.

1. Preferred Return

In most real estate syndications, preferred return is a critical component that benefits the limited partners (passive investors). This structure ensures that passive investors receive a certain percentage return on their invested capital before the general partner (syndicator) takes any share of the profits.
The preferred return is typically between 6% and 10%. For example, if a syndication deal offers an 8% preferred return, the limited partners are entitled to 8% of their initial investment before any additional profits are split between the GP and LP.
It’s important to note that preferred return is not a guaranteed payout; it depends on the property’s performance and cash flow. However, it provides some security for investors by prioritizing them over the general partner in the profit distribution process.

2. Profit Splits After Preferred Returns

Once the preferred return is satisfied, the remaining profits are split between the limited partners and the general partner based on a pre-determined equity split. The split ratio is typically structured as 70/30 or 80/20, where the limited partners receive the larger share of profits, and the general partner receives the smaller share.

Example: If a deal has a 70/30 equity split, 70% of the remaining profits after preferred returns go to the limited partners, and 30% go to the general partner.

This structure aligns the general partner’s incentives with the limited partners because the GP’s share of the profits only comes after the preferred return is paid to investors.

3. Cash Flow Distributions

During the hold period of the investment, which typically lasts 5-7 years, profits are distributed based on the property’s cash flow. This cash flow comes from rental income minus operating expenses, loan payments, and other costs associated with managing the property.

The cash flow is distributed first to fulfill the preferred return for limited partners. After that, any remaining cash flow is divided according to the equity split between the LPs and the GP.

For investors seeking passive income, cash flow distributions are one of the primary benefits of real estate syndication, as they provide regular payments throughout the investment’s life.

4. Capital Gains Distributions

When the property is sold or refinanced at the end of the investment’s hold period, the capital gains (profits from the sale or refinancing) are distributed. These distributions typically occur after the sale of the property, and the proceeds are first used to return the limited partners’ initial capital investment.

Once the investors’ capital is returned, any remaining profits from the sale are split based on the equity agreement. In many cases, investors may see a larger payout at this point compared to the regular cash flow distributions, especially if the property has appreciated significantly in value during the hold period.

5. Profit Waterfall Structures

Many syndication deals use a waterfall structure to determine how profits are distributed. This structure may include multiple tiers of profit distribution based on achieving specific return thresholds. For example:

• Tier 1: Limited partners receive their preferred return.
• Tier 2: Remaining profits are split 70/30 between LPs and the GP.
• Tier 3: If returns exceed a specific target (e.g., 15% IRR), the GP may receive a higher share, such as 50% of the profits.

The waterfall structure is designed to incentivize the general partner to maximize the property’s performance, as they stand to earn more if they exceed performance expectations.

6. Fees and Expenses

In addition to profit splits, limited partners should be aware of fees charged by the general partner. These fees typically cover the cost of managing and operating the property. Common fees include:

• Acquisition fees (typically 1-3% of the purchase price).
• Asset management fees (1-2% of gross revenue or total asset value).
• Disposition fees (typically charged when the property is sold).

While these fees reduce the overall profits, they are standard in syndication deals and compensate the GP for managing the investment.

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