Real estate private equity is a simple arrangement wrapped in a lot of paperwork. A sponsor finds a property, writes a business plan for it, and raises money from private investors to buy it. The investors typically provide most of the equity and stay out of daily decisions. The sponsor does the work and is paid for it.
Sponsors and passive investors
The sponsor, often called the general partner or GP, finds and underwrites the property, arranges the loan, raises the equity, runs the business plan, reports to investors and decides when to sell or refinance. The sponsor usually controls the entity that owns the property.
Passive investors, often called limited partners or LPs, typically provide most of the equity. Their liability is generally limited to what they invest. They share in cash flow and in sale or refinance proceeds, in the order the operating agreement sets.
Many deals use an LLC, with the sponsor as “manager” and investors as “members”; others use a limited partnership.
The life of a deal
- Source. The sponsor finds a property, often through brokers or its own network.
- Underwrite. The sponsor models price, budget, rents, expenses, financing and exit, then tests what happens if those assumptions miss. See how MPIRE evaluates an acquisition.
- Raise. The sponsor prepares offering documents and raises equity.
- Acquire. Investor funds, the loan and any sponsor capital pay the purchase price, closing costs and reserves.
- Execute. Depending on the plan, the sponsor renovates, builds, leases and improves operations. See how value-add real estate creates value.
- Refinance or sell. A refinance can return capital while the deal continues; a sale usually ends it. See how real estate refinancing works.
- Distribute. Cash flow and sale or refinance proceeds are paid out according to the operating agreement.
How a deal is structured
Investors own interests in an entity that owns the property, not the property itself. In a single-deal syndication, the sponsor typically forms a new LLC, called a special purpose vehicle or SPV, to own one property or portfolio. A fund pools capital for several properties, often including some not yet chosen when you invest.
| Feature | Single deal | Fund |
|---|---|---|
| Ownership | An interest in one deal’s LLC | An interest in a pool of properties |
| What you review first | The property and its plan | The strategy and any assets already bought |
| Concentration | One business plan | Several business plans |
The capital stack
The capital stack ranks the money that pays for a property by who gets paid first.
- Senior debt, typically a mortgage loan secured by the property, is paid first and usually costs the least.
- Mezzanine debt or preferred equity, when a deal uses it, sits between senior debt and common equity.
- Common equity, the sponsor’s and investors’ money, is paid last. It takes the first loss and keeps what is left after everyone ahead of it is paid.
Hypothetical example: ignoring closing and selling costs, a $10 million property is bought with a $6.5 million interest-only loan and $3.5 million of equity. If it later sells for $8 million, the lender is still owed $6.5 million, leaving $1.5 million of the $3.5 million in equity. Here a 20% drop in value wipes out about 57% of the equity. Leverage magnifies gains and losses on equity. More in debt vs. equity real estate investments.
How sponsors are paid
Sponsors are typically paid through fees and a share of profits. Both vary widely, and each offering’s documents set them out.
Fees
- Acquisition fee: one-time, at closing, usually a percentage of the purchase price.
- Asset management fee: ongoing, often a percentage of invested equity or revenue.
- Other fees can include construction management, property management, financing and disposition fees.
Most fees are paid whether or not the deal performs, though some offerings defer certain fees until investors are paid.
The promote
The larger part of a sponsor’s potential pay is often the promote, also called carried interest: a share of profits above a hurdle. Distributions typically go to investors first, until they have their capital back plus the hurdle amount set in the operating agreement. Anything above that is split between investors and the sponsor at a stated ratio, sometimes in several tiers. Reaching the hurdle is not assured; it only sets the order in which any profits are shared.
Hypothetical example: investors contribute $1 million, and at sale $1.4 million is available to distribute. The first $1 million returns their capital. Assume the hurdle is met once investors receive another $100,000. The remaining $300,000 is split 80/20: $240,000 to investors, $60,000 to the sponsor. With only $900,000 available, investors would receive all of it and lose $100,000, and the sponsor would earn no promote. This shows mechanics only, not a prediction for any deal.
The offering documents
Three documents typically define the investment. Where they differ from any presentation, website or conversation, including this article, the documents control.
- Private placement memorandum (PPM): the property, business plan, sponsor, fees, conflicts of interest and, at length, the risks.
- Operating agreement: the entity’s rulebook, covering the sponsor’s authority, investor rights, the distribution waterfall, calls for more capital and limits on transferring your interest.
- Subscription agreement: your commitment to invest a stated amount, with representations about you, including accredited status.
Consider having your own attorney or tax adviser review them.
Regulation D: 506(b) and 506(c)
Most private real estate offerings rely on an exemption from SEC registration, usually Rule 506 of Regulation D, which has two versions.
- Rule 506(b) prohibits general solicitation, so the sponsor cannot advertise the offering and generally raises from people it already has a relationship with. It allows any number of accredited investors and up to 35 non-accredited investors, who must be financially sophisticated (alone or with an adviser) and receive additional disclosure.
- Rule 506(c) allows general solicitation, including public ads and websites, but every purchaser must be accredited and the sponsor must take reasonable steps to verify it: for example, reviewing tax returns or account statements, or getting written confirmation from a CPA, attorney, registered investment adviser or broker-dealer.
Under either rule, the sponsor files a notice called Form D with the SEC within 15 days after the first sale, and the interests you buy are restricted securities that cannot be freely resold.
An accredited-status question on a website sign-up form is a self-reported filter, not verification. In a 506(c) offering, the sponsor verifies accredited status later, before accepting your investment. See what is an accredited investor.
Illiquidity and holding periods
There is generally no public market for your interest, and transfers usually need the sponsor’s consent. Expect your capital to stay in for the full business plan, which often runs several years.
Hold periods are estimates. Interest rates, lending conditions, construction delays or the local market can push back a sale or refinance. Distributions can be reduced or paused, and some operating agreements let the sponsor call for more capital, which can dilute investors who don’t contribute. You can lose some or all of your investment. Most deal entities are taxed as partnerships, so expect a Schedule K-1 each year, sometimes later than your other tax forms.
Questions to ask a sponsor
- What has to go right for the plan to work, and what happens if it doesn’t?
- Which deals have you taken from purchase to exit, and which missed their plan?
- What is every fee, what is the promote, and when is each paid?
- How much of your own money is in this deal, and on what terms?
- What is the loan’s size, rate type and maturity, and who guarantees it?
- Which Rule 506 exemption are you using, and how will you confirm I’m accredited?
- How do I confirm wire instructions before I send money?
How MPIRE fits this model
MPIRE is a sponsor based in Houston that describes itself as an operator, not only an investor. It combines acquisition, development, construction, asset management and capital strategy in one company, so the team that underwrites a deal also carries out the plan. See why invest with MPIRE.
The Ohio portfolio is one example, listed on the portfolio page. It is an existing, occupied portfolio of 197 assets (270 units and 33 buildable lots) across ten Ohio markets.
These specifics vary by offering and are set out in each offering’s documents:
- Entity structure:
- Sponsor compensation:
- Co-investment and guarantees:
- Securities exemption:
See how investing works for each step from first call to funding.
Key takeaways
- The offering documents, not the pitch, set your rights, the sponsor’s pay and the order of distributions.
- Equity is paid last: it takes the first loss and keeps what remains after everyone ahead of it is paid.
- A 506(c) offering can be advertised, but the sponsor must take reasonable steps to verify that every investor is accredited.
- Invest only money you can leave in place for the full business plan and can afford to lose.
