The GP and LP roles
Every syndication has two sides. The general partner, often called the sponsor, finds the property, negotiates the purchase, arranges financing, oversees management and decides when to refinance or sell. The limited partners supply most of the equity and receive an ownership interest, but they do not manage the business.
The sponsor usually invests some of its own money too, though the amount varies widely between deals. What the sponsor contributes most is time, expertise, relationships with lenders and brokers, and frequently the personal guarantees or carve-out obligations lenders require. In exchange, the sponsor earns fees and a share of profits that is larger than its share of the invested capital.
The ownership entity
The property is generally held by a single-purpose limited liability company or limited partnership formed just for that deal. Investors buy membership or partnership interests in that entity, and the sponsor or an affiliate serves as its manager or general partner. The operating agreement or partnership agreement is the rulebook: it sets out management authority, investor rights, how cash is distributed, what fees are paid, how transfers work and what happens if things go wrong.
Because the entity is typically taxed as a partnership, it does not pay federal income tax itself. Income, losses and depreciation pass through to investors and are reported to each of them on a Schedule K-1.
The capital stack
The capital stack describes every source of money used to buy the building and the order in which each gets paid. Higher positions are paid first and take less risk; lower positions are paid last and absorb losses first.
- Senior debt: the mortgage from a bank, agency lender or other lender, secured by the property. It is repaid before any equity receives anything.
- Mezzanine debt or preferred equity: optional layers that sit between the mortgage and common equity. They receive a defined return ahead of common equity, often with limited upside.
- Common equity: the capital from limited partners and the sponsor. It is paid last and bears the first losses, but it also receives the remaining profit after everyone above it is paid.
Fees commonly seen in syndications
Sponsors are compensated through a combination of fees and a share of profits. Names and amounts vary from deal to deal and should be spelled out clearly in the offering documents. Fees commonly seen in the industry include an acquisition fee paid at closing for sourcing and executing the purchase, an ongoing asset management fee for overseeing the business plan and investor reporting, a refinance fee when new debt is placed, a disposition fee when the property is sold, and sometimes construction management or loan guarantee fees.
Property management fees are separate and go to whoever manages the building day to day, which may be a third party or a sponsor affiliate. When evaluating any deal, add up all fees, see when each is paid and whether it is paid regardless of performance, and understand where any sponsor affiliates are earning money.
Preferred returns and waterfalls
The waterfall is the order in which distributable cash flows to investors and the sponsor. Many waterfalls start with a preferred return, which is a hurdle rather than a promise: investors are entitled to receive distributions up to that rate before the sponsor shares in profits, but only if the property generates the cash. If it does not, the unpaid amount may accrue, depending on the agreement, and there is no guarantee it is ever paid.
A simplified, purely hypothetical waterfall might work like this. First, investors receive distributions until they have received their preferred return. Second, on a sale or refinance, investors receive back their contributed capital. Third, remaining profits are split between investors and the sponsor, for example 70% to investors and 30% to the sponsor. Some agreements add a catch-up tier for the sponsor or additional hurdles that shift the split as returns rise. The real terms of any deal are only those in its documents.
The lifecycle of a deal
Most syndications follow the same broad arc. During acquisition, the sponsor signs a purchase agreement, completes due diligence, secures the loan and raises equity from investors before closing. During operations, the sponsor carries out the business plan, which may include renovating units, improving management, adjusting rents to market and controlling expenses, while sending periodic reports and distributions when cash flow allows.
Some deals refinance partway through, replacing the original loan with new debt and potentially returning some capital to investors. Eventually the property is sold, the loan is repaid, and the net proceeds run through the waterfall. Every stage carries risk: plans can be delayed, refinancing can be unavailable on acceptable terms, and a sale may happen later or at a lower price than anticipated.