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CRE 101: Limited Partnerships in Montana

If you keep up with Sterling CRE market analysis, you know that commercial assets are hard to come by in some of Montana’s hottest markets, like Missoula and Bozeman. So, how can you get into commercial real estate investment when direct ownership isn’t an option? How does that work?

 

Sometimes, Montana CRE limited partnerships can be the right choice for investors.

Essentially, limited partnership entails investing in an existing CRE project that is run by a general partner, or GP. The GP takes on the financial risk for the entire project, while the limited partner only takes on risk in proportion to their investment. The flip side is, of course, that the limited partner (or LP) also reaps the rewards in proportion to their investment.

LP deals are a good way to diversify your portfolio across asset types, as well as limit your risk. Instead of putting one large down payment on a single commercial building, you can instead spread that amount across multiple deals.

A drawback to LP investing for some is that, like a mutual fund, you relinquish control of the day-to-day decision-making for the property. In that way, an LP investor is truly passive. That’s desirable for some investors, but not for others.

So what do these deals look like?

Most will have a business plan and prospectus. Generally, this outlines the big picture, like a plan to build apartments, lease them up to stabilization, re-finance and then hold for 7 years. Or, maybe it’s build, stabilize, then sell within 18 months.

Some LP deals are available an existing project instead of a new build. That might look like the partnership acquiring the project, remodeling the interiors, improving management, refinancing and hold for 5 years. Then, the project would be sold.

There are numerous business plans out there. Finding an offering is actually becoming easier as more of these become available.

But how do you get out of one of these deals?

We covered the basics points of limited partnership deals in an earlier video above.

Essentially, limited partnership entails investing in an existing CRE project that is run by a general partner. The general partner takes on the financial risk for the entire project, while the limited partner only takes on risk in proportion to their investment.

The flip side is, of course, that the limited partner also reaps the rewards in proportion to their investment.

LP deals are a good way to diversify your portfolio across asset types, as well as limit your risk. Instead of putting one large down payment on a single commercial building, you can instead spread that amount across multiple deals.

But what about exiting a limited partnership? How does that work?

That usually comes down to two questions. The first is, are you investing in a project-specific deal, like a pre-defined deal on one property that you know the details of in advance? Or are you investing in a fund that invests in multiple deals?

A fund, sometimes called a “blind fund,” will usually have a pre-defined scope of what types of projects it would invest in. That might mean the fund invests in Bozeman-based apartment projects that anticipate, for instance, a target internal rate of return of 16% and cash-on-cash average yield of 6%.

Project-specific deals will generally keep LPs locked in while the business plan runs its course. If you put money in at the outset and want to get out prior to the planned exit in the business plan, it’s difficult to do so. In that way, they are somewhat illiquid.

When the project sells, there is sometimes – but not always – an option to stay with the entity and do a 1031 exchange into the next project. However, that requires lining up a bunch of moving parts. Most of the time, a deal gets to its planned end state, the property is sold, and the distributions are made in accordance with the operating agreement.

If the individual investors are happy with the performance of the investment and want to stick with the sponsor on the next project, they often do so by starting the process over and rolling proceeds from one successful deal forward into another one.

With a fund, there are usually more jumping-off points than with a project-specific deal. Meaning, that when a “liquidity event” occurs for the fund, it provides an opportunity for investors to get in – and out. Those liquidity events could be a sale or refinance of an individual asset within the fund’s portfolio that opens up cash to allow investors to cash out if desired.

There are usually restrictions on how this can happen since not everyone can cash out all at once.

So, we’ve covered what a limited partnership looks like and how you can get in and out of one. If you are ready to jump into a limited partnership, how can you determine a good opportunity?

In earlier videos, we covered what constitutes a limited partnership and how investors can enter and exit these opportunities. Determining good vs. bad opportunities usually comes down to a few factors.

So first, what do you want the investment to do: grow your equity egg? Produce cash flow to live off of? Offer tax benefits? Or some combination of those? Once you determine what you want from the investment, look for funds of project-specific deals that meet those goals and also have an investment thesis, or concept, that makes sense to you. In places like Missoula, Bozeman, and Kalispell, the investment concept usually revolves around the sustained population growth and overall desirability of the areas and finding supply gaps in the market.

As an example, there is a profound lack of housing in Missoula, coupled with a population growth of 1.8%-2.0% per year. Investing in housing projects, whether it be apartments, build-for-rent single-family communities, or even condo projects, relies on the rising tide of population growth to carry rents up in the coming decade. What other gaps exist in the current market?

In Missoula and Bozeman, there is also a severe lack of quality flex/warehouse offerings. Vacancy in warehouse in Missoula is less than 5% and it is really difficult for companies looking for last-mile distribution facilities to find them.

As a result, rents have climbed considerably. So, an investment thesis might center on filling that market gap. Once you find an investment concept you like, ask yourself if you are comfortable with the risks associated with each geography and asset type. That’s next up in our series on limited partnerships.