Investing Carries Risk
Investing inherently carries risk. You may lose your investment and you may lose the money you invested in it. Depending on how you are investing, your other assets or income may also be at risk. Syndications in effect reduce some of these risks - protecting the limited partners. Real estate syndications bring two groups, general partners and limited partners, together to acquire and manage a real estate asset. General partners work actively to ensure the success of the investment while limited partners invest capital to fuel and fund the investment to success.
"Limited partners’ risks are only as great as the amount of capital they invest.
Financial Risks of Limited Partners In Real Estate Syndication
Limited partners’ risks are only as great as the amount of capital they invest. This risk can be increased if an investment is underfunded and a capital call occurs. A capital call is when limited partners are asked to invest additional capital due to some financial challenge the investment is facing. To prevent this from happening, general partners may seek additional funding from loans, new limited partners or themselves. In a worst-case scenario, the limited partner would lose their initial capital investment and the additional capital investment(s). This is an exception to the norm. To protect the limited partner a syndication should be formed with a large enough operating budget/ capital reserve to offset unforeseen financial challenges.
Legal Risks In Real Estate Limited Partnership Structure
Legal risks are structured away from limited partners and placed on the general partners. If there were an incident on the property that resulted in litigation a plaintiff would have no grounds to sue the limited partners or have any claims to the limited partners’ assets. Therefore, the limited partner would have nothing more to lose than the capital they have already invested. In this way the limited partner has legal and financial protection while still enjoying the benefits of investing in real estate. This is also the case with loan guarantees.
General partners act as the guarantors for the mortgages on multifamily assets. Limited partners do not.
"...although a limited partner risks losing their capital investment, they are protected from financial repercussions in excess of that
If the investment does poorly and the loan goes into default, the mortgage lender would seek repayment from the general partners. Limited partners need not worry about their credit scores being affected, wages being garnished or any expectation for them to pay off the loan balance. Their exposure is limited to the amount they have invested. So, although a limited partner risks losing their capital investment, they are protected from financial repercussions in excess of that. In this way limited partners have financial protection from lenders.
General Partners Help To Protect Limited Partners In Real Estate Syndication
Experienced general partners also help to protect the limited partners from failure. If you have ever tried anything new chances are it took a few tries until you were good at it. Investing is no different. There is a reason why experienced investors such as Warren Buffet and Sam Zell are role models and highly sought after. While there are no guarantees with investing, the more experienced an investor and the better their track record the greater their chances of future success. If you are a new investor or otherwise unfamiliar with best practices for running a successful syndication, there is a higher risk of failure and loss of your invested capital than if you were to partner with a group of experienced individuals. The general partnership team is composed of several individuals who bring the needed experience for a syndication to be successful. While also reducing risk to your capital, being a limited partner in this setting may also offer opportunities to learn how a syndication is run.
The knowledge gained in this manner would increase chances of success if the investor eventually plans to become an active investor – providing an education that more than pays for itself. When investing large sums of capital, limited partners are further protected by the experience of the general partners.