Investing in commercial real estate often requires significant capital, making it difficult for individual investors to purchase properties on their own. To overcome this challenge, groups of investors typically pool their resources to collectively invest in large-scale properties. This pooling of capital is organized through different deal structures, which determine how responsibilities, profits, and risks are shared among the participants. The three most common deal structures in commercial real estate are Joint Ventures, Syndications, and Delaware Statutory Trusts (DSTs).

In this blog, we will dive into each of these deal structures, explaining how they work, the benefits they offer, and the risks they carry. This knowledge will help you make more informed decisions when considering real estate investments, especially if you’re new to the market or simply exploring different options.

What Is a Deal Structure?

The term “deal structure” refers to the arrangement that outlines the roles, rights, and responsibilities of each party involved in a commercial real estate investment. When multiple investors or firms participate in a deal, the structure will define how the property is managed, how profits are distributed, and who is liable for the property’s financial performance.

A well-drafted deal structure is essential for ensuring that all parties are clear on their obligations and expectations, thus avoiding potential conflicts. It also determines how much each investor stands to gain or lose from the deal.

Common Types of Commercial Real Estate Deal Structures

While each deal is unique, most commercial real estate investments can be categorized into one of three common structures: Joint Ventures, Syndications, and Delaware Statutory Trusts. Let’s break down each of these in detail.

1. Joint Venture

A Joint Venture (JV) is a partnership between two or more parties who combine their resources and expertise to accomplish a specific investment goal, such as purchasing and managing a commercial property. Each party in the JV brings something to the table, whether it’s capital, experience, or property management skills.

A JV is typically governed by a formal agreement that outlines each party’s contributions, decision-making authority, and profit-sharing arrangements. The agreement also addresses how to handle disputes or additional capital needs.

Benefits of Joint Ventures

• Shared Resources: Investors can pool their capital to purchase larger properties that would otherwise be out of reach.
• Shared Responsibilities: Management duties can be divided, which reduces the burden on any one partner.

Risks of Joint Ventures

• Potential for Disagreements: If roles and responsibilities are not clearly defined, conflicts can arise, leading to costly disputes.
• Trust Issues: It’s crucial to vet potential partners thoroughly, as a JV’s success hinges on trust and collaboration.

2. Syndication

Syndication is another common structure that allows multiple individual investors to pool their funds and invest in a large property. In a syndication, there are two key groups: the General Partner (GP) and the Limited Partners (LPs).

• General Partner (GP): The GP is responsible for sourcing, financing, and managing the property. They handle the day-to-day operations and strategic decisions, including leasing and property improvements.
• Limited Partners (LPs): The LPs are passive investors who provide the capital but have no say in the property’s management. They receive a portion of the profits based on their investment but do not participate in the decision-making process.

Benefits of Syndications

• Passive Income: LPs earn income passively from property rents and profits without being involved in management.
• Fractional Ownership: Investors can participate in large-scale, institutional-grade properties without needing to manage them.
• Preferred Returns: Some syndications offer a preferred return, ensuring that LPs are paid first before the GP receives any share of the profits.

Risks of Syndications

• Limited Control: LPs have no direct influence over property decisions, which can be frustrating if the GP’s management doesn’t align with their expectations.
• Dependence on the GP: The success of a syndication depends largely on the GP’s experience and ability to execute the investment strategy.

3. Delaware Statutory Trust (DST)

A Delaware Statutory Trust is a legal structure that allows multiple investors to hold fractional ownership in a property while benefiting from certain tax advantages. It’s similar to a syndication but offers the added benefit of being used in a 1031 exchange, which allows investors to defer taxes on the sale of a property by reinvesting the proceeds into another like-kind property.

DSTs can be used for various property types, including multifamily, office, retail, and industrial buildings. They typically require a relatively low minimum investment, making them accessible to a wider range of investors.

Benefits of DSTs

• Tax Deferral: One of the key advantages of DSTs is their ability to be used in a 1031 exchange, allowing investors to defer capital gains taxes.
• Passive Income: Like syndications, DST investors receive passive income from the property without having to manage it.
• Inheritance Benefits: DST shares can be inherited, and heirs may benefit from a stepped-up cost basis, which reduces capital gains taxes.

Risks of DSTs

• Accredited Investor Requirement: DSTs are typically only available to accredited investors, which limits their accessibility.
• Illiquidity: Investments in DSTs are usually long-term, requiring a holding period of five to ten years, making it difficult to access funds early.

Private Equity Real Estate Deals

Private equity firms often structure their deals as syndications. These firms act as the General Partner, handling all aspects of the deal, from finding the property to managing it after the purchase. Investors, as Limited Partners, provide capital but remain passive throughout the process.

There are two types of syndications within private equity deals:

1. Fund-Level Syndication: Investors contribute to a pooled fund that will be used to acquire properties at a later time. The exact properties are not known upfront.
2. Deal-Level Syndication: Investors contribute capital to a specific property or project and know exactly what they are investing in from the start.

Both options come with their own set of benefits and risks, so it’s important for investors to assess which structure suits their investment goals and risk tolerance.

Understanding the Fees and Profit Distribution

Private equity deals typically involve various fees for the General Partner’s services, such as origination fees, asset management fees, and disposition fees. These fees should be transparent and competitive with industry standards.

Regarding profit distribution, many private equity deals use a “waterfall” structure, where profits are split between the General Partner and Limited Partners based on predetermined thresholds. For example, if a property’s return exceeds a certain percentage, the General Partner may receive a higher share of the profits to incentivize them to maximize the investment’s potential.

Conclusion

Choosing the right deal structure for commercial real estate investments depends on your personal goals, investment size, and risk tolerance. Whether it’s a Joint Venture, Syndication, or Delaware Statutory Trust, each structure has its own set of advantages and challenges. By understanding these structures and how they work, you can make more informed decisions and choose the best option for your investment strategy.