Partnerships and Other Equity Investment Vehicles <ul><li>Review of Joint Forms of Real Estate Ownership </li></ul><ul><li...
The Business of Raising Equity <ul><li>Most real estate today is held in joint forms of ownership </li></ul><ul><ul><li>La...
Joint Forms of Ownership <ul><li>Joint forms of ownership split cash flows after debt service </li></ul><ul><li>Allocate c...
Joint Ownership Structures <ul><li>Most joint ownership vehicles are tax efficient  </li></ul><ul><ul><li>“flow-through” e...
Joint Ownership Structures (cont.) <ul><li>Partnerships </li></ul><ul><ul><li>General and limited </li></ul></ul><ul><li>L...
Partnerships <ul><li>Equity capital raised through a “private placement” </li></ul><ul><li>May be dedicated or multi purpo...
General Partnerships <ul><li>All investors are considered to be “general partners” </li></ul><ul><ul><li>All partners bear...
Limited Partnerships <ul><li>Combines limited liability of a corporation with the tax benefits of individual ownership </l...
L.P. Structure Limited Partnership Limited Partner Limited Partner Limited Partner General Partner
Partnership Allocations <ul><li>Cash flow and tax attributes can be allocated on a negotiated basis </li></ul><ul><ul><li>...
Partnership Capital Accounts <ul><li>Capital Accounts are the record of financial results for each partner </li></ul><ul><...
“Substantial Economic Effect” <ul><li>Tax rule governing use of disproportionate allocations of tax benefits of real estat...
Legal Considerations in Real Estate Partnerships <ul><li>Investors must be “accredited” under Reg D of the Securities Act ...
What’s an Association? <ul><li>Legal entity with the following attributes: </li></ul><ul><ul><li>Has a business purpose </...
Avoiding Classification as an “Association” <ul><li>Two features of partnerships allow them to maintain their tax attribut...
Limited Liability Corporations <ul><li>Most “partnerships” use this structure today </li></ul><ul><ul><li>Texas was first ...
LLC Structure LLC Member Member Member Managing Member
Joint Ventures <ul><li>Investment agreements dealing with multiple parties </li></ul><ul><ul><li>Each party is its own leg...
Joint Venture Structure Joint Venture LLC  Venture Partner  Venture Partner Texas Venture, LLC Sullivan Partners, L.P.
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Class Lecture Notes - Lecture #12 10/23/2003

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Class Lecture Notes - Lecture #12 10/23/2003

  1. 1. Partnerships and Other Equity Investment Vehicles <ul><li>Review of Joint Forms of Real Estate Ownership </li></ul><ul><li>Lecture Map </li></ul><ul><ul><li>Purpose of joint investing in real estate </li></ul></ul><ul><ul><li>Forms of joint ownership </li></ul></ul><ul><ul><li>Legal considerations </li></ul></ul>
  2. 2. The Business of Raising Equity <ul><li>Most real estate today is held in joint forms of ownership </li></ul><ul><ul><li>Large capital requirements of asset </li></ul></ul><ul><ul><li>Limited resources </li></ul></ul><ul><ul><li>Portfolio diversification and risk management </li></ul></ul><ul><li>For those who manage joint real estate investments, opportunity to earn “promotes” </li></ul><ul><ul><li>Incentive returns tied to investment results </li></ul></ul>
  3. 3. Joint Forms of Ownership <ul><li>Joint forms of ownership split cash flows after debt service </li></ul><ul><li>Allocate cash flows according to risk borne by each equity investor </li></ul><ul><ul><li>Tier of cash flows: the “waterfall” </li></ul></ul><ul><ul><li>The waterfall is not always pro rata to amount of equity invested in a deal </li></ul></ul><ul><li>Tax attributes can also be re-allocated </li></ul>
  4. 4. Joint Ownership Structures <ul><li>Most joint ownership vehicles are tax efficient </li></ul><ul><ul><li>“flow-through” entities </li></ul></ul><ul><ul><li>Pass tax benefits directly through to owners as individuals </li></ul></ul><ul><ul><ul><li>Avoid double taxation of corporate form </li></ul></ul></ul>
  5. 5. Joint Ownership Structures (cont.) <ul><li>Partnerships </li></ul><ul><ul><li>General and limited </li></ul></ul><ul><li>Limited Liability Corporations </li></ul><ul><li>Joint Ventures </li></ul>
  6. 6. Partnerships <ul><li>Equity capital raised through a “private placement” </li></ul><ul><li>May be dedicated or multi purpose </li></ul><ul><ul><li>Dedicated -> single, identified asset </li></ul></ul><ul><ul><li>Multi-purpose -> pools of capital, managed funds </li></ul></ul>
  7. 7. General Partnerships <ul><li>All investors are considered to be “general partners” </li></ul><ul><ul><li>All partners bear risk and liabilities of investment equally </li></ul></ul><ul><ul><li>Rarely if ever used today </li></ul></ul><ul><ul><li>Owners are treated individually for tax purposes </li></ul></ul><ul><ul><ul><li>No double taxation </li></ul></ul></ul>
  8. 8. Limited Partnerships <ul><li>Combines limited liability of a corporation with the tax benefits of individual ownership </li></ul><ul><li>Structure </li></ul><ul><ul><li>A General Partner acts as managing partner </li></ul></ul><ul><ul><ul><li>Provides liability shield to investors </li></ul></ul></ul><ul><ul><ul><li>Has some investment, minimal ownership interest </li></ul></ul></ul><ul><ul><ul><li>Typically also a limited partnership, corporation or llc </li></ul></ul></ul><ul><ul><li>Limited Partners are passive investors </li></ul></ul><ul><ul><ul><li>Put up majority of capital </li></ul></ul></ul><ul><ul><ul><li>Cede operating control to the GP </li></ul></ul></ul><ul><ul><ul><li>No responsibility to cover future shortfalls/losses </li></ul></ul></ul>
  9. 9. L.P. Structure Limited Partnership Limited Partner Limited Partner Limited Partner General Partner
  10. 10. Partnership Allocations <ul><li>Cash flow and tax attributes can be allocated on a negotiated basis </li></ul><ul><ul><li>Disproportionate allocations reflect varying levels of risk in the transaction </li></ul></ul><ul><ul><li>L.P.’s </li></ul></ul><ul><ul><ul><li>Put up most of the capital </li></ul></ul></ul><ul><ul><ul><li>Take most of the equity risk </li></ul></ul></ul><ul><ul><ul><li>Receive priority returns of cash flow -> “preference” </li></ul></ul></ul><ul><ul><li>G.P.’s </li></ul></ul><ul><ul><ul><li>Earn a “promote” or incentive interest </li></ul></ul></ul><ul><ul><ul><ul><li>Reward for reaching/exceeding projected returns </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Deferred to future in exchange for use of outside capital </li></ul></ul></ul></ul>
  11. 11. Partnership Capital Accounts <ul><li>Capital Accounts are the record of financial results for each partner </li></ul><ul><li>Capital accounts change with cash flow (deficits) and/or net income (loss) </li></ul><ul><ul><li>Positive changes ↑ capital accounts </li></ul></ul><ul><ul><li>Negative changes ↓ capital accounts </li></ul></ul><ul><li>Disproportionate allocations cause partners’ capital accounts to move unequally during the investment period </li></ul><ul><ul><li>Must be rebalanced at termination of partnership </li></ul></ul>
  12. 12. “Substantial Economic Effect” <ul><li>Tax rule governing use of disproportionate allocations of tax benefits of real estate ownership </li></ul><ul><ul><li>Put into place in early 1990’s to eliminate abuse of tax shelters </li></ul></ul><ul><ul><li>Allows IRS to look through the structure to make sure that capital accounts are rebalanced over time through ongoing or residual value allocations </li></ul></ul>
  13. 13. Legal Considerations in Real Estate Partnerships <ul><li>Investors must be “accredited” under Reg D of the Securities Act of 1933 </li></ul><ul><ul><li>Exempt from SEC filings </li></ul></ul><ul><ul><li>Minimum financial net worth, income, sophistication tests </li></ul></ul><ul><li>Documents must accurately describe the cash and income allocations and treatment of partnership capital accounts </li></ul><ul><li>Must not be an “association” in order to qualify for partnership tax treatment </li></ul>
  14. 14. What’s an Association? <ul><li>Legal entity with the following attributes: </li></ul><ul><ul><li>Has a business purpose </li></ul></ul><ul><ul><li>Primary objective is to distribute economic gains from the entity </li></ul></ul><ul><ul><li>Continuity of life </li></ul></ul><ul><ul><li>Centralized management </li></ul></ul><ul><ul><li>Limited liability </li></ul></ul><ul><ul><li>Free transferability of ownership interests </li></ul></ul>
  15. 15. Avoiding Classification as an “Association” <ul><li>Two features of partnerships allow them to maintain their tax attributes: </li></ul><ul><ul><li>Limited life </li></ul></ul><ul><ul><ul><li>Termination date of partnership </li></ul></ul></ul><ul><ul><ul><li>Earlier of date certain or asset sale </li></ul></ul></ul><ul><ul><li>Restricted transferability </li></ul></ul><ul><ul><ul><li>No public market in ownership interests </li></ul></ul></ul><ul><ul><ul><li>Right to sell controlled by partnership entity </li></ul></ul></ul>
  16. 16. Limited Liability Corporations <ul><li>Most “partnerships” use this structure today </li></ul><ul><ul><li>Texas was first state to adopt LLC format </li></ul></ul><ul><ul><li>Must be allowed by state law for use </li></ul></ul><ul><li>Complete corporate liability shield for both “managing member” and other investors </li></ul><ul><li>Enjoy all tax and structural attributes of partnerships </li></ul>
  17. 17. LLC Structure LLC Member Member Member Managing Member
  18. 18. Joint Ventures <ul><li>Investment agreements dealing with multiple parties </li></ul><ul><ul><li>Each party is its own legal entity </li></ul></ul><ul><ul><ul><li>Individuals, corporations, partnerships, llc </li></ul></ul></ul><ul><ul><li>One party typically deemed the manager of the venture </li></ul></ul><ul><ul><li>Venture agreement can itself be a partnership or an llc </li></ul></ul>
  19. 19. Joint Venture Structure Joint Venture LLC Venture Partner Venture Partner Texas Venture, LLC Sullivan Partners, L.P.
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