Partnerships and Other Equity Investment Vehicles

1. Partnerships and Other Equity Investment Vehicles Review of Joint Forms of Real Estate Ownership Lecture Map Purpose of joint investing in real estate Forms of joint ownership Legal considerations

2. The Business of Raising Equity Most real estate today is held in joint forms of ownership Large capital requirements of asset Limited resources Portfolio diversification and risk management For those who manage joint real estate investments, opportunity to earn “promotes” Incentive returns tied to investment results

3. Joint Forms of Ownership Joint forms of ownership split cash flows after debt service Allocate cash flows according to risk borne by each equity investor Tier of cash flows: the “waterfall” The waterfall is not always pro rata to amount of equity invested in a deal Tax attributes can also be re-allocated

4. Joint Ownership Structures Most joint ownership vehicles are tax efficient “flow-through” entities Pass tax benefits directly through to owners as individuals Avoid double taxation of corporate form

5. Joint Ownership Structures (cont.) Partnerships General and limited Limited Liability Corporations Joint Ventures

6. Partnerships Equity capital raised through a “private placement” May be dedicated or multi purpose Dedicated ? single, identified asset Multi-purpose ? pools of capital, managed funds

7. General Partnerships All investors are considered to be “general partners” All partners bear risk and liabilities of investment equally Rarely if ever used today Owners are treated individually for tax purposes No double taxation

8. Limited Partnerships Combines limited liability of a corporation with the tax benefits of individual ownership Structure A General Partner acts as managing partner Provides liability shield to investors Has some investment, minimal ownership interest Typically also a limited partnership, corporation or llc Limited Partners are passive investors Put up majority of capital Cede operating control to the GP No responsibility to cover future shortfalls/losses

9. L.P. Structure

10. Partnership Allocations Cash flow and tax attributes can be allocated on a negotiated basis Disproportionate allocations reflect varying levels of risk in the transaction L.P.’s Put up most of the capital Take most of the equity risk Receive priority returns of cash flow ? “preference” G.P.’s Earn a “promote” or incentive interest Reward for reaching/exceeding projected returns Deferred to future in exchange for use of outside capital

11. Partnership Capital Accounts Capital Accounts are the record of financial results for each partner Capital accounts change with cash flow (deficits) and/or net income (loss) Positive changes ? capital accounts Negative changes ? capital accounts Disproportionate allocations cause partners’ capital accounts to move unequally during the investment period Must be rebalanced at termination of partnership

12. “Substantial Economic Effect” Tax rule governing use of disproportionate allocations of tax benefits of real estate ownership Put into place in early 1990’s to eliminate abuse of tax shelters Allows IRS to look through the structure to make sure that capital accounts are rebalanced over time through ongoing or residual value allocations

13. Legal Considerations in Real Estate Partnerships Investors must be “accredited” under Reg D of the Securities Act of 1933 Exempt from SEC filings Minimum financial net worth, income, sophistication tests Documents must accurately describe the cash and income allocations and treatment of partnership capital accounts Must not be an “association” in order to qualify for partnership tax treatment

14. What’s an Association? Legal entity with the following attributes: Has a business purpose Primary objective is to distribute economic gains from the entity Continuity of life Centralized management Limited liability Free transferability of ownership interests

15. Avoiding Classification as an “Association” Two features of partnerships allow them to maintain their tax attributes: Limited life Termination date of partnership Earlier of date certain or asset sale Restricted transferability No public market in ownership interests Right to sell controlled by partnership entity

16. Limited Liability Corporations Most “partnerships” use this structure today Texas was first state to adopt LLC format Must be allowed by state law for use Complete corporate liability shield for both “managing member” and other investors Enjoy all tax and structural attributes of partnerships

17. LLC Structure

18. Joint Ventures Investment agreements dealing with multiple parties Each party is its own legal entity Individuals, corporations, partnerships, llc One party typically deemed the manager of the venture Venture agreement can itself be a partnership or an llc

19. Joint Venture Structure