Passive Investor Series Part 2: Hourly wage breakdown of a GP vs LP
There is a time and place to get involved in the active side of real estate. If there is a lack of capital, then it may be a necessity to be on the active side. You put in your sweat equity while others bring in the capital.
However, when one believes they can get into the active side of investing and be hands-off in the process will learn some very hard lessons. To be an active investor, means you have to be “active” if you want to be successful. There is time, effort, and still even capital required to put into the deal in order to successfully get the deal done.
Hands down, the best position you can take in an investment or syndication is that of the passive investor. Not only is there great cash flow and tax benefits, but the fact you don’t have to do anything once you invest your money is a huge benefit. The difficult part is finding the right sponsor to invest in.
On the other hand, being a sponsor or active investor, there is a large time commitment required. You are expected to do everything including but not limited to finding deals, negotiating, conducting due diligence, finding lenders, submitting required documents to lenders, finding and hiring inspectors, finding and hiring attorneys, and raising money from investors. This is just to close the deal. After closing, there are asset and construction management tasks which are another beast.
Below is an example of the estimated number of hours put in on a recently competed deal as an active investor (sponsor):
Purchase price: $8,000,000
Equity Raised: $2,700,000
Acquisition Fee: 2%
Asset Management Fee: 2%
Cash-on-cash Return: 9%
For the 1,563 hours spent on the acquisition of this property, we received an acquisition fee of $95,000 after reimbursing for out-of-pocket expenses, which comes out to about $60/hour.
By comparison, here are the number of hours spent on a completed deal as a passive investor:
As can be seen, being a passive investor in a syndication will require exponentially less time than an active sponsor. The hours accumulated are just for acquisition and the time spent for asset management is not included.
Moving forward, let's say on average the sponsor spends 10 hours a week on asset management and investor relations since they hired a property manager and general contractor to handle those items. This would come out to another 520 hours a year.
On the other hand, the limited partner spends 30 minutes a month to read the monthly update and an hour to review the quarterly financials. In one year, the limited partner is spending 8 hours a year to review the reports and financials.
The reality is the sponsor makes their money at the sale of the property and will earn an asset management fee while managing the asset. With a five year hold, this is what we can expect the sponsor and limited partners to earn from the deal above including a refinance: (Limited partner investment = $100,000)
One thing to keep in mind with the sponsor proceeds is that there are typically more than one sponsor in a syndication. Therefore, these numbers must be split amongst each sponsor. Let’s assume the equity split amongst the sponsors are equal, the proceeds will then be split as follows:
With the 10 hours per week of asset management, the sponsor’s average earnings per asset management hour is $59, which is equal to the hourly wage during acquisition.
When comparing this to the passive investor who is only spending an average of 8 hours per year reviewing this investment, their average earnings per hour is $1,233.
From this example, it shows the best position in a syndication is that of the passive investor. They spend the least amount of time on the investment, hence the passive title, and they have the exponentially higher earnings per hour rate. This frees up the passive investor to do other things while their money is working for them.
The sponsor does have the opportunity to earn well by being active, but it does come with additional sweat equity and is also dependent on the number of other sponsors involved in the deal.