There's a lot of real estate investors in this forum so I want to get your advice.

5 investors contribute $100K each. Total fund is $500K. The fund will invest in commercial buildings and houses/apartments.

What's a fair compensation structure for management and investors?

Another example. You see a good deal and you need to put 100K down. You have 50K. Another investor will put in 50K and does nothing else. You do everything. What's a fair compensation structure?

Thanks.

That short answer is whatever you negotiate. These numbers are pretty small, but typically distributions will be:

1. Return of capital
2. Preferred return to passive money partner (6-12%)
3. 80/20 in favor of money partner until a certain IRR (15-20%ish)
4. 65/30 in favor of money partner until another IRR (25%ish)
5. 50/50 thereafter

Of course, the non-money partner may be getting fee income (management fee, development fee) along the way. BTW the numbers in your OP are really small and seem more well-suited to an investment in one property than "a fund." Note that there are all kinds of securities laws pitfalls, so consult an attorney.

If you're implying that the investors won't have management control, you should seek out the advice of a good SEC attorney before moving forward. Pooling money from investors who don't have active participation in the enterprise is considered a security, and there are federal and state regulations in place that require registration and perhaps more.

In terms of the financial structure, it really depends on the specific roles. Are the investors truly passive and hands off? If so, it's typical to do a preferred return on the cash flow to the investors with a split (50/50, 60/40, 70/30 are common) above the matched preferred return and on the back end sales profits.

Operator often gets a fee upfront for putting the deal together (3% is typical) and may get paid for work done on the project over and above management of the deal (for example, property management work).

For the other deal, I'd suggest using debt instead of equity. Offer to pay him somewhere in the 10-12% range.

I used $100K so it's easier to understand. Suppose it's $1m each and there's 20 investors to create a $20m fund. Thanks.

Again, unless each of the investors has an active role in the company that takes title to the property, what you are creating is a security and is regulated by the SEC and the individual states in which you are operating. You'd likely want to create a private placement memorandum (PPM) and ensure that you register and comply with all securities rules.

Typically, you can expect to pay $10-20K for the legal/accounting/filing for a single PPM.

Another big point here is that it's very likely a Securities attorney would tell you that most/all of the investors would need to be accredited to ensure compliance and minimize legal risk.

Thanks for the help guys.

Yes, you absolutely need a PPM. The GP should get an acquisition fee and an ongoing asset management fee. Carried interest structures are bad and expensive for LPs, so if you want a "fair" compensation structure, you should avoid that.

This is oddly close to the situation I am currently looking at.

I believe the main difference is that
there is a single project that the investors are looking at.
It is not a "fund" that invests in different properties.

There are 4 investors, each putting up around $125-$150k each and
the property has a total value of approximately 2.2m
The property has its own current/existing management company.
We can change it, but will likely just keep them on.

The outstanding balance is financed.
Would this fall under the "security" definition if only one of the investors
dealt with the management company and the other three were hands off?

There are safe harbors. I believe if the total amount raised is under $1m there is an exemption, with another exemption for raising up to $5m as long as resale is restricted. In the over a million but less than 5 million range, there are SEC registration and financial statement reporting requirements. In both cases you have to raise money only from accredited investors.

Yes, this would be considered a security. The key is that you're pooling funds among multiple passive investors (regardless of how many projects the money is used for).

Yes, there are exemptions. But, you still need to file with the SEC, file with the states where you're doing business and create a PPM for investors to avoid any potential issues later if people lose money.

Also, you may need to ensure that the investors are accredited.

Is there some way ie. a golden rule that separates passive from active investors?

Say if we were to structure the purchase so that we were partners in a corporation and the corporation purchased the property would we be able to avoid the security requirements?

Do the partners have voting rights in the company?

Can they make day-to-day decisions for the company?

Do they participate in any day-to-day activities?

These are a few of the things that will be considered...that said, I'm certainly not an expert on securities laws, so if this is pertinent to something you're actually doing, consult an attorney...

Would recommend forming a LLC instead and avoiding an actual partnership. Limited or general Partners can lead to some problematic legal situations, especially if doing commercial real estate with tenants.

He should do an LLC at the asset level. But at the fund level he should use a GP/LP structure.

OP: Read Riverman's first post about general structuring for returns then call a local lawyer who specializes in funds.