WATERFALLS AND EQUITY SPLITS
When you commonly refer to a waterfall you might flash back to a past vacation (we could all use one of those right now). In the world of multifamily real estate and syndication this term has a bit more complicated connotation. It is an integral part of structuring equity returns in a deal. Depending on how favorable the structure is you may profit enough to book a trip to see your next real waterfall in person.
How are investors paid in a syndication?
A multifamily syndication is the partnering of passive and active investors for the purpose of acquiring, and managing multifamily assets. The majority of capital is invested by the passive investors (limited partners) while the managing of the asset and hands-on work is done by the active investors (general partners). The general partners get paid fees such as asset management fees as well as a share of the profit from the investment.
The passive investors get a percentage of the profit based on the amount they have invested and agreed equity splits. The structure of the deal should be reviewed to make sure there is alignment of interest between both general partners and limited partners.
What is a preferred return?
Preferred return refers to the limited partners getting priority to receive distributions from the profits generated by the syndication. Simply, they must earn this return first before the general partners can be paid. Limited partners invest with the goal of making a return. The preferred return increases the probability of this but does not guarantee it.
"The preferred return increases the probability of this but does not guarantee it. “
If a deal does poorly and there is no profit, the desired preferred return may not be achieved. Limited partners are incentivized to make the investment more profitable as they will not be compensated until their passive investors achieve the agreed preferred return.
Preferred return may be cumulative over the lifespan of the investment or annually depending on the type of multifamily syndication you are partaking in.