Equity Waterfall Deal Structures

Justin Kivel
A free video tutorial from Justin Kivel
Real Estate Investing & Financial Modeling
4.7 instructor rating • 19 courses • 43,282 students

Learn more from the full course

The Real Estate Syndication Process

How To Raise Money to Invest Profitably Commercial Real Estate Properties

01:50:06 of on-demand video • Updated June 2021

  • Understand the entire process from start to finish on how to purchase a commercial property and raise money to do it
  • Know the details of the full life-cycle of a real estate investment transaction and build the confidence to close deals
  • Confidently communicate with investors and partners after acquiring a property
English [Auto] So we've talked about waterfall structures a lot in this class and I've talked about we're going to go over this later on in the course. Well, this is that later on in the course. So equity waterfall structures are really the backbone of real estate syndication. It's how people make money, how real estate syndicators make money for making strong investment decisions and performing based on the business plan and exceeding investor expectations. So the investor is happy and the general partner or sponsor or syndicator is very happy. Here's how the sponsor is going to make outsized returns on their initial investment and really the sweat equity that you hear talked about all the time. So first you're going to have for an equity waterfall structure, a preferred return hurdle. So what does this mean? Well, your investor is going to say, I want an eight percent return on my money and everything up to an eight percent annualized return on their money. Then the investor, the limited partner investor and the general partner investor are going to split those returns, what's called pari passu or side by side. So if the general partner puts up five percent of the equity and the limited partner puts up 95 percent of the equity, then up to that eight percent annualized return, the limited partner is going to get 95 percent of the profits and the general partner is going to get five percent of the profits. However, with an equity waterfall structure, anything over that preferred return, it's going to have some sort of promoted interest for the general partner. And this is how general partners make their money. So if the preferred return is eight percent, but the property actually receives a 15 percent annualized return, then the general partner is going to earn a percentage of what the limited partners profits would be. And that's determined by the promoted interest. So what does that actually mean? Well, if we're talking about that same deal, if that same deal achieved a 15 percent annualized return and the preferred return was eight percent, and there was also an agreement that said there was going to be a 20 percent promote over that preferred return, then what that would mean is that the general partner would take 20 percent of what would otherwise be the limited partner profits. So I'll show you guys the math in a second in an Excel example. But what that essentially means is that the general partner is taking 20 percent of that 95 percent that the limited partner would get from those profits. So I have a little snapshot of what an equity waterfall might look like down here. And in the next lesson, we're going to jump into an equity waterfall example at a really high level. We don't need to get bogged down with the details for the purposes of this course. I have another class called the Real Estate Equity Waterfall Modeling Masterclass. If you really want to dig deep into how these models are built. But for now, I want you guys to understand the opportunity and how general partners and sponsors make money. So I'll see you in the next lesson or we're going to go into that Excel example.