Help with Waterfall Promote Structure Modelling
Hi,
Currently working at a firm that owns 100% of a development project and running some analysis. The CIO mentioned looking at this development and running an analysis at bringing a LP in just before construction start to shorten the development horizon and juicing the GP returns.
I'm not really sure what this entails and how to model this out. Know how to build a basic waterfall and promote structure assuming that partner buys in at T=0 and flows through with equal contributions and a promoted distribution structure. But not sure how to show an LP entering at a certain time period (at a certain price) would juice GP returns.
If LP bought in at asset/market price, wouldn't the structure and returns effectively be the same if they bought in today? A little lost on how to proceed so any help is appreciated.
I assume when the LP is brought in you would “true-up” to your pro-rata shares. So GP would get “refunded” for predev costs, and the venture would begin at the true-up event t=0 and the IRR clock for the JV starts ticking.
If you wanted to understand the GP Metrics from before you formed the JV through exit, you’d just add the cash flows in front of the newly formed JV’s cashflow.
Someone feel free to tell me I’m wrong or this isn’t the way to do it.
If the metrics support it, you could also try to get a land lift, which would add more dollars in your pocket at the true-up.
Makes sense thanks for the response. So in essence I can perhaps treat it as two series of Cashflows, one Cashflow from before JV, then initiate the JV buy-in at some time in the future and model that as a go-forward waterfall.
I'd need more info to answer your question fully, but going from no promote to getting promote definitely juices the returns.
Thanks for response.
In essence, the CIO mentioned that we should time when we bring in the partner to juice GP returns.
What I don't understand is how timing the partner equity right before construction (say T=12) versus having them right now (T=0) is any different in terms of GP returns (assuming the same hurdle rates and promote structure).
If they entered in today, we would just presume the JV % split on the costs and then calculate distributions upon reversion. But if they enter in later, wouldn't they just buy in at the true-up costs between now and then and the same structure apply?
Confused at how these two scenarios differ from each other.
Ah ok, still could be a few things but that narrows it down:
1) as No_Cap mentioned bringing them in later could allow you to earn a profit on the investments you've made to date as the deal has been de-risked (e.g., if you entitled the land, got permits and then bring in the investor)
2) The later you bring them in, the later their pref clock starts ticking, so they'll buy in at the dollars today, but they won't have earned any pref because they didn't have those dollars outstanding. Now, your firm had to have those dollars outstanding and you have some cost of capital (either the interest costs if it's a company line of credit, or the opportunity cost of other investments if it's the owners money, etc.), but that doesn't always get factored in in RE.
Assuming an IRR-based hurdle structure, IRR is a time-sensitive metric. If your equity is in for less time but you take out the same profit before promote, then you are going to naturally have a higher IRR. This is because there is less accrued required returns to hit your hurdles (i.e. it takes less money to get a 8% IRR over 2 years than it does over 4 years), which means there's more money distributed disproportionately to the GP.
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