For those of you that have done deals on the side with partners, how have you structured your arrangement? Any must haves or deal terms to avoid? What did your waterfall look like as far as thresholds? Any pref? I know that there are a million ways to skin the cat but curious to hear everyone's experience and suggestions, all input is welcome.
I am in the planning stages of doing a value-add apartment deals with a former colleague who is HNW and would provide a bulk of the capital along with their balance sheet for the loan requirements. I would plan to contribute a portion of the equity and also manage the entire value add process. This would be my first deal on my own account but I have worked in the industry for ~3 years and currently work for a large developer.
First deal would be smaller, likely below 10 units. We are looking for a longer term hold so my current plan is to do a synthetic sale upon stabilization and then crystallize the ownership structure based on the returns from the waterfall in place for the value add period, at which point distributions would be made pari paisu.
just did a 70ish-unit deal in a suburb near where I live. $1m equity raise.
90/10 to an 8% pref
50/50 thereafter
once Class B (LP) gets a 1.7x on their money, the split flips to 20/80.
we're going to own this "forever" so we were focused on a multiple hurdle.
Classic country club split with a twist on the x hurdle.
1.7x is going to take a refi or something though?
Does your pref compoud?
Yes, it’s a value-add play. We bought it at a material discount to market (directly from a 92 y/o man) and are renovating units. well refi in year 3 and return money.
What was your process to finding a deal like that? Did you cold email/call owners?
start to finish, a year and a half. first meeting was a breakfast. half year later we had dinner. he had tax issues. then it was a weekly dinner at his house for 3 months while watching baseball and eating ice cream. he wanted a friend, I think. grew comfortable with me. we signed a contract that he didn’t read or negotiate. we closed in 45 days.
I paid like $45k unit in a B+ market. fully marketed it’s like $60k unit
How many people total was it syndicated with (Just ball park 1,10,100)?
Not sure if hustle, or just elder abuse.
Youse still mates?
8% does not compound.
Can you explain what you mean by
“90/10 to an 8% pref 50/50 thereafter
once Class B (LP) gets a 1.7x on their money, the split flips to 20/80”
I am interested in learning more about the waterfall distribution structures. What resources or guides would you recommend? Appreciate it. Thanks
I'm not the guy but at a high / basic level: Two Investors: X & Y Lets say the project is supposed to return 10% Up to the 8% return, whatever dollar amount that is (eg. $8M), X will get 90% ($7.2M) and Y will get 10% ($0.8M) The dollars that comprise the 8% to 10% range (eg. $2M), will be split 50/50 X ends up with $8.2M Y ends up with $1.8M
For the last part, it depends on when the investor/LP makes 1.7x on their initial money into the project. At the point that threshold is hit/achieved, the money after that point switches from 50/50 to 20/80 (at least thats how I read it)
Interesting, how did you decide that 1.7x was the right number? Sounds like you got a great deal if you are going to achieve a 20% IRR over the first 3 years without even selling. I would have to imagine its a pretty rural market at $45K/door though?
Is there anything about this structure that you don't like or wish you could change? Did the partner guarantee the loan and if so was that a driver in determining the split?
I am looking at a similar equity raise since I'm in a low cap market. Given the cash on cash would never exceed 8% I would have to lower the pref and equity multiple to ever get paid any promote on the deal. Am I right in assuming that your 8% pref is for cash flow only and is not an IRR pref?
If you can force rent increases you can probably make it work with a going in cash on cash that is lower than your pref.
As for the 1.7x, we ran a number of different scenarios - 1.5x, 1.7x, 2.0x - and ultilametly selected the hurdle based on what we believed we could sell to the investors and that which we believed was achieveable based on our business plan.
Suburb of a secondary market in the Midwest. Right across from a major mall and 30,000 VPD. Low PP was due to off-market nature of the acquisition. The property next door is under contract for $60k per unit.
We guaranteed the loan on behalf of the partnership.
As to what I would change, probably nothing. It's a good structure that gives our partners cash flow and residual ownership once we complete the value-add. Under a different type of structure, I might be more incentivizedto sell (e.g. an IRR hurdle). With this structure, once we return 1.7x our investors money, we'll get 80% of cash flow....no real need to sell until my kids go to college (if even then).
We haven't closed anything yet, but we've been underwriting to a simple 80/20 split, no pref. JV structure. We've been looking at 50 units and under, which is why this structure makes sense for us. But on the few 100+ deals we've looked at, we've done 70/30, 9% pref, 60/40 after.
What's the driver of the additional structuring and higher capital outlay on the larger deals? Is it something that you're finding more sophisticated LP capital requires vs partners on the smaller deals?
I am not 100% sure on what you are asking, but institutions generally have much more favorable (to the LP) terms than a F&F type split that is being discussed here.
Big institutional LPs can demand better terms because they bring other things to the table - Name brand recognition to banks = credit worthiness on the loan, seller can be more sure it will close, ect.
Partly yes, on larger deals sophisticated investors are more attuned to these kinds of splits. It also gives us a little more credibility to show that we know what we're talking about and doing. But mostly I'd say that we do it more for the GPs (aka us) to be incentivized to work harder on the deal to get generate higher returns because they know that they'll get a chunk of the return too.
On smaller deals, the numbers just don't work out as well to structure it this way and to add incentives to the GPs.
Let me know if that makes sense!
90/10 until 8% pref. Then GP catchup until 70/30 (to get some CF during project hold) Then 70/30 until 15% IRR (3-5 yr hold) Then 60/40 thereafter.
Tried to push 50/50 after pref but received pushback.
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