Best way to learn Real Estate Waterfalls?

This is a reply to a pretty old post, but I would to practice waterfall modeling on any templates you may have to share.

Thank you

-Steve

<em>No_Name</em>:

https://www.adventuresincre.com/category/re-modeli...

After you read REFJ, download the waterfall link above. This will make sense after the REFJ journal, but you need to learn three basic types...WF's with IRR hurdles, with EM hurdles, and WF's that use both... Also keep in mind the compounding rate for the pref rate (is it monthly, quarterly, annually, etc.>?...)
The Real Estate Finance Journal is a great read on JV Waterfalls and Promote structures. Agree that it's important to learn the concept of a waterfall before looking at the models...because without that foundation the layout wont make sense. Heck if you/your Co. can afford the 1000/mo subscription, it is by far the best and most technical RE Finance publication out there...

In it's simplest of explanations...
think of a deal with two partners (commonly referred to as the GP and LP or JV relationship). #1 puts up 90% of the equity, #2 puts up 10%. Since #1 is the primary equity source, he gets a larger split up front. The main equity partner, per the term sheet, will agree to split the profits more favorably with #2 AFTER the project has returned an IRR or EM that they are satisfied with. Keep in mind these larger equity sources are not in the business of 40%+ IRR's, but doing many deals that earn 10-15% IRR's.
Thus, the typical layout is partner #1 gets a "preferred rate" (pref rate), typically @ 10%. Then, once the project hits a 15% IRR, lets say cash flows get split 70/30 between #1/#2. Once the project reaches 20% IRR, the ratio changes to 60/40 between #1/#2...Usually, the last hurdle will be a 50/50 split on profits...

The reason it's called a waterfall is because of how the cash flows fall off. You start with say 1M of available CF. After you hit hurdle 1, and the CF's are split between both parties per the term sheet (70/30 lets say), there is (1M - paid out CF). Thus the NEW "available CF" is lower, and is then split based on the next hurdle, should it be reached.... And so on and so on....hence a "Waterfall" of CFs...

If at all possible, ask your company for a list of prior term sheets on deals that you have done. Over time, youll be able to read a term sheet and know what company it is based on the structure. You'll pick up that company ABC always wants an equity multiple attached to prevent against time value erosion of the IRR hurdle, or that Co. XYZ compounds their pref rate quarterly instead of annually.

Waterfalls can be extremely simple in theory and even practice, but also can get very complicated very quickly. Add in a participating loan, or a catch up provision across multiple LP's...and it becomes a headache. Thus, knowing the foundation is very important.

Also, depending on how your company is laid out, more often than not the property accountants are the ones that house these models and data. I worked a lot with waterfalls, but mainly within our underwriting model to determine if our promote was attractive enough to do the deal based on LOI's we believe would look like...

This is such a fantastic contribution! Thank you for elucidating all of this! Really appreciate it :)

WIREAlum

Best way to learn them is to build them over and over. It's mind-numbing and tedious, but it works. 

this ...AND, test it by playing w the exit cap rate (or whatever) to see what it looks like if it only achieves X, Y or Z segment of the waterfall.  once you do that a few times you'll see with your own eyes if the waterfall is working or if it's slightly fucked up.