Fund Level Waterfall Modeling

I am not on the acquisition side but am interested in learning about the waterfall mechanics behind this fund-level structure. If anyone could provide insight that would be helpful. 

For example, Palladius Real Estate Fund 1 has an opportunity fund where they will return a 7.00% preferred return to LPs and the subsequent GP/LP split of profits will be 30/70 thereafter. 

Questions

  1. Does that mean the GP will not earn any return until a 7.00% preferred return has been hit?
    1. Let's say in theory the fund only buys one property and that deal returns a 6.00% net IRR ... would all of the profit go to the LP in the form of an initial "return of capital" hurdle?
      1. Still curious if this is a return of capital hurdle
  2. How would you model an LP IRR check in a waterfall at a fund level?
    1. This may be a stupid question but bear with me 
      1. I am more used to a waterfalls in deals where the deal is property-by-property and the GP/LP capital split is done upfront. For example, John is going to buy a $10m office building and is seeking a 30/70 GP/LP equity split structure. 
        1. What exactly is the LP contribution to check my IRR?
          1. Update - Figured this out
 
Most Helpful

Since you answered the second one yourself I'll give input on the first question. Yes, if you give a 7% preferred return then the first 7% of cash flow would go to the LP and then you would claw back 7% so you are both whole at 7% returns for that distribution and then split the remaining cash flow 30/70. If you don't hit 7% returns (in your case 6%) then the GP would get nothing for that distribution. I've seen some deals structured that there is no accrual on the return (i.e. the remaining 1% would not be required to be paid in the next distribution) and then pref equity deals that have an accrual basis on the return (i.e. whatever that 1% nets out to be would be added onto the 7% required in the next distribution). 

 

Thank you for the insight. An additional question if you have time… have you ever seen any uncommon waterfall provisions in the wild other than the standard (a LP preferred return, clawback provision, carried interest)?

 

When you're saying the GP would claw back so you're both at 7% returns are you trying to say that the GP's LP contribution is subordinate to the other LPs? I've heard of that but every fund I've seen is pari passu through return of capital/pref.

Also, from your response it sounds like you're not talking about an IRR hurdle (i.e., on an IRR hurdle the return of capital has to occur before you get into the promote), which is also extremely uncommon for fund level deals in my experience. 

 

On your first question:

At the institutional level you're going to see a waterfall start with some IRR hurdle a 6%, 7%, etc., depending on the risk bucket you're in, followed by a return of capital. During those hurdles the LP, which includes the GP's actual contributions (if an acquisition fee is rolled in the accounting can get a little wonky because it technically needs to be subordinate), are all done pari passu. Everybody gets out the percentage of the equity stack that they put in to it.

 

Appreciate the insight. I’d buy you coffee if you’re ever in Hou

 

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