How to structure waterfall/promote when selling off part of deal at close?

When structuring a waterfall/promote for a deal where part of the property is sold off at close (e.g., retail condo), the key is to align incentives between the GP and LP while ensuring fair compensation for the GP's efforts in securing and executing the retail sale. Based on the most helpful WSO content, here’s how you might approach it:

1. Separate the Retail Sale from the Main Deal Waterfall

• Treat the retail condo sale as a distinct transaction within the overall deal. This allows you to isolate the proceeds and allocate them appropriately.
• Create a "mini-waterfall" for the retail sale proceeds, ensuring the GP is compensated for the value created by securing the retail buyer.

2. Adjust the Capital Contributions

• Since the LP's capital isn't being fully utilized for the retail portion, you can structure the waterfall to reflect this. For example:
  • Allocate a smaller portion of the retail sale proceeds to the LP, proportional to their actual capital contribution.
  • The GP could receive a higher promote or a fixed fee for arranging the retail sale.

3. Incorporate a Promote for the Retail Sale

• Add a specific promote tier for the retail sale proceeds. For instance:
  • LP receives their capital back first (if any was used for the retail portion).
  • GP receives a promote (e.g., 20-30%) on the remaining retail sale profits.

4. Reinvest or Distribute Retail Sale Proceeds

• Decide whether the retail sale proceeds will be reinvested into the remaining project or distributed to the partners:
  • Reinvestment: If proceeds are reinvested, adjust the LP's capital account to reflect the additional equity.
  • Distribution: If proceeds are distributed, ensure the waterfall accounts for the LP's preferred return and any promote owed to the GP.

5. Consider a Fee for the GP

• Since the GP is taking on the effort and risk of securing the retail buyer, you could include a transaction fee or success fee for the GP, separate from the promote.

6. Example Waterfall Structure

Here’s a simplified example: - Retail Sale Proceeds: 1. LP receives return of any capital used for the retail portion. 2. GP receives a transaction fee (e.g., 1-2% of retail sale price). 3. Remaining profits are split (e.g., 70/30 to LP/GP). - Remaining Project: 1. LP receives return of capital and preferred return (e.g., 8-10%). 2. Profits are split based on standard hurdles (e.g., 70/30 to 15% IRR, 60/40 to 20% IRR, 50/50 thereafter).

7. Document Everything Clearly

• Ensure the operating agreement or JV agreement explicitly outlines how the retail sale proceeds will be handled, including any fees, promotes, or reinvestment terms.

By structuring the waterfall this way, you ensure the LP is fairly compensated for their capital, while the GP is rewarded for the additional value created by securing and executing the retail sale. If you're still unsure, consulting with a real estate attorney or financial advisor experienced in JV structures can help fine-tune the details.

Sources: Waterfall for long term hold, Best way to learn Real Estate Waterfalls?, https://www.wallstreetoasis.com/forum/real-estate/waterfall-technical-question?customgpt=1