Hey everyone
We are currently looking to structure our first JV for a MF development deal. There is some confusion in the office regarding structuring and modeling the promote. The question is, how long is the typical hold period for a deal like this? We typically look at deals as a 10 year hold. However, if we assume that the deal is a 10 year hold, the IRR in the deal looks really low and the sponsor barely exceeds the pref threshold. However, if we assume a 5 year hold (2 years to develop + 1 year to stabilize) the deal looks much better for the sponsor.
So the question is-- -How long is the typical hold period when modeling out MF development deals? -Does taking out construction debt with a perm loan impact the waterfall distributions? -What happens in the event that we decide to buyout the sponsors equity stake in the deal at some point?
Sorry for so many questions! Thanks.
How long is the typical hold period when modeling out MF development deals? There is no "typical hold period." It is entirely dependent on the business plan agreed upon at the onset of the investment.
Does taking out construction debt with a perm loan impact the waterfall distributions? To the extent that the refinancing proceeds returns a large chunk of capital to the investors, this will increase IRR signficantly.
What happens in the event that we decide to buyout the sponsors equity stake in the deal at some point? What happens? You buy them out. How it happens? There are many different buyout provisions: (1) Shotgun Clause, (2) Third-Party Appraisal, (3) The Cake Scenario (I'm making up the name but its when one party selects the value, and the other party decides if it's a buyer or a seller at that price). There are plenty of other buyout provisions so feel free to chime in.
Just going off the first point, in many of our deals we insitute an equity multiple minimum to align all parties' interests on the hold period. This way, a sponsor won't push for an early sell to juice IRR (and hit promote earlier).
^This
Obviously there are still 100 ways to structure this but I think using a Equity Multiple is the best way to keep everyone aligned.
Another way to do it, is realign equity at year 5 based on the price. You keep everything the same and instead of them getting a promote or selling the 95/5 split become 90/10 or 85/15 and you can continue cashing flowing and the proceeds are distributed without a promote on exit in year 10.
Very interesting. Thanks for the insight guys. Regarding this point--we explored having a synthetic promote based on a valuation in Year X. We just weren't sure how the cash flows are split beyond that period and whether they would also get compensated upon disposition.
The way I have seen this type of "equity realignment" in the past is all equity is converted to preferred equity and there is no longer a waterfall structure, you would use the valuation (Another term that changed deal to deal to come up with the meaning) to proportionally divide the equity based on the value of the implied promote in year 3/5/7 (Usually coincides with a big capital event like a ReFi) when the LP doesn't what to sell but the GP wants to badly. This is done so that an asset can be held indefinitely with the cash flows being split pari-parsu solely based on equity. In the event of a sale it is also split based on equity in the deal.
This is used to make sure a JV partner isn't selling just to get out in year 5 because they have no money, most JV are open to a realignment because it allows them to realize some gains on their book and get paid for the business plan that they implemented, while also getting to benefit from a larger cash flow due to their new larger Preferred equity interest,
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