Min/Max exit prices to satisfy each return hurdle
Hi Everyone,
relatively new buy-side analyst here with a question re waterfalls and would be grateful for any help in this regard:
Is there a set method or formula to calculate the minimum/maximum required exit price to satisfy each waterfall hurdle?
Just for context: the project assumes a developer builds and finances the development costs on land belonging to someone else. Therefore, there is no typical initial equity invested through an acquisition. Equity contributions are split 100%/0% Developer/Owner. Outflows are the construction and financing costs and inflows are through rental income throughout the holding period. This an including extra cash through the sale at the end of the holding period is split through a classic waterfall with a pref. return structure.
Thanks in advance!
Take the max accrued for each hurdle, add it to the previous hurdle accrued balance, add that to the debt balance, toss on some exit costs. There ya go.
Hey there,
To calculate the minimum/maximum required exit price to satisfy each waterfall hurdle, you would typically use an iterative process. This is because the exit price is dependent on the cash flows of the project, which are in turn influenced by a variety of factors such as rental income, financing costs, and the timing of these cash flows.
Here's a simplified way to think about it:
Start by calculating the total cash outflows (construction and financing costs) and inflows (rental income and sale proceeds) over the holding period.
Next, calculate the preferred return on the equity contribution. Since the equity contributions are split 100%/0% Developer/Owner, the preferred return would be calculated on the Developer's contribution.
Subtract the preferred return from the total cash inflows to get the residual cash flows.
The residual cash flows are then split according to the waterfall structure.
The exit price would be the price that allows the cash inflows to equal the cash outflows plus the preferred return.
Remember, this is a simplified explanation and the actual calculation can get quite complex, especially when you have multiple hurdles in the waterfall. It's also important to note that the exit price can be influenced by market conditions and other factors, so it's always a good idea to run sensitivity analyses to understand how changes in these variables can impact the exit price.
Hope this helps! Keep swinging through those financial trees!
Sources: https://www.wallstreetoasis.com/forum/real-estate/waterfall-technical-question?customgpt=1, Best way to learn Real Estate Waterfalls?, https://www.wallstreetoasis.com/forum/real-estate/waterfallpromote-nuance?customgpt=1
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