Building a small cash flow portfolio of industrial assets ($5-10M assets) that is funded by brokers, friends, family, etc. and generally hitting returns of 12-14% IRR. Right now we have been just charging a AQ fee of 1.5-2.0% and a small AM fee. Just curious to see if anyone has done anything creative around a promote structure that doesn't incentivize selling the asset yet is simple enough to understand for small retail investors?
Some of these assets have low cash yields up-front so don't want to be held to pref. but has anyone done something like 20% of cash flows after equity paid back through re-fis/etc. Not trying to get rich overnight but hoping to turn in into a full time job rather than something I do off the side of my desk...
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Based on the most helpful WSO content, here are some insights and suggestions for structuring a promote for long-term holds, particularly for small cash flow portfolios of industrial assets:
Equity Multiple Hurdles:
Promote Based on Cash Flows:
Tiered Promote Structure:
Front-Loaded Promote:
Adjust Ownership Percentages:
These structures can help align the interests of the GP and LPs while ensuring the GP can realize their promotes without the need to sell the asset.
Sources: Promote Structure Alternatives, When does the promote split actually occur?, Promote vs Carried Interest vs Catch up, Best way to learn Real Estate Waterfalls?, Real Estate Profit Split - Friends and Family - LT Hold
IRRis not a great metric for a long term hold (7 year or longer imo). I think to solve this, generally people negotiate a % of distributions over a 2x equity multiple.
This is a dream scenario for any GP.. only seen a few guys negotiate these terms in an institutional setting. There are a handful of 'never sell' shops that raise evergreen funds. Some funds implement a rolling look back for promote over a preferred return threshold.. I.e. 20% promote over 8% pref with a 3 year lookback / clawback
This - just structure a multiple hurdle. Everyone understands what a 1.5x or 2x means on their money. It's also super friendly for long term holds because the longer you hold the more promote you get.
Just structure the promote as an American style waterfall. If you return a certain preferred return to your investors in a year, you receive X% of the remaining cash flow. So you provide an 8% annual pref to investors, and above an 8% you receive 50% of the distributions.
Math example:
There is $100,000 of preferred equity. 8% annual pref is $8,000. In a year where you have $10,000 of cash flow, your investors receive their pref plus 50% above that, so they get $9,000 and you get $1,000. As you refinance, proceeds go towards paying down the preferred equity. At some point, if you've paid investors back their equity, you have a 50/50 split of the deal.
This is the most simple structure for a long-term hold. Others will "crystalize" a promote, but man good luck explaining that to your friends.
Thanks for this, I think this makes the most sense. Harder to scale up since we can only generate these returns on assets that are too small for sophisticated privates or any institution.
Maybe, maybe not. My firm has done hundreds of deals with this as the structure. We aren't Blackstone, but we do okay. It's a really simple structure, easy to explain, and doesn't put time pressure on us to sell existing deals.
This is exactly how I structure our deals, small $1-10MM typically. Investors are family, friends, and HNW individuals. None of them are in the real estate, finance or investing space. Such a simple structure to explain. 8% cumulative noncompounding preferred return. Split 50/50 over the pref during operations. Any capital event pays back capital, accrued pref, and then is also split 50/50. As noted above, eventually you'll be 50/50 on all cash flow. For value add deals, you may be 50/50 rather quickly. The other alternative would be just a straight split without a pref. For instance, investors get 80% you get 20%.
This is really helpful, thank you. Any chance you have a scrubbed model you can share that you use for your shop?
this is the right structure.
if you co-invest - are you getting pref pari passu?
This structure makes sense but doesn't it make investors much less eager to hold long term? I feel like as soon as the pref is paid back and you're at 50/50 on cash flows, a CoC of say, 10% turns into 5% for the investor, and he could find better elsewhere.
Or maybe I'm misunderstanding the structure?
Is being 50/50 on cash flow the same as owning 50% of the building?
Common structure for “indefinite” holds is that every ~5 years you perform a 3rd party appraisal/valuation and calculate a promote calc off of a hypothetical sale.
Alternatively, a 1 time promote crystallization following stabilization in value-add stabilize to hold deals.
Never seen a re calc. How does this work if values go down? The splits change in favor of the LP again?
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