Say you have the benefit of having rich friends and you'd like to acquire, as the GP, multifamily real estate with the intention of holding in perpetuity. That is, never sell.
What is a fair and equitable profit split for such a transaction that would allow for majority ownership by the GP after some hurdles are achieved?
I have a few in mind, but would love to get any input based on what you may have seen / done in your careers.
Thanks!
A majority ownership stake for the GP? I'm not certain how that's possible; you can certainly have a clause which allows you to buy out your LPs at some valuation, but that isn't a profit split. You can also have an equity step in or something; value the property as if it were going to be sold, calculate what your promote would be, and then cram down your investors by taking a piece of the ownership equal to your hypothetical promote.
But it's highly unlikely that gets you to 51%
So typically, this type of investment effort would be an LLC, not GP / LP. Depends on how closely held this is. Are you creating an investment pool funded by many locals and plan on running like a REIT? All the operating expense flows through to the bottom line and each unit holder get there dividend and you get what's left (plus a bunch of fees on the operating side)?
Or are you just a group of guys buying a property and everyone puts in $X. If so, you're piece would be commensurate with your buy in. If there are fees for running the program, so be it. They can be paid to you provided they're reasonable and fair market value. If you wan tto be the realtor / broker you get the reasonable fee. If you are an attorney, you draw up the docs, you get the fee. Other than that it's pretty simple. Everyone gets their % based on buy in. I'm in several of these.
Sorry, maybe I asked this the wrong way.
More specifically, what would be an appropriate waterfall given the equity source. For example, pari-passu to an 8.0% return, then 70/30 thereafter.
If you're holding in perpetuity, you're unlikely to get a meaningful enough IRR unless you have several refinancings during the life of the investment. It's hard to say what the appropriate waterfall and splits are. Are your LPs sophisticated or unsophisticated? Are you friends with these people and would like to have the reputation as an honest dealer or do you want to hit them with onerous waterfall terms...? etc, etc etc.
Agreed, if the idea is to hold for forever, then you likely want an asset mgmt fee and some sort of cash on cash return hurdle that gets paid with some regularity. Believe the link below has what you need...
https://www.adventuresincre.com/real-estate-equity-waterfall-model-cash…
I mean, to my earlier post, there are ways to monetize a promote in a long term hold situation. No, you won't get the big cash payout that you would at a capital event, but you can ensure a bigger piece of the deal going forward and get cash flow that way. In my experience it's a lot more palatable to investors; it looks better than taking an above the line annual fee like an AM fee, and aligns GP interests with LPs.
It might be easier to use equity multiple hurdles than IRR hurdles if it's long-term and you don't have the right to buy people out.
I was working on a similar raise recently it was 6% pref, 50/50 split after the pref. No fees (other than property management).
We had another group that wanted to come in and was solely focused on the splits and making sure we didn't sell prior to Year 7 so we offered ((90/10 deal) 8% pref, 20% promote to a 12% IRR, 25% promote over a 15%, and then 30% above 15% IRR. Since I presume your deal is small like ours was and you'd like to make more than $100 a month, in this instance we loaded up the fees. 1% acq, 1% upfront financing, 2.5% AM, 1% on any refinance, 1% disposition and above market PM fees. We also had CM fees for rehab work and other ways to make money.
Basically I'm saying there's no set way to do it.
EM hurdles - you'll find it's A) easier and 2) much easier for someone not in RE to understand
I used to work for a family office that dealt with syndicating HNW investors money into middle-market ($5-$20MM) multifamily RE deals. Although they pitched the deals based on a 5-year hold, their business plan was to always hold in perpetuity and create "mailbox money" for future generations. Basically, they were selling the cash-on-cash numbers which is what their investors were looking for. The deals were generally medium to sometimes heavier value-add.
Their typical go-to structure was the following:
1) 1% AM Fee (Equal to 1% of initial equity invested) 2) 1% Acquisition Fee (Equal to Gross Purchase Price) 3) .50% Refinance Fee (Equal to new loan amount) 4) 6% pref (that would compound if accrued as unpaid) followed by a 70/30 split (70% LP, 30% GP)
They would typically put it 5% of the total equity requirement as an LP investor as well to show conviction in the deal and have skin in the game.
We do this on MF developments. Annual 6% pref (non-compounding) during construction. Annual 10% Pref (non-compounding) after stabilized. After the pref is paid current 60%/40% split.
Basically you refi once stable pay off the pref. There's also an Asset MGMT fee of 1% before the pref.
What are the going in JV splits?
Funding LP 100% / GP 0% Equity LP 60% / GP 40% Deferred Fee bascially LP but "at risk"
Is the refi used to return principle to the LP?
Proceeds are treated differently than CF. Both are waterfalls of sorts.
Proceeds 1. Pref 2. Return of Capital 3. Promote
CF 1.Pref 2. Split
Important note. The Pref is more of a fixed dividend than a compounding interest / IRR model. The Pref amount if based on current capital account. So with a refi, you can pay down any pref due and reduce the capital account thereby reducing the pref amount.
I would create some sort of cashflow split promote off of CoC tested quarterly. Say 90/10% (pari passu) to 10% CoC and 25/75% thereafter. Also, you could charge an AUM fee.
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