I am trying to think about the best way to structure a JV where one party would want to remain unlevered and the other would still be sufficiently incentivized to not seek a partner that also wanted leverage. My initial thought was that you would calculate the returns under market leverage levels for similar deals, calculate the total $ of the promote based on a levered structure, and then offer an unlevered structure (lower IRR hurdles and MOIC hurdles) that generated the same promote. Any thoughts? Also, if you wanted to run that analysis, any better way to convert levered to unlevered vs. guess and check?
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A possible approach is to conduct a DCF analysis, using the same targeted IRR as the discount rate for the new deal. Then you can calculate what purchase price and further play with other variables to see what future cash flows and reversion price would need to be obtained in order reach your targeted promote and overall IRR.
A less quantitative approach is to use goal seek.
we have done the unlvd promote with our core fund before. Generally the GP puts in less equity, 2.5% instead of 5.0%. The structure that we have used typically is a synthetic loan that will be used to determine the promote. Most GP's just struggle to get comfortable with the lower hurdles that in practice generate the same returns
How does the synthetic loan work? You agree on a leverage structure as a part of the deal and then you just run a separate set of books with the loan applied based on the agreement?
Exactly. So we got a debt quote from a lender based on the LTV, term etc that we agreed upon with our partner and then ran that through our model to figure out the projected promote.
Got it. Thanks!
I've seen this before. Usually the LP that pushes for it for one reason or another.
Regardless of if an investment is levered or unlevered, the GP typically has a return target are trying to achieve assuming a base case investment period, whether it's IRR or EM driven. If the LP wants the deal to be unlevered, then the GP should solve for a promote structure that allows them to achieve similar economics to a levered deal with a levered promote structure. In theory, the developer should be ok with slightly less economics given that there is less risk associated with an unlevered deal.
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