Hi All,
It's been a while since I've done a pref equity deal. And honestly, I'm racking my brain trying to figure out how to model it with 2 tiers.
Pref of 7% , then a split of 70/30 until 15%, and then 50/50.
I get the 7% Pref, but then how do I calculate the first tier? There has to be a difference between deal level IRR of 7% and Pref Return IRR regarding amount required to meet each.
The 7% is based off of contributed capital from Pref Equity, but the above 7%-15% split is based off of a deal level IRR(correct?)
honestly, this one stings a bit man...there are countless waterfall threads on here - along with attached workbooks that answer your question and then some. Please google first.
simply, the above scenario should be a very very simple modelling exercise, albeit i understand youre unfamiliar with JV structures.
Model the 7% pref based on the equity contributions for each partner. Some things to consider is the compounding of said pref. Is it annually? if so, and your CFs are on an annual model basis, then no adjustments needed. If it's compounded monthly, youll need to use the EFFECT(7%,12) formula in places where you had the flat 7% prior. Best thing to do, is run an XIRR check at the bottom, and make sure that net of equity returns and pref returns...you are earning the 7%
For the IRR hurdle...correct, it is slightly different. Pref rates are based on each parties' specific capital contributions. Hurdle rates are almost always based on the investors capital. Meaning, when the INVESTOR receives an IRR of x%, the hurlde is considered cleared. To do this, simply have a line that calculates how much distirbutions would be needed to earn the hurdle rate. Then have a line that shows your actual available distributable cash flow. using a max/min function, you should be able to generate a simple working model. Again, at teh bottom, apply the XIRR check to make sure you're working it correctly.
again - check the forums...check ACRE.com....tehre's countless resources out there on this topic.
You're an ass. I didn't ask for how to do a JV waterfall. Which is mechanically simple as you don't need to account for a hard return.
I hadn't done a pref deal in 5+ years, so my memory is hazy.
I asked a specific question related to how to get the tier 2 cash flows given what I thought was a strange bifurcation of property level cash flow.
But your response did not address my question. What I did end up figuring out is that I take the current pay from the pref equity amount and throw in a paypack in year 10. Then I have a common equity model that has participation splits for the pref equity partner and the sponsor. I even modeled in a catch up, I was hoping someone could have helped me out sooner.
I'm not sure i understand your question. You are correct, a 7% pref return will not equate to a 7% IRR.
You cannot achieve an IRR until you get your return of capital, so that typically happens on the sale or a refinance.
What I do is use a MIN function for that first tier (minimum of what you need to achieve a 15% IRR or what the actual distribution is.
I guess I'm an ass too because I don't see how this is that different from any other waterfall with the exception of the pref. Calculate the pref, then in your next tier accrue at a 15% IRR and subtract the previous pref payments from the distributions required to clear the tier.
That's not right, because the previous pref is only a percentage of the Pref Equity capital. Depends on how the pref equity is structured, but if it similar to a debt facility and gets a non-compounded coupon(but with participation) then your actual common equity waterfall is from the cash flow after the pref coupon and repayment.
In other words, this is not a preferred return on common equity where returns and the waterfall are run pari-pasu. This is senior to common equity, but with participation in the common waterfall(of which there is just 1 sponsor). Subtracting the pref would equal less than a 7% IRR on total equity.
Right? I'm serious, I want to know if I'm missing something.
Ok yeah I misunderstood and was wrong in that case. In my eyes there's two scenarios depending on how the JV reads. In either scenario I would treat it like mezz and subtract the pref out at the deal level cash flow:
a) The waterfall tracks off the pref equity party's IRR. In which case you pull out the pref at the deal level above FCF, and dump that FCF into your waterfall. I would think you still net prior pref payments out of the distributions accrued to clear that tier though, as they are impacting that party's IRR. Then whenever you're calculating investor level returns you pull the pref payments from your monthly (deal level) cash flow and add them to that party's cash flow so that it's accounted for in calculating their return.
b) The waterfall tracks off of the deal level cash flow. In which case you just deduct it above FCF, run a normal waterfall, and again pull the pref payments from your monthly cash flow for the purpose of calculating the pref party's IRR.
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