Hello all,
How quickly should investors be getting their money back in a ground-up multifamily development? On a 3-year merchant build they are getting their money back from reversion, but what about on a longer hold period of 5,7, or 10 years? At a year 2 or 3 refinance, should investors be getting 50% of their equity back? 30%? 75%? All of it? I know it depends on the investor, but would or would not be acceptable? More broadly, how quickly should capital be returning on a deal with a long term exit strategy?
annoying answer - but it depends.
yes short term deals, you get all your pop at reversion...typically the asset is sold within 1yr of lease-up, so there is usually not a cash flow from operations made during the hold. So the investors get a lump sum payment, of which you break down per the waterfall agreement
on longer holds, it all depends on the waterfall structure. What I see most common in longer term holds, is the waterfall differentiates between cash flow from operations and cash flow from a capital event (sale, refi, etc). The cash flow from operations will looks something like pref rate, hurdle I, hurdle II, hurdle III...meaning it is a return 'ON' your equity. In the same light, cash flow from a capital event waterfall will most often be the same as cash flow from operations, but with an additional hurdle added after the pref for return of equity.
The purpose of this is for investors to earn a cash on cash yield on their investment during the hold...typically this rarely exceeds the preferred return hurdle. So investors expect, on say a 10yr hold, from years 3-9 they are going to get, say 8%. When they sell at year 10, they get their equity returned, plus whatever promote based on the hurdle structure.
Again, it varies....some JV agreements just have one waterfall structure and dont differentiate between operations and capital event...with the understanding that the chance of the deal clearing the pref hurdle from operations is unlikely...so you end up at the same place in the end - but with a simpler term sheet and less legal fees ;)
generally yes, at reversion. If you think about it conceptually...if you have a $100M development with 65% LTC, you are putting in $35M of equity. Your levered cash flow after debt service payments is not going to be that significant, maybe enough for some small distributions post-stabilization, but in terms of recapturing the equity dollar for dollar it's going to take a major capital event. On a longer term hold maybe this is achieved via the combination of a refi and rent growth that boosts the CFADS to something more significant.
This varies from deal to deal... Generally, no one would roughly ballpark return of capital in this manner.
Think about it this way. A decent yield on cost for development projects is 6%-7%. How many times does 6%-7% go into 35%(equity) of 100%(of total project costs).
5-6 Years until you get return of capital without a capital event. Ideally your take-out loan should return proceeds above your initial construction loan amount. Then you should have a sale capital event in year 7-10.
If one is targeting 100-150 bps spread, and using 65%-70% leverage assumptions for construction and perm, it seems to me one would be able to pull out atleast 50% of equity at stabilization most of the time. If the above is correct, how come people don't?
Most people do.
My LP shop doesn’t care when we get our initial capital back. On long term development holds, 7-10 years, its more about clipping a 10-12% irr and a 2.0+ equity mult.
That said, during the hold you get your pref return back first, 9-10%, followed by return of equity capital contribution. It usually takes a major capital event to clear the pref hurdle during the hold so we don’t expect to get the full equity amount back till reversion. That’s from a legal doc standpoint. There are different ways to look at equity NBV from an accounting standpoint.
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