Waterfall for long term hold
Hello,
Has anyone had experience with a structuring promoted interest waterfall for a development deal with no planned exit. The developer builds and owns their projects for the long term and planning to bring on a JV equity partner with the same long term hold strategy. I have only dealt with deals in which sponsor earns promote at exit. I am contemplating a promote based on stabilized yield on cost with multiple tiers. I would be grateful if anyone could provide examples of what they've seen/worked on.
Thank you
While I can't specifically comment on the models that you are using, they should be applicable to long-term or perpetual holds. In general, it is difficult for a deal to hit all of its various promote structures or IRR hurdles until its reversion.
The various IRR hurdles will represents your required stabilized yield on costs.
I haven't done one, but talked to an equity broker when we were looking at a deal we wanted to hold long-term. His suggestion was to drive the promotes off multiples. Trying to hit a 12-15% IRR on a 15 year hold is pretty tought
I've worked on a few of these recently. We have a few options
Upon stabilization go through some valuation process (3 appraisals, BOV's, refi calcs) and come up with a value for the property. Using a simulated sale and the estimated value from your valuation process calculate the total proceeds to the developer and LP reset their ownership of the asset accordingly and distribute all proceeds according to the new ownership %'s. No further promote for the GP on the transaction.
Establish a "transition date" and various NOI targets for the development at that transition date. For each NOI target have a dedicated "developer success fee". This incentivises the developer to maximize NOI within a certain time frame. Payout the success fee accordingly and then split the remaining proceeds going forward with respect to your capital contributions.
Build a put option into the operating agreement and, if the property is performing well, exercise that option to buyout the developer's interest and continue to hold the asset long term.
picklemonkey hit it on the head. You can also waterfall off of an Cash/Cash expectations set out prior to the projects agreed upon by GP/LP. The distributions come out on an annual basis. We've done this with REITS that're holders. Pretty similar to the "NOI" target presented in picklemonky's 2nd point.
Excellent! Thank you so .much for your input.
Great response. On #2, how do you think about sizing the "developer success fees" ?
Obviously that is a highly negotiated point. Usually it ends up being a few % (2% - 5%) of the deal valued using the NOI achieved.
In this instance, the developer uses that money to pay out his acquisitions employees' promote and retains the ownership and long term cash flow.
When a firm's compensation structure doesn't work with the synthetic sale scenario we try to use this option to satisfy all stakeholders.
Synthetic sale is the way to go here in my experience
Thank you for your reply.
Yup, do a hypothetical sale, convert promote to equity, call it a day.
Just set up a tiered system based on annual cash flow yield based on total cost. I’ve built one that resets every year on month one, such that the “promote” or 2nd tier isn’t reached until the last few months. On the same model, a capital event would flow through another waterfall.
Do you have a model on this you could PM me. This is what we're looking for exactly.
Instead of a reversion, use a cash-out loan to take-out the equity partner. Most equity has call provision for a minimum period to be invested. I get that some smaller equity sources structure their capital to own after the investment horizon, but for a forcasting/modeling perspective there needs to be a terminal event even if it doesn't come to fruition.
You could structure it pari-pasu as well.
A simplified version would be to offer a preferred return after which the equity converts to a predefined percentage.
E.g. after the LP gets their money back + a 10% pref, GP gets 20% of equity and LP gets 80%.
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