Why is an 8% hurdle so common in commercial real estate investing
Seems kind of low
[{"id": "hrt1u0f", "text": "I always thought it was to mirror average annual return of the stock market.  So like investor at least get that kind of return first before promote gets paid", "replies": [], "depth": 1}, {"id": "hrt2plk", "text": "It follows the 1% rule.  \n\nAnd 8% is better than you think.  It\u2019s hedged against inflation, so 8% is actually 8%, compared to the stock market where 8% tends to only net you around $5% during normal market conditions.  \n\nAlso, if you have a rental that operates at an 8% cap, you can leverage it and typically get an 18%-22% return on your money and still have it hedged against inflation, effectively giving you 4x the returns you get in the market if you just buy and hold general funds.  \n\n8% is just a cap rate, not the actual rate of return on your cash.", "replies": [{"id": "hrt49e0", "text": "But does it not mean that for an $100k I only get $108k back at the end of 5 or 10 years", "replies": [{"id": "hrt4mj1", "text": "No.  An 8% return on $100k would net you $8,000/yr, or $80,000 every ten years.\n\nIf you used that $100k as a 20% down payment on a property operating at an 8% cap, you would likely get a net return of $20,000/yr, or $200,000 every 10 years\n\nOn top of that, the value of your home tends to appreciate faster than inflation rises.  So if you put $100k down on a home, over the course of 10 years you\u2019d make $200,000 from rent, your property\u2019s value would have increased about $150,000, and your tenants would have paid down about $100,000 on the home.  \n\nSo in 10 years, you\u2019d be up $450,000, which is a 45% return on your cash on an 8% cap property.", "replies": [{"id": "hrt4zzu", "text": "I\u2019m looking at a crowdfunding investment opp that has a hurdle rate of 8% and projects a total return on a $100k investment of $108k", "replies": [{"id": "hrt57m7", "text": "An 8% return in 5-10 years isn\u2019t an 8% return.  That\u2019s a 0.8%-1.6% return.  You\u2019re losing money by doing that.", "replies": [{"id": "hrtloxt", "text": "Hurdle rate is calculated as IRR, which means it is an annualized rate. It would be 8% compounded, not total.", "replies": [], "depth": 6}], "depth": 5}, {"id": "hrujy5e", "text": "If you cannot calculate 8% return on $100,000 correctly you should not be investing.  Please conduct additional due diligence or obtain an investment broker.", "replies": [{"id": "hruk7un", "text": "I\u2019m learning the ropes here. I\u2019m not saying 8% rate of return. I\u2019m saying 8% hurdle rate.", "replies": [{"id": "hry2tiw", "text": "An 8% hurdle rate usually means that the sponsor (you) doesn\u2019t get a \u201cpromote\u201d (extra fees) until the investment hits an annualized IRR of 8%. \n\nAchieving an 8% hurdle rate means that investors have been paid back all initial capital in full, and have achieved an 8% annualized, time value adjusted return on that capital (IRR).", "replies": [], "depth": 7}], "depth": 6}], "depth": 5}], "depth": 4}, {"id": "hrtly6b", "text": "Why are you talking about a home in the commercial real estate sub? Appreciation will be driven by inflation in rents (often built into the lease) and changes in market cap rates.", "replies": [{"id": "hrtql22", "text": "I own 60 commercial real estate units. They\u2019ve appreciated much like my residential ones are", "replies": [{"id": "hrup3mz", "text": "That guy is silly.", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}, {"id": "hrt56ee", "text": "Neither, it just means that the person you\u2019re investing with who manages the asset (the GP) and you (the LP) get cash flows pari passu (equal based on cash contributions) until such cash flows get you and the GP an 8% compounded return, usually calculated using the XIRR function in excel. Once both parties make 8% the GP typically gets a promoted interest which means their split of cash flow is higher after the 8% hurdle is achieved. If for example they had a 20% promote above an 8%, the GP would get 20% of any cash flow after an 8% then the other 80% would be split pari passu between the GP and LP.", "replies": [], "depth": 3}, {"id": "hrutv9r", "text": "This is wrong. You get 8% every year in compounding interest. It's not uncommon for investors to double their money in 5-10 years.", "replies": [{"id": "hrv6m3s", "text": "This is weird then because they clearly show you get 108k after 5 years", "replies": [{"id": "hrv6shm", "text": "If that's true, it's a terrible investment. \"Risk free\" US Treasury bonds have better returns...", "replies": [{"id": "hrv6x0y", "text": "Hence why I asked.", "replies": [], "depth": 6}, {"id": "hrwxwty", "text": "Ibonds were paying 7.11% when I looked last week", "replies": [{"id": "hrx6x4u", "text": "Yeah ibonds are compounded semi-annually. That\u2019s every 6 months. Not every 5-10 years. I can\u2019t believe some of the comments I get on Reddit man\u2026", "replies": [{"id": "hrxdf7m", "text": "I simply pointed out a quick example to bolster your point. \n\nSorry for the agreement.", "replies": [{"id": "hrxdxob", "text": "That isn\u2019t clear, and I don\u2019t think it needed bolstering either, but hey thanks for the sarcasm!", "replies": [{"id": "hrxnf0b", "text": "weak tea is weak, troll on", "replies": [{"id": "hrxq9xq", "text": "Blue sky is blue, will do", "replies": [], "depth": 11}], "depth": 10}], "depth": 9}], "depth": 8}], "depth": 7}], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}, {"id": "hstg9qf", "text": "This math is very very wrong", "replies": [{"id": "hsth0nh", "text": "Not my math", "replies": [{"id": "hstv868", "text": "Maybe your understanding. You don't get 8% after 5-10 years. It's an annual hurdle rate. You get 8% annually + a % above whatever revenue comes in above 8%. It's an annual number not a life of deal number. What was the cap rate?", "replies": [{"id": "hsu32mk", "text": "8cap", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "hrvf9bt", "text": "Hey you figured it out too!\n\nWe actually have so much competition in private equity for our business? To invest with us the developer. We give 6% preferred return. We usually sell in the first couple years of first lease and your yearly ROI is around 30% now with leverage. It\u2019s quite absurd. The money along the way is great and you can float the project with a half empty building if things get bad.\nWe were getting 24% ROI before money started pumping in 5 years ago.\n\nIt\u2019s also nice to have actual control over your assets. If your reading this and looking to invest you need at least a million cash but probably more and make sure the developers cost to build is low. We are getting this number with cost to build about 1/3rd of sale price.", "replies": [], "depth": 2}], "depth": 1}, {"id": "hrt42w0", "text": "It\u2019s the default in all private equity investing, it\u2019s ubiquity in real estate is derivative. (Of course, begs the question why 8% is the PE default).", "replies": [{"id": "hrte3s2", "text": "Because it\u2019s the standardized amount that investors expect so it\u2019s just ubiquitous", "replies": [], "depth": 2}], "depth": 1}, {"id": "hrt4dg1", "text": "I\u2019m curious if you are referring to the cap rate vs rate of return on the total  investment vs rate of return on the cash investment. \n\nIn general, rate of return reflects risk and needs to be compared to comparable investments. For example, if you invest in a diversified group of stocks, you can quickly access most of your investment at any time, barring a total market downturn. A single-property real estate investment is much riskier due to the difficulty of getting out of it quickly and it\u2019s lack of diversification, so you\u2019d expect a higher rate of return. Given that, I assume you\u2019re referring to the cap rate, which u/ShrimpyEatWorld6 explained.", "replies": [], "depth": 1}, {"id": "hrtq079", "text": "8% you mean as pref? It makes sense. 3% for inflation, 5% as a return.", "replies": [{"id": "hrvrmx0", "text": "3% inflation?!", "replies": [{"id": "hrwxxu4", "text": "Average", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "hrtwjle", "text": "Well my only thought is that the S&amp;P averages like 7% over the long term, so for the added risk and management it would make sense to not take less than 8% when you could just stick your money in an ETF or mutual fund and make the same amount of money with less work and upfront capital.", "replies": [], "depth": 1}, {"id": "hru3taa", "text": "You also have to factor in depreciation.  The return should be tax free of very close if it is a fee simple asset.  Add in debt pay down,rent growth, potential cap rate compression and you could easily average 20% tax free returns over the life of the investment.", "replies": [], "depth": 1}, {"id": "hrvrgus", "text": "Depends on the asset class", "replies": [], "depth": 1}, {"id": "hrvzt95", "text": "Huh? It\u2019s often 8% pref. return to LP, before GP gets a cut. That\u2019s an APY.  Look at total IRR which is often 12-20% depending on the asset class and deal structure.", "replies": [], "depth": 1}]