Real estate investing waterfall for new construction multifamily - please review structure
I’ve been buying, building, fixing, renting, managing and financing real estate for 22 years.  But now I’m doing a deal that’s a bit bigger than I want to do on my own ($16 million total cost) and I’m going to have some buddies invest along side of me. I have the investors lined up and this is NOT a solicitation. We are just starting to negotiate and they asked me for a proposal.  

For those of you who have experience as a syndicator or participant, can you give me a summary of what the current market is for such investments?

I’m thinking it’s something like:

-project is owned 60% by limited partner investors who invest cash  and 40% by the general partner for nominal consideration.  My company would be gp and I would also buy around 1/3 of the LP interests and have plenty of skin in the game. 

-first, a 6% cash on cash return on deployed capital to the limited partners. 

-then, 6% catch-up return on the non-cash investment of the gp interest 

-then 60-40 on everything in excess in favor of the investors. 

-every quarter, do the same calculation until the initial cash is paid back through a refinance then 60-40 in perpetuity. 

I’d also like a call option - is it fair to have the right to buy back all equity at a price where investors receive an 18% IRR (XIRR)?

Thanks for your input!
[{"id": "hyun7rj", "text": "From my experience the limited partnership puts up the cash for construction owning the property and building, the tenant leases it and pays a fixed dividend every year for, well life. Not sure the type of property/ zoning your looking at constructing so that might change.", "replies": [], "depth": 1}, {"id": "hyuvr5h", "text": "What you are suggesting is close enough to market. First hurdle on development projects is usually higher - around 8%. \n\nWaterfalls typically include a promote to the GP. You should be asking for higher split as the GP if you achieve certain return hurdles. The last hurdle should be 60-40 on everything in favor of the GP for example. There are many ways to structure this but you are selling yourself short in what you outlined, especially when you are giving the investors a priority return.\n\nThe call option is fine. 18% IRR is fair in today\u2019s marketplace.", "replies": [{"id": "hyuzglr", "text": "Ok, flip from 60-40 to 40-60 after what hurdle?  Return of initial capital?  12-14% irr?  Thanks for your input!", "replies": [{"id": "hyv41vw", "text": "After the return of capital. \n\n\nHurdle 1: 6% return to investors.\n\nHurdle 2 : 6% catchup to GP. \n\nHurdle 3: return of capital to investors.\n\nHurdle 4: return of capital to GP. \n\nHurdle 5: 65% to GP / 35% to LP. \n\nThis type of waterfall gives a preferred return to the investors, which minimizes their risk. They should get less upside in the backend.", "replies": [{"id": "hyws188", "text": "I have never seen a deal structure this bad for limited partners in my entire life and I\u2019ve seen hundreds of deals and invested in many. I would be so outraged I probably never would do business with the sponsor again because I\u2019d worry they are crooks. Perhaps I\u2019m not understanding your post correctly.", "replies": [{"id": "hyx1iav", "text": "Similar to you, I have worked on probably thousands of these. \n\nMaybe you are misunderstanding. I do agree the first hurdle is low (8%-10% is more realistic). But you\u2019ve never seen a 25% promote over an 8% IRR? That is essentially what this is.\n\nKeep in mind in this example the GP is providing 40% of the capital, which is higher than the typical 80/20 or 90/10. Also being a pref structure, LPs will be getting a lower return. A mid-high teens IRR is a good target under this structure. This type capital is widely available in the market. \n\nIf we are talking about a pari passu structure, the hurdles and promotes are different.", "replies": [{"id": "hyxn8md", "text": "Ah got it, you factored in the GP contribution in the split. That makes much more sense.", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "hyuysoc", "text": "Are these your friends or pure investors? If friends first, why not pari passu with some front end and back end fees for you. \n\nAnyone but a savvy investor is going to be way confused by hurdles and they will likely have the perception that you\u2019re making more profit than you actually are. \n\nOtherwise those hurdles seems fine in a hypothetical position.", "replies": [{"id": "hyuz94l", "text": "Thanks investors are other business guys with some real estate experience. They\u2019ll understand the structure. I think market rate is fair and they\u2019ll be ok with it. Just trying to confirm where the market is. Thanks!", "replies": [{"id": "hyuzemd", "text": "We\u2019ll, we also don\u2019t know the asset class or your thesis. New construction office a bit different than an industrial building.", "replies": [{"id": "hyuzmxh", "text": "Pretty solid location. New construction mixed-use building with mostly multifamily.  I already manage other buildings in same market.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "hyvyrtx", "text": "You should run your projection through the waterfall and see what the total IRR would be for them. That can help you tweak what the promote could be and what your investors would be good with. I've been seeing deals with estimated IRR of 14-18% for LPs. If their IRR is too big after the calc, cut yourself a bigger promote.", "replies": [], "depth": 1}, {"id": "hywf9sh", "text": "What is the debt structure? Projected LTV on the perm? Will you be the guarantor during construction?\n\nWhat is the current land ownership? Will you be doing all the permitting before land purchase? \n\nOver what time frame are you looking to be able to buy out your equity at 18%? I haven\u2019t seen this before. Does not seem fair to investors who are taking big risk. Effectively makes their investment a high interest loan subject to a first lien of bank debt and removes any upside for them. \n\nWhat is the 6% catch up on non cash to gp? I have not seen that before. What figure is it based on? \n\nMost deals I see are minimum 8% pref, no LP liability outside initial capital contribution, and projected IRRs over a 3-5 year period of 25% for new development. \n\nExisting cash flowing assets will have a lower IRR (15-20) because there is more competition for them and they have established cash flow whereas new development is much riskier and so less people do it (successfully).\n\nI would say that typically I see a 25% IRR is achieved over 3-5 with a 70/30 split after an 8% preferred return with a 60/40 LTV loan.", "replies": [], "depth": 1}, {"id": "hywm93r", "text": "For development, LPs should get a higher expected IRR or 25%+ given the risk and lack of cash flow. Otherwise, promote seems reasonable.", "replies": [], "depth": 1}, {"id": "hyzaqby", "text": "Those splints bend the LP\u2019s over. Don\u2019t get me wrong, a GP should be compensated for putting the deal together and most likely guaranteeing the loan. But the LPs are taking on a large financial risk as well especially for a development. On our multi family developments we aim to get our LP\u2019s 19-23% IRR within a 3-5 yr timeframe. Here\u2019s what we typically do. \n\nPref: 8% on unreturned capital\nReturn of capital comes from refi proceeds once the development is leased up and operating. And from sales proceeds. \nTier 1 returns (cash on cash) non-cumulative: based on unreturned capital. returns above 8% and up to 12% are split 80/20 (LP/GP)\nTier 2 (non cumulative) based on unreturned capital. Everything above 12% is split 60/40 (LP/GP) \n\nThis is still aggressive. But you should consult with a lawyer who specializes in reg D and waterfall structures. You can either do a cash on cash set up or an IRR. We typically deal with investors who don\u2019t  understand IRR as much as cash on cash, so thats why we use a cash on cash split. You want to make it simple enough so the LP\u2019s know exactly what they are paying the GP to put the deal (investment) together. \n\nIf your LP\u2019s would prefer a higher pref you could compromise and also bake in an an incentive refi proceeds fee or sales proceeds fee into your operating agreement. So if you end up refinancing the project for $15M, you can get a $50k fee, if you refi above $16M you get a $100k refit fee. You can do the same thing on the backend of the sale. \n\nThere are lots of ways to do it. Don\u2019t take anything above as legal advice, you need to consult a lawyer when setting up reg d 506 (b) or (c) syndications to make sure you\u2019re checking all of the boxes.", "replies": [], "depth": 1}]