Real estate

IRR and equity waterfall

Anyone can compute a promote. What this shows is which dollar went where: the tier walk gives every tier the cash that arrived at it, the split it took, how much of the GP's side was promote rather than a return on its own co-invest, and what was carried down. The preferred return accrues on unreturned capital under whichever of the three readings of “8% pref” the operating agreement actually says, hurdles are enforced against the LP's own IRR, and a tier that never opens on your cash flow is called out as dead weight in the document.

as entered

Assumptions

base

Deal

Cash flow

Purchase price$

Equity at closing$

The capital call the waterfall returns. The rest of the price is debt.

Annual cash flow$

After debt service. What reaches the partnership, not what the property earns.

Holdyears

Exit

Sale price$

Not used while the exit is a cap rate. The implied price is on the build.

Exit year NOI$

Exit cap rate%

Costs of sale%

Loan payoff$

The balance repaid at sale. Equal to the original loan on interest only debt, less if it amortised.

Preferred return

Preferred return% a year

How it accrues

An 8% pref accrues three different amounts under these three readings. Nominal monthly compounds to 8.30% a year.

Order of the first two tiers

Promote

GP co-invest% of every call

Funded pari passu. The GP is an LP for the part it funds.

GP catch-up% of profit

Zero turns the tier off. Set it to the promote the bands pay, or the GP ends above its stated share.

LP IRR hurdleGP promote

thereafter

Bands are paid in the order shown, so the hurdles have to ascend. The last band has no hurdle because there is nothing above it.

Model

LP IRR

13.80%

LP multiple

1.81x

GP promote

$1,226,205

Deal IRR

15.36%

checkThe residual band (tier 5, 60/40 thereafter) received nothing, so its 40% promote never applies. The LP's IRR is 13.8%. The tier is dead weight on this cash flow.

Returns

5y hold

Returns for the deal and for each partner: contributions, distributions, profit, equity multiple, IRR and share of profit.
Measure	Deal	LP	GP
Contributed	$10,000,000	$9,000,000	$1,000,000
Distributed	$19,360,000	$16,320,415	$3,039,585
Profit	$9,360,000	$7,320,415	$2,039,585
Equity multiple	1.94x	1.81x	3.04x
IRR	15.36%	13.80%	26.56%
Share of profit	100.00%	78.21%	21.79%

The GP co-invests, so its column mixes a pro rata return on its own money with the promote on everyone else's. The tier walk separates the two.

Tier walk

every dollar, in stack order

Forecast by year, 1. Preferred return to 2. Return of capital to 3. 80/20 to a 12% IRR to 4. 70/30 to a 15% IRR to 5. 60/40 thereafter, containing tier by tier.
Line item	1. Preferred return	2. Return of capital	3. 80/20 to a 12% IRR	4. 70/30 to a 15% IRR	5. 60/40 thereafter
Tier by tier
Cash entering tier	$19,360,000	$15,186,680	$5,186,680	$1,888,695	$0
To LP	$3,755,988	$9,000,000	$2,374,549	$1,189,878	$0
To GP	$417,332	$1,000,000	$923,436	$698,817	$0
of which promoteabove pro rata	$0	$0	$659,597	$566,608	$0
Tier totalWorking, 1. Preferred return: $3,755,988 + $417,332 = $4,173,320	$4,173,320	$10,000,000	$3,297,985	$1,888,695	$0
Cash carried down	$15,186,680	$5,186,680	$1,888,695	$0	$0

1Preferred return$4,173,320
Cash entering
$19,360,000
To LP
$3,755,988
To GP
$417,332
Carried down
$15,186,680
2Return of capital$10,000,000
Cash entering
$15,186,680
To LP
$9,000,000
To GP
$1,000,000
Carried down
$5,186,680
380/20 to a 12% IRR$3,297,985
Cash entering
$5,186,680
To LP
$2,374,549
To GP
$923,436
of which promote
$659,597
Carried down
$1,888,695
470/30 to a 15% IRR$1,888,695
Cash entering
$1,888,695
To LP
$1,189,878
To GP
$698,817
of which promote
$566,608
Carried down
$0
560/40 thereafter$0
Cash entering
$0
To LP
$0
To GP
$0
Carried down
$0

Read it left to right: cash entering a tier, what each side takes there, and what is carried down to the tier below. A tier whose total is zero never opened on this cash flow. The promote line is the GP's take above its pro rata share of contributed capital, so a co-investing GP's own return is excluded from it.

Distributions by year

derived from the acquisition

Forecast by year, Y0 to Y1 to Y2 to Y3 to Y4 to Y5, containing distribution table.
Line item	Y0	Y1	Y2	Y3	Y4	Y5
Distribution table
Project cash flowto the partnership	-$10,000,000	$600,000	$600,000	$600,000	$600,000	$16,960,000
LP capital called	-$9,000,000	$0	$0	$0	$0	$0
GP capital called	-$1,000,000	$0	$0	$0	$0	$0
LP distributions	$0	$540,000	$540,000	$540,000	$540,000	$14,160,415
GP distributions	$0	$60,000	$60,000	$60,000	$60,000	$2,799,585
LP net cash flow	-$9,000,000	$540,000	$540,000	$540,000	$540,000	$14,160,415
GP net cash flow	-$1,000,000	$60,000	$60,000	$60,000	$60,000	$2,799,585
LP unreturned capitalyear end	$9,000,000	$9,000,000	$9,000,000	$9,000,000	$9,000,000	$0
LP accrued preferredyear end	$0	$180,000	$374,400	$584,352	$811,100	$0

The build

deal, tiers, partners

Calculation build. Each row is one step of the workings, the arithmetic that produced it where there is any, and its value.
Purchase price	$25,000,000
Equity at closingthe capital call the waterfall returns first	$10,000,000
Implied debt60% of price$25,000,000 - $10,000,000 = $15,000,000	$15,000,000
Exit value5.5% cap on NOI of $1,760,000	$32,000,000
Less: costs of sale	-$640,000
Less: loan payoff	-$15,000,000
Net sale proceeds$32,000,000 - $640,000 - $15,000,000 = $16,360,000	$16,360,000
Total contributions	$10,000,000
Total distributions	$19,360,000
Deal profit$19,360,000 - $10,000,000 = $9,360,000	$9,360,000
1. Preferred returnLP 3,755,988 / GP 417,332	$4,173,320
2. Return of capitalLP 9,000,000 / GP 1,000,000	$10,000,000
3. 80/20 to a 12% IRRLP 2,374,549 / GP 923,436	$3,297,985
4. 70/30 to a 15% IRRLP 1,189,878 / GP 698,817	$1,888,695
5. 60/40 thereafterLP 0 / GP 0	$0
Preferred return, effective annualIRR hurdles always compound at the rate quoted	8.00%
GP promotethe GP's take above its pro rata share of capital	$1,226,205
LP multiple	1.81x
LP IRRannualised	13.80%
GP multiple	3.04x
GP IRRannualised	26.56%
Promote share of profitcross-checkGP promote over deal profit: what the GP earned for the promote alone	13.10%
LP share of profit	78.21%
GP share of profit	21.79%

LP IRR

sensitivity

Sensitivity table. Rows vary Exit cap rate, columns vary Annual cash flow. The base case cell is marked "base case".
Exit cap rate downAnnual cash flow across	$540,000	$570,000	$600,000	$630,000	$660,000
5.00%	16.01%	16.17%	16.33%	16.49%	16.65%
5.25%	14.77%	14.95%	15.12%	15.28%	15.44%
5.50%	13.42%	13.61%	13.80% base case	13.99%	14.17%
5.75%	12.13%	12.32%	12.51%	12.70%	12.89%
6.00%	10.73%	10.95%	11.17%	11.39%	11.61%

Every cell is a full re-run of the waterfall, not an interpolation, because a promote is a step function on the exit and a smoothed grid would hide the step.

GP promote

sensitivity

Sensitivity table. Rows vary Exit cap rate, columns vary Annual cash flow. The base case cell is marked "base case".
Exit cap rate downAnnual cash flow across	$540,000	$570,000	$600,000	$630,000	$660,000
5.00%	$2,195,696	$2,271,412	$2,347,127	$2,422,843	$2,498,558
5.25%	$1,564,960	$1,619,583	$1,690,060	$1,765,776	$1,841,491
5.50%	$1,116,960	$1,171,583	$1,226,205 base case	$1,280,828	$1,335,451
5.75%	$707,916	$762,539	$817,162	$871,785	$926,408
6.00%	$444,270	$479,470	$514,669	$549,869	$585,069

The same grid read for the promote. Compare the two: the promote moves faster than the LP's return, and where it accelerates is where a hurdle was cleared.