Over the years, Michael and I have built and shared numerous real estate equity waterfall models, all multi-tiered and most with internal rate of return (IRR) hurdles. And as our readers have downloaded those models, I’ve received dozens of requests for an equity waterfall model with a simpler partnership structure. This model seeks to be an answer to those requests.
A Real Estate Partnership Structure for Dummies
I had lunch this week with an A.CRE reader and newfound friend, and he said something during our conversation that range true when it comes to real estate limited partners (or LPs) : “If a prospective investor can’t understand a deal, they simply say no.”
Having spent time working for and with both institutional and mom-and-pop real estate investors, I can attest to the truthfulness of that statement. If an investor doesn’t understand how a given real estate partnership structure works, he or she is not likely to pull the trigger. And so it behooves us as the sponsors of a deal, to propose a structure suitable to the sophistication level of the partners.
Not a dummy? Check out my 4-tier real estate equity waterfall model with IRR and equity multiple hurdles (monthly periods)
This real estate equity waterfall model is an example of a simple partnership structure you might use with less sophisticated partners. The model assumes a preferred return to some annual cash-on-cash return hurdle, and then a split that generally pays a disproportionate share of the excess cash flow to the sponsor above the preferred return (i.e. the promote). No time value of money component, a single waterfall tier, and a simple calculation both the sponsor and LP could quickly make on the back of a napkin at any time during the investment period.
Adding the Equity Waterfall Model with Cash-on-Cash Return Hurdle to Your Model
The model is not standalone. Meaning, you’ll need to model property-level cash flows in a separate model, drop this worksheet into that model, and then link the relevant cells.
- You can either model the property-level cash flows from scratch, or use one of our standalone models (e.g. apartment, industrial, office, retail, All-in-One). Make sure you have investment, operation, and residual cash flows broken out and that they are modeled on an annual basis.
- With your property-level cash flows complete, you’ll pull this worksheet into your property-level model. To do this, open both workbooks side-by-side. Mouse-over the ‘Waterfall (CoC) – Annual’ tab in the equity waterfall workbook, click and drag it into your property-level model’s worksheet tabs section along the bottom of the window. This will merge the two workbooks.
- With the equity waterfall model added to your property-level model, you’ll next link the relevant cells. In the equity waterfall model (download below), you’ll notice various blue font cells. At minimum, you’ll need to link the analysis start date (F36), Net Property-Level Cash Flow (row 39) and the Net Proceeds from Sale (row 38) to the applicable cells in your property-level model. You might also consider adding the partnership structure assumptions to your master assumptions tab. Make sure to change the font color of any cell linked to elsewhere in the workbook from blue to green.
Using the Equity Waterfall Model with Cash-on-Cash Return Hurdle
Once you’ve linked the waterfall model to your property-level model, using the waterfall model is simple.
- Set the sponsor contribution percentage (how much equity the sponsor will contribute) in cell C7. The LPs contribution percentage will automatically be calculated in cell C8.
- Set the preferred return percentage in cell D13. This is the annual required return owed to the limited partner(s), and is based on annual cash-on-cash return (annual before-tax-cash-flow divided by capital contributed to date plus any unpaid preferred return).
- Set the distribution percentage (what percent of cash flow is distributed to each partner) for preferred return, promote during operations, return of capital, and promote at capital event cash flows. So for instance, up until the LPs have hit an 8% preferred return in a given year, the before-tax-cash-flows might be split 5% to the sponsor, 95% to the LPs per each partners’ initial contribution percentage. However, once the LPs have earned an 8% cash-on-cash return in a given year, any excess cash flow might then be split at some disproportionate share (i.e. the promote) such as 50% to the sponsor, 50% to the LP for the rest of that year.
- Review the sponsor and limited partners’ cash flows and equity returns in rows 21 through 33.
Video Walk-through – Equity Waterfall Model with Cash-on-Cash Return Hurdle
Below find a walk-through video I created showing you how to use the equity waterfall model. I recommend you download the accompanying Excel Workbook and follow along as I talk through the model. If you have any questions or comments, please don’t hesitate to reach out using the link in my bio at the end of this post.
Download The Model
To make this model accessible to everyone, it is offered on a "Pay What You're Able" basis with no minimum (enter $0 if you'd like) or maximum (your support helps keep the content coming - typical real estate models sell for $100 - $300 each). Just enter a price together with an email address to send the download link to, and then click 'Continue'. If you have any questions about our "Pay What You're Able" program or why we offer our models on this basis, please reach out to either Mike or Spencer.
Note (especially for Gmail users): The model is sent via email and occasionally is blocked by spam filters. If you don't see the email arrive within five minutes, check your spam folder.
Real Estate Equity Waterfall Model with Cash-on-Cash Return Hurdle
- Single cash-on-cash return hurdle
- Promote excess cash flow during both operation and at a capital event
- Annual periods
- Simple alternative to partnership structures with multi-tiered IRR or Equity Multiple hurdles
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About the Author: Born and raised in the Northwest United States, Spencer Burton has over 15 years of real estate investment and development experience. In his current position, Spencer assesses new acquisition, development, and debt opportunities for a $45bn real estate fund. He resides in Dallas, TX.