A question came up recently in the A.CRE Accelerator’s real estate waterfall modeling course regarding how to model GP Catch Up and LP Clawback provisions. I put together a quick video tutorial in response to that question, and in doing so I realized I had never shared to A.CRE a real estate equity waterfall model with the ability to model a GP catch up or LP clawback. So allow me to introduce the ‘Real Estate Equity Waterfall Model with Catch Up and Clawback’.
Note: If you’re an A.CRE Accelerator member, click here access the thread where we discussed how to model catch up and clawback provisions. I also created a video for you to watch and provided an example Excel file to download.
What Types of Partnership Structures This Model Can Handle
This equity waterfall module is one of the more versatile that I’ve built for the A.CRE Library of Excel Models. While no equity waterfall module can do it all, this particular module covers many of the common structures you might run into – both in the United States and internationally.
In terms of what this tool can do. With this module, you can
- Model either American-style or European-style waterfalls (read about American vs European waterfalls).
- Use either hard or soft hurdles (read about soft hurdles)
- Model soft hurdles using GP Catch Up and/or LP Clawback provisions
- Assume the GP contributes some or no capital
- Set custom distribution percentages for each partner; by default distribution percentages are determined by a promote assumption, which is assumed to be paid by the partnership (read about promote calculations)
- Use separate distribution assumptions during operation compared to at reversion; this feature is available in my Equity Waterfall Model with a Cash-on-Cash hurdle as well
- Model up to two tiers during operation and up to four tiers and three IRR hurdles at reversion
- Analyze a hold with up to 10 annual periods (plus time zero)
Given the versatility of this model, I plan to add it to our A.CRE All-in-One model in the near future.
How to Use the Real Estate Equity Waterfall Model with Catch Up and Clawback
I’ve built this module to be visually similar to my other real estate equity models. So if you’ve used them, this will feel familiar. The general logic of the model works as follows:
- During operations. Distributions are made to the partners based on their pro rata share of contributions until the LP has hit its preferred return. Next, excess cash flow goes to payback accrued pref but NOT to pay down the original capital account balance. Thereafter, any excess cash flow is split per the distribution percentages in cells G11:H11.
- At the capital event. Distributions are made to the partners based on their pro rata share of contributions until any accrued preferred return has been paid and each partner has received a full return of capital. Thereafter, excess cash flow is distributed based on the three IRR hurdles and promote assumptions entered in cells E14:H17.
- European-Style Waterfall. To set the model to be European-style (i.e. no promote paid until LP receives full return of capital and hits preferred return), simply set the GP’s promote during operation to be 0%. Otherwise, set a promote for the GP during operation and the GP will be promoted before the LP receives a full return of capital. Note that European-style waterfalls are actually far more common these days, even in the U.S., and the European-style waterfall is the methodology our other models use.
Allow me to now discuss each of the inputs in this module, and then I’ll finish with a quick video walk-through of the tool.
- Ownership share. The percentage you enter determines the contribution percentage by the partners. The Catch Up and Clawback provisions are only available when the LP contributes 100% of the required capital.
- GP Catch Up Option. Set the LP ownership share to 100% and toggle ‘GP Catch Up’ to ‘Yes’ for this module to be activated. Once activated, the logic is as follows:
- The LP receives 100% of distributions during operation until all capital has been returned and it has achieved an internal rate of return over the hold period equal to the preferred return assumption.
- Then, 100% of all excess cash flow is distributed to the GP (i.e. the catch up) until the GP has received a share of the excess profits (i.e. Total LP Distributions – Capital Contributed) equal to its first promote level (cell F15).
- So if the LP was distributed 500,000 in profit in order to hit its preferred return and the GP promote level is 15%, the GP will be distributed in its catch up the lesser of any cash flow remaining or 500,000/(85%) x 15% = 88,235 ; which equates to 15% of the total profit required to get the LP to its preferred return.
- LP Clawback. Set the LP ownership share to 100% and toggle ‘LP Clawback’ to ‘Yes’ for this module to be activated. Once activated, the logic is as follows:
- Any promote distributed to the GP during operation is subject to the Clawback if the LP does not reach its preferred return hurdle at the capital event.
- You can test this by setting the GP promote during operation (cell F11) to a value greater than 0 and then setting the ‘Reversion Cash Flows’ to 0. With insufficient property-level cash flow for the LP to achieve its preferred return, the GP will be obligated to return its promote paid during operation (see row 27 – GP Distribution and row 81 – GP Adjusted Distribution)
- Distribution – Operation. In cells E10 and F111, set the preferred return hurdle rate and the GP promote % above that hurdle. The LP and GP distribution percentages are automatically set based on the ownership share (preferred return) and the GP promote.
- Distribution – Capital Event. In cells E14:H17 you can model the return of capital and three promote tiers for the capital event cash flow.
- Property-Level Cash Flows. For this module to work properly, you will need to link the levered property-level investment cash flows (i.e. negative acquisition and development cash flows from your DCF), operating cash flows (i.e. cash flow after financing line), and reversion cash flows (i.e. net proceeds from sale). In the below video I show you how to link this model to my All-in-One model.
Video Walk Through – Real Estate Equity Waterfall Model with Catch Up and Clawback
Allow me to show you how to use this model. If you have questions, please don’t hesitate to reach out.
Download the Real Estate Equity Waterfall Model with Cash-on-Cash Hurdle
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 – similar real estate equity waterfall models sell for $100 – $300+ per license). 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.
We regularly update the model (see version notes). Paid contributors to the model receive a new download link via email each time the model is updated.
v1.20 – April 2, 2019
- Fixed an error in the Tier 1 Distribution row where in rare instances, the Tier 1 cash flow exceeded the hurdle
- Fixed an error where GP Distribution % in Tier 3 was incorrect
v1.10 – March 21, 2019
- Added logic to handle rare situations where there is a period with negative Investment CF
v1.00 – March 19, 2019
- Initial release
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.