Real estate equity waterfalls are critical for structuring partnerships, especially when dealing with multiple Limited Partners (LPs). For years, the equity waterfall model, particularly one featuring annual periods and Internal Rate of Return (IRR) or Equity Multiple hurdles, has been a cornerstone tool for real estate professionals. This model, frequently updated based on user feedback, provides a structured approach to distributing profits in real estate ventures.
This article delves into the intricacies of equity waterfall models designed for scenarios involving multiple partners, specifically focusing on structures with two LPs. We will explore how these models work, their key features, and why they are essential for ensuring fair and transparent returns in complex real estate deals.
Understanding the Real Estate Equity Waterfall Model
The equity waterfall model is a tiered distribution system that dictates how cash flow is allocated among partners in a real estate investment. It outlines a predetermined order in which profits are distributed, ensuring that each partner receives returns based on their agreed-upon priorities and hurdle rates. These hurdle rates are typically based on either IRR or Equity Multiple, providing benchmarks for performance that trigger different distribution tiers.
This specific model accommodates up to four tiers, allowing for sophisticated distribution structures. In the first tier, the focus is on ensuring the LPs achieve their preferred return and recoup their initial capital. Distributions at this stage can be structured in two ways: pari-passu (pro-rata based on equity contribution) or LP-first, prioritizing the Limited Partners. The LP-first approach also often includes a “catch-up” provision for the General Partner (GP) in subsequent tiers.
Beyond the initial tier, subsequent tiers (two through four in this model) distribute cash flow based on a promote structure. This promote, also known as carried interest or carry, rewards the GP for exceeding predetermined performance hurdles. These hurdles, again, can be defined as either IRR or Equity Multiple targets, allowing for flexibility in structuring the incentive framework.
For those seeking a simpler model, a Real Estate Equity Waterfall Model with One Cash-on-Cash Return Hurdle might be more appropriate. However, for deals with multiple partners and complex return expectations, the tiered IRR and Equity Multiple model provides the necessary sophistication.
Equity Waterfall as an Integrated Module
It’s important to understand that this equity waterfall model is designed as a module to be integrated into larger real estate financial models. It is not intended to be a standalone tool. Therefore, it assumes that you have already developed a property-level cash flow projection, often within a Discounted Cash Flow (DCF) analysis. The model then takes the net levered cash flow from your property-level model as its input and applies the waterfall distribution logic.
Many comprehensive real estate DCF models incorporate both property-level cash flow modules and partnership-level waterfall modules. Indeed, several models in our library of real estate Excel models already have this exact equity waterfall module built-in, demonstrating its widespread applicability and utility.
Dynamic Period Analysis: Annual and Monthly
The model is built to handle both annual and monthly periods over a 10-year analysis timeframe. This dynamic nature is crucial for adapting to various investment horizons. The length of the analysis is fully adjustable; by linking the model to your property-level net cash flow and leaving unnecessary periods blank, the model automatically recognizes and hides those periods, streamlining the output and focusing on the relevant timeframe.
Timing of Distributions: Preferred Return, Capital Return, and Promote
A key feature within this model is the detailed breakdown of distribution timing. It separates the timing of preferred return, return of capital, excess cash flow, and promote distributions for each partner. This granular view allows users to forecast precisely when specific hurdles are expected to be met and understand the composition of each partner’s distributions.
The model’s methodology prioritizes preferred return distributions first, followed by the return of capital. For a deeper dive into the rationale behind this approach, you can refer to this blog post explaining the timing of preferred return vs. return of capital in an equity waterfall with IRR hurdles.
Adaptability for Multiple Partners and Complex Structures
While the base model is structured for one GP and one LP, its foundation is designed for expansion. Adding more IRR or Equity Multiple hurdles, extending the analysis period, or incorporating additional partners is readily achievable. Furthermore, the model can be adapted to accommodate more complex scenarios, such as modeling a double promote structure or even integrating both equity multiple and IRR hurdles within the same waterfall.
For those seeking tailored solutions, A.CRE Consulting offers bespoke modeling services to handle unique project requirements.
Video Resources for Enhanced Understanding
To further assist users, video walkthroughs are available, comprehensively covering the model’s features and functionalities. These videos incorporate enhancements up to version 1.5, including the Equity Multiple hurdle, the GP Catch Up provision, a dynamic 10-year hold period, and various other refinements.
Adjusting the Hold Period: A Quick Tutorial
A brief tutorial demonstrates the simplicity of adjusting the analysis period within the model. The =IF(XX=””,”” logic implemented in the formulas allows for this dynamic adjustment based on data input in the header row, making the model highly flexible to different investment timelines.
Solving for IRR and Equity Multiple Hurdles Simultaneously
Version 1.6 introduced a significant enhancement, enabling users to solve for both IRR and Equity Multiple hurdles within a single analysis. A dedicated video explains how this feature works, providing guidance on leveraging this advanced capability.
Accessing the Equity Waterfall Model
The Real Estate Equity Waterfall Model with IRR and Equity Multiple Hurdles (Annual + Monthly Periods) is available on a “Pay What You’re Able” basis. This flexible approach allows users to access this valuable tool regardless of budget constraints. Simply enter your desired contribution (including $0 if needed) and an email address to receive the download link. Your support, at any level, helps sustain the ongoing development and improvement of these resources.
Proceed to Download Page
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Model Evolution: A Historical Perspective
The development of this model has been iterative, driven by user needs and evolving industry practices:
- Initially built with IRR hurdles only, it expanded to include equity multiple hurdles, eventually merging into a combined model offering both options.
- Recognizing the need for monthly analysis, a separate equity waterfall model with monthly periods was created for shorter-term investments.
- This equity waterfall module has been integrated into various other A.CRE models, including the Real Estate Portfolio Acquisition Model and the All-in-One Model.
- Features like the GP IRR or EMx Catch Up option and the ability to test for both IRR and Equity Multiple hurdles in the same analysis were added based on user feedback and forum requests.
- The model now includes both annual and monthly versions, and, as of the latest update (v1.94), supports up to five tiers with user-selectable tier numbers.
Version Log: Continuous Improvement
The model’s version history reflects ongoing enhancements and bug fixes, ensuring users always have access to a refined and reliable tool. Recent updates include:
v1.951
- Logic adjustment for IRR + Emx scenario.
v1.95
- Fixes for IRR + EMx option and version tab link.
- Placeholder value updates.
v1.94 – Mar 19, 2024
- Version tab and placeholder value updates.
- Extensive formula improvements for dynamic hold periods and consistency.
- 5th tier addition across all waterfall types.
- User-selectable tier number feature (2 to 5 tiers).
- Formatting fixes.
v1.93 – Jan 4, 2022
- Monthly module IRR calculation fix using XIRR.
- Error check formula updates.
- OFFSET() function added for dynamic monthly XIRR calculations.
v1.92 – Sep 7, 2021
- GP ‘Required Return’ calculation fix for monthly periods.
v1.91 – Aug 2, 2021
- GP Catch Up heading restoration.
v1.9 – Jul 7, 2021
- ‘Analysis Period’ output added to annual and monthly tabs.
- XIRR formula rewrite for dynamic hold periods in monthly tab.
- IRR hurdle calculation update to ACTUAL/365.
v1.8 – Apr 23, 2021
- Preferred return and return of capital summary error fix.
- ‘Partnership Returns – Monthly’ module addition with monthly period adaptations.
v1.7 – Feb 3, 2021
- Breakdown of Preferred Return, Return of Capital, Promote, and Excess Cash Flow.
v1.6 – Oct 8, 2020
- Complete redesign for IRR + Equity Multiple hurdle capability.
v1.51 – Dec 30, 2019
- Minor dummy value changes and label consistency improvements.
v1.5 – Dec 8, 2019
- Walkthrough video update and mini-tutorials added.
- Instruction note revisions and single-click hide/unhide for waterfall calculation.
- Formatting and label consistency updates.
v1.4 – Sept 14, 2019
- Version tab and header design updates.
- Input cell background removal for formatting consistency.
- Tier 1 label clarification.
v1.3 – May 31, 2019
- GP IRR and Equity Multiple Catch Up option added.
- IRR check label and Equity Multiple number formatting fixes.
- VLOOKUP() function replacements for efficiency.
v1.22 – December 10, 2018
- Promote Structure input and note clarifications.
v1.21 – July 13, 2018
- Hold period adjustment logic improvements and circular reference fix.
v1.20 – June 17, 2018
- Sponsor fee modeling option added.
- Currency reference removal for international usability.
- Tab renaming and formatting improvements.
- Error check formula revision and hurdle 1 modeling simplification.
v1.10 – December 29, 2017
- Equity Multiple hurdle option added.
- Bug fixes and monthly waterfall module link added.
About the Author: Spencer Burton, with over 20 years of real estate experience and $30+ billion in underwriting, is President at Stablewood. He holds degrees from Florida State University and Cornell University.
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