Investing with a Waterfall Structure

Imagine you and a group of friends decide to go invest together in an old apartment building sitting on a hill overlooking a growing city. You’re the ‘sweat equity’ partner, the one with the blueprint, the contractor contacts, and the late nights coordinating repairs and improvements. Your friends are quiet investors who chipped in most of the money, trusting you to turn that building into a cash-generating machine.

Think about this: when the rent checks start arriving and, years later, you finally sell the property for a profit… who gets what? And in what order?

That’s where the waterfall structure comes in; it decides exactly how every dollar cascades down through different pools of investors and partners.

Let’s dive in further!

For Limited Partners and General Partners, a partnership agreement would be forged prior to purchasing the property. This ensures that everyone is clear on their role, and how returns are divided up throughout the life of the property ownership. The first portion of profit comes from cash flow of the property.

-          Return of Capital: The first division of the waterfall, and how investors receive their original investment back. Profits are not divided further amongst the team until every investor’s capital is ‘returned’ to them.

-          From there, the waterfall spills into the second pool, the Preferred Return (Pref): In the agreement, a percentage is determined that states investors will receive a certain percentage on their investment before the general partners receive profits. Standard Preferred Returns are about 8% but can vary depending on the business plan and specific deal.

-          The third pool: After the Preferred Returns percentages are met, additional profits are split between Limited Partners and General Partners. This can be an 80/20 split (LP/GP), or some other breakdown, again, depending on the deal.

• The Partnership Agreement would also have details about when the property is performing so well, the IRR meets a specific goal (let’s say, 12%) and all the above categories have been met. In this case, the LP/GP split may change to 60/40 or 70/30, as a reward to the GP team for successful management of the property.
  

-          Selling the property: At the sale of the property if the business plan was successful, everyone gets their original capital back, Limited Investors receive their accumulated 8% preferred return and the remaining profit flows through the promote tiers, rewarding performance for the GP team.

The waterfall structure develops trust amongst the partners and is a helpful way for Limited Partners to see the value in their investments being managed in a hard asset versus the stock market. The waterfall is more than a financial framework — it’s the pledged example of trust. It defines how risk and reward are shared, and whether your GP team is aligned with your long-term goals.

As we have said many times, we care about you, and your investment. If you have questions about this type of investment structure, or you are ready to move your money into a property, let's talk!

God Bless,

Kristin + Caleb