In apartment syndications, a waterfall describes how, when, and to whom funds are paid in an apartment syndication deal. The type of waterfall will determine the returns to the Limited Partners and General Partners.
Ultimately, you as the General Partner decide which waterfall structure to have in place for your deals.
In this blog post, I will outline the waterfalls for the most common apartment syndication structures.
Waterfall #1: 8% Preferred Return Only
Compensation structure: Class A passive investors receive an annualized 8% preferred return only. Class B General Partners receive all profits.
Waterfall for cash flow
- Cash flow is distributed to Class A until they receive an annualized return of 8% based on their initial capital contribution
- Any remaining distributable cash flow is distributed to Class B
Waterfall for capital transaction (i.e., a sale, supplemental, or refinance)
- Repay the unreturned capital contributions of Class A investors (i.e., their initial equity investment amount)
- Make up arrearages in Class A preferred returns (if applicable)
- Any remaining distributable cash is distributed to Class B.
Waterfall #2: 8% Preferred Return + 70/30 Split
Compensation structure: Class A passive investors receive an annualized 8% preferred return and 70% of the profits. Class B General Partners receive 30% of the profits.
Waterfall for cash flow
- Cash flow is distributed to Class A until they receive an annualized return of 8% based on their initial capital contribution
- Any remaining cash flow is split 70/30, with 70% paid to Class A and 30% paid to Class B
Waterfall for capital transaction
- Repay the unreturned capital contributions to Class A investors (the amount is either the initial equity investment or the reduced equity investment based on the capital returned from 70% profit splits)
- Make up arrearages in Class A preferred returns (if applicable)
- Cash is distributed to the General Partner until such time as the General Partner has received an amount equal to 30% of the cumulative amount distributed (i.e., total distributions from cash flow, including preferred return and profits)
- Any remaining cash is split 70/30, with 70% paid to Class A and 30% to Class B
This is the waterfall structure that is currently set up on the Simplified Cash Flow Calculator, which you can download for free here. In the LP/GP Returns data table starting in cell B67, input the preferred return percentage to Limited Partners and the profit split to Limited Partners. The annual LP Return and GP Return is automatically calculated based on the preferred return, profit split, and flow of cash based on the waterfall catch up structure outlined above.
At the sale, the unreturned capital contribution to the Limited Partners is their initial equity investment minus cash received, which you can see calculated on the IRR Calculation tab.
Waterfall #3: 8% Preferred Return + IRR Hurdle
Compensation structure: Class A passive investors receive an annualized 8% preferred return and 70% of the profits up to a 13% IRR. After a 13% IRR is achieved, Class A passive investors receive 50% of the profits. Class B General Partners receive 30% of the profits up to a 13% IRR to Class A. After a 13% IRR to Class A is achieved, Class B receives 50% of the profits.
Waterfall for cash flow
- Cash flow is distributed to Class A until they receive an annualized return of 8% based on their initial capital contribution
- Any remaining cash flow is split 70/30, with 70% paid to Class A and 30% paid to Class B
Waterfall for capital transaction
- Repay the unreturned capital contributions to Class A investors (the amount is either the initial equity investment or the reduced equity investment based on the capital returned from 70% profit splits)
- Make up arrearages in Class A preferred returns (if applicable)
- Cash is distributed to the General Partner until such time as the General Partner has received an amount equal to 30% of the cumulative amount distributed (i.e., total distributions from cash flow, including preferred return and profits)
- Cash is split 70/30, with 70% paid to Class A and 30% to Class B up to a 13% internal rate of return
- Remaining cash is split 50/50 between Class A and Class B
There can be more or more hurdles. For example, 70/30 up to 13% IRR, 60/40 up to a 15% IRR, and 50/50 thereafter.
Waterfall #4: Two Passive Investor Tiers
Compensation structure: Class A passive investors receive an annualized 10% preferred return. Class B passive investors receive an annualized 7% preferred return and 70% of the profits. Class C General Partners receive 30% of the profits.
Waterfall for cash flow
- Cash flow is distributed to Class A until they receive an annualized return of 10% based on their initial capital contribution
- Cash flow is distributed to Class B until they receive an annualized return of 7% based on their initial capital contribution
- Any remaining cash flow is split 70/30, with 70% paid to Class B and 30% paid to Class C
Waterfall for capital transaction
- Repay the unreturned capital contributions to Class A investors (since Class A isn’t receiving a profit split, their capital account isn’t reduced)
- Repay the unreturned capital contributions to Class B investors (the amount is either the initial equity investment or the reduced equity investment based on the capital returned from 70% profit splits)
- Make up arrearages in Class A preferred returns (if applicable)
- Make up arrearages in Class B preferred returns (if applicable)
- Cash is distributed to the General Partner until such time as the General Partner has received an amount equal to 30% of the cumulative amount distributed (i.e., total distributions from cash flow, including preferred return and profits)
- Any remaining cash flow is split 70/30, with 70% paid to Class B and 30% paid to Class C
Waterfall #5: General Partner Catchup
This is a waterfall catch up structure that you, the syndicator, can receive distributions starting from day 1.
Compensation structure: Class A passive investors receive an annualized 8% preferred return and 70% of the profits. Class B General Partners receive an annualized 3.43% preferred return and 30% of the profits.
Waterfall for cash flow
- Cash flow is distributed to Class A until they receive an annualized return of 8% based on their initial capital contribution
- Cash flow is distributed to Class B until they receive an annualized return of 3.43% based on the Class A initial capital contribution (3.43% is the equivalent to a 70/30 split between Class A and Class B – 70/30 = 8/x; 70x=240; x=3.43)
- Any remaining cash flow is split 70/30, with 70% paid to Class A and 30% paid to Class B
Waterfall for capital transaction
- Repay the unreturned capital contributions to Class A investors (the amount is either the initial equity investment or the reduced equity investment based on the capital returned from 70% profit splits)
- Make up arrearages in Class A preferred returns (if applicable)
- Make up arrearages in Class B preferred returns (if applicable)
- Any remaining cash flow is split 70/30, with 70% paid to Class A and 30% paid to Class B
These are the waterfalls for the five most common passive investor compensation structures.
Make sure you download the free simplified cash flow calculator (here), which has the waterfall #2. If you plan on using a different waterfall catch up structure, you will need to update the formulas in this or other cash flow calculators accordingly.