Investment Guide
Real Estate Waterfall Model Explained
How profits flow between sponsors (GPs) and investors (LPs) in real estate syndications. Understand preferred returns, promotes, and IRR hurdles.
How profits flow between sponsors (GPs) and investors (LPs) in real estate syndications. Understand preferred returns, promotes, and IRR hurdles.
A real estate waterfall is a tiered distribution structure that determines how investment profits are split between General Partners (GPs) and Limited Partners (LPs). Typical structures include an 8% preferred return to LPs, followed by tiered promotes of 10-40% to GPs as IRR hurdles are met. Waterfalls align GP and LP incentives.
Cash flows "fill" each tier before spilling over to the next, like water cascading down.
LPs receive their original investment back, plus a preferred return (typically 8%)
GP begins receiving a share of profits above the preferred return hurdle
GP's share increases as the project exceeds performance targets
Maximum GP participation for exceptional performance
Essential terms you need to understand before evaluating any syndication.
The minimum return LPs receive before the GP participates in profits. Typically 7-10%, with 8% being most common. Acts as a hurdle the sponsor must clear.
The GP's disproportionate share of profits above hurdles. A 20% promote means the GP gets 20% of excess profits despite contributing only 5-10% of equity.
Return thresholds that trigger changes in profit splits. Common hurdles: 8%, 12%, 15%, 18%. About 85% of waterfalls use IRR as the hurdle metric.
Allows the GP to receive 100% of profits after the pref until they "catch up" to their target promote percentage. Favors sponsors.
Lets LPs reclaim GP profits at deal close if returns fell short. Protects investors but requires enforcing at exit—which can be awkward.
Requires the GP to return excess carried interest if the fund underperforms. Only works if the GP has funds available to return.
What's "market" for preferred returns, promotes, and hurdles?
Two fundamentally different approaches to distributing profits.
| Factor | American (Deal-by-Deal) | European (Whole Fund) |
|---|---|---|
| When GP Receives Carry | On each deal as it exits | Only after LPs receive full capital + pref across all deals |
| LP Protection | Lower—early winners fund GP carry even if later deals fail | Higher—GP must clear hurdles fund-wide |
| GP Cash Flow | Steadier—carry throughout investment period | Lumpy—may wait 6-8 years for carry |
| Common In | U.S. markets, smaller funds | Europe, institutional funds globally |
| Clawback Risk | Higher—GP may need to return carry if fund underperforms | Lower—carry isn't paid until fund performs |
European waterfalls are generally considered more LP-friendly because they prioritize full capital return before any GP participation.
5 questions to ask before investing in any syndication.
Look for 8-10%. Below 7% is aggressive. Cumulative prefs are better than non-cumulative.
Cumulative means unpaid pref rolls over. Non-cumulative resets annually, so you may lose returns forever.
Standard is 10/20/30% promotes at 8/12/15% hurdles. Watch for aggressive structures that reach 40%+ promote early.
Catch-up favors GPs. Lookback protects LPs but requires enforcement. Know what you're signing.
European is more LP-friendly. American lets GPs take carry before you're made whole across the fund.
The most common preferred return is 8%, used in about 40% of deals. Other common rates include 10% (30% of deals) and 7% (8% of deals). The pref ensures LPs receive a minimum return before sponsors participate.
A promote (carried interest) is the GP's disproportionate share of profits above hurdles. A 20% promote means the GP gets 20% of excess profits, even if they only contributed 5-10% of the equity.
IRR hurdles are return thresholds that trigger changes in profit splits. Common hurdles are 8%, 12%, 15%, and 18%+. As returns exceed each hurdle, the GP's share of incremental profits increases.
European (whole fund) waterfalls are more LP-friendly because GPs can't receive carry until all LP capital plus preferred returns are returned across the entire fund, not just individual deals.
Cash flow data feeds waterfall calculations
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