What is a Waterfall Structure?

A waterfall structure is a method of distributing profits in a real estate syndication that changes the profit split based on the performance of the investment. It is designed to align the interests of the GPs and LPs by rewarding the GPs for achieving higher returns.

The Preferred Return (Pref)

The foundation of most waterfall models is the preferred return. This is a threshold return (e.g., 8% annualized) that the LPs must receive before the GPs earn any share of the profits (their "promote").

For example, if the deal generates a 6% return in year one, 100% of that cash flow goes to the LPs. The GPs receive nothing until the 8% hurdle is cleared.

Tiers and Hurdles

Once the preferred return is met, the remaining profits are split according to defined tiers or "hurdles." A common structure might look like this:

• Tier 1: 100% to LPs until an 8% preferred return is achieved.
• Tier 2: 70% to LPs / 30% to GPs for returns between 8% and 15% Internal Rate of Return (IRR).
• Tier 3: 50% to LPs / 50% to GPs for any returns exceeding a 15% IRR.

Why Use a Waterfall?

Waterfalls protect LPs by ensuring they receive a baseline return before the GPs share in the upside. Simultaneously, they heavily incentivize GPs to outperform expectations, as their share of the profits increases significantly at higher return tiers.