In private equity, a 'waterfall' refers to the priority sequence in which profits from an investment are distributed among the general partners (GPs) and limited partners (LPs). It's akin to a multi-tiered waterfall, where the water - the profits in this analogy - cascades down different levels, each representing a phase in the profit distribution process.
Consider an example: A real estate fund acquires a property, invests in improvements, and then sells it at a profit. According to a typical 'European Waterfall' structure, the first tier - the top of our waterfall - ensures the return of the original capital to the LPs. The second tier provides the LPs with their preferred return, a predefined percentage on their initial investment.
Only after these two levels are satisfied does the waterfall flow to the third tier. Here, the remaining profits, often called 'excess profits,' are divided between the LPs and GPs. It's common for this split to favor the GPs, typically around an 80-20 LP-GP ratio, incentivizing fund managers to exceed the preferred return threshold.
Investing in real estate syndication as a Limited Partner (LP) is an attractive option for generating passive income and building wealth. However, the viability of such investments significantly hinges on the specific deal terms negotiated at the outset. These terms shape the risk and return profile of the investment, influencing the overall financial outcome for LPs.
We just recently held our 2024 Multifamily Market Outlook webinar and a big part of looking ahead is looking back at some of the key moments in 2023 that lead us to the assumptions we make looking forward. So for this blog, we are going to focus on recapping some of the highlights of 2023 and current trends that we believe will most profoundly impact our investment decisions in 2024.
2023 was one of the most eventful years for the commercial real estate industry since 2008. An industry renowned for its cyclical nature, the industry had been riding high for nearly 12 years until the inevitable realities of the market took hold. The age-old adage rings true: what goes up, must come down. The shift began in 2022, fueled by the Federal Reserve's aggressive rate hikes, and was further intensified by a range of factors from basic operational challenges to wide-ranging global events.
Looking back at the beginning of 2023, which feels like ages ago, there was a sense of optimism, spurred by a temporary decrease in the 10-year U.S. Treasury index – a key indicator for our sector – to 3.3% from a high of 4.25% in October 2022. However, this optimism was short-lived as the index climbed again, hitting over 5.00% in October. The financial markets were further shaken by historic bank failures in March, leading to a sharp drop in lending and transaction volumes. Consumers began to feel the pinch, and the predicted downturn in rental prices materialized. As the year progressed, a series of events unfolded, adding stress to the real estate capital markets. Here, I share my thoughts on the three most significant events of 2023 in the industry and what we might hope for 2024.
Key Events of 2023:
Bank Failures: The downfall of Silicon Valley and First Republic banks – the second and third largest in U.S. history – had a profound and lasting impact. The aftermath saw a significant decrease in construction loan availability from regional banks, critical for many developers, leading to a drop in new construction projects.
Federal Reserve's Inflation Fight: The Consumer Price Index reached a peak of 9.1% in June 2022. Since then, the Federal Reserve has been clear about its intention to raise the Fed Funds rate as necessary to bring inflation down to its 2% goal. This rapid and sustained rate hike has particularly impacted real estate businesses and developers reliant on floating-rate loans, which are closely tied to the Fed Funds rate. Many pro formas from 2020, 2021, and early 2022 did not foresee these rate hikes, resulting in a need for significant additional capital to cover rising interest costs. While the approach to achieving economic stability needs precision, the December CPI at 3.3% suggests that the Federal Reserve's strategy is having an effect.
Political and Geopolitical Turbulence: On a brighter note, a government shutdown was averted in November, though the issue may resurface soon here in early 2024. The conflict in Ukraine, now almost two years ongoing, continues to affect material and energy prices, among other issues. The events in Israel on October 7th were among the most shocking and tragic in recent memory, contributing to regional instability and unpredictable challenges and risks. The concurrent presence of two major geopolitical conflicts adds a layer of economic uncertainty.
When it comes to investing in real estate as a limited partner (LP), one of the most critical decisions you'll make is choosing the right sponsor. A sponsor, or general partner, is responsible for managing the investment property and executing the business plan. Their expertise, experience, and track record can significantly impact the success of your investment.
If you spend any time around commercial real estate, you’re bound to hear the terms core, core plus, value-add and opportunistic real estate thrown around. These terms are used to define the level of risk and return potential of an investment property. Not only are the physical attributes of the property used to define an investment but the amount of debt financing to support the project is also imperative.
To explain why the debt financing has such an important role, I find it easy to understand if you look at a single-family property. If a property has a long-term lease in place, it can sound attractive to a conservative investor who wants to play it safe. However, if the same property has been primarily financed through debt with very little equity, it can paint a very different picture. Should the property value decrease, the owner could end up owing more on the property than it’s worth.
As a commercial real estate investor, you should know about each of these terms. Let us take you through them one by one to help you understand them better.
Welcome to our in-depth educational series designed for those looking to master the art of multifamily syndication. Whether you’re aspiring to syndicate your own multifamily investment, aim to join a private equity firm in this sector, or simply want to be a more informed passive investor, this resource is tailored to provide you with comprehensive knowledge and practical insights.
This series is structured as a virtual course, broken down into detailed sections, each focusing on a crucial aspect of multifamily syndication. Through this blog series, you will gain a deep understanding of the market dynamics, legal frameworks, financial analysis, and much more that are essential to succeeding in this field. Each blog will link back to this start page so you can come back here and see all the topics in one place.
Course Overview:
Below is a detailed layout of the course, segmented into key sections. Each section header is followed by a series of topics. Click on the topics to access the dedicated blog posts for detailed information and insights.
Private equity real estate (PERE) is an alternative investment that continues to captivate the interest of investors worldwide for its historical performance and place it fills in a successful portfolio. It involves pooling capital from various investors to directly invest in real estate properties or real estate-related companies.
In the complex world of real estate syndication, understanding the intricate structures of Limited Liability Companies (LLCs) is key to maximizing your investment's potential. As a real estate syndicator or investor, grasping the nuances of these LLCs can provide significant advantages, from tax benefits to streamlined management. Let's break down the four critical LLCs commonly used in real estate syndication and their roles in the investment process.
We are a private equity real estate firm offering investment opportunities for accredited investors. We specialize in multifamily acquisitions and development.
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