Tilden Moschetti: How do waterfalls work in a
syndication? Well, that's what we're going to be talking about
right now. My name is Tilden Moschetti, I am a syndication
attorney with the Moschetti syndication Law Group.
You may be wondering to yourself exactly how our distributions
going to happen, what are these things called waterfalls that I
hear about how to what our preferred returns? How does it
all fit together? That's what we're going to be talking about
right now. So let's go to our whiteboard. And take a look at
what of just a very simple scenario so that we can be
better understood. So let's say we have a property that we
bought for $5 million. All cash. And we raised that $5 million
entirely from investors just for the ease of doing the analysis.
And out of that $5 million, so it pays rents, right? That's how
most properties happen. They, they pay rents, and then there's
some sort of appreciation that gets distributed at the end. So
let's say we've told our investors hey, look, investor,
we're gonna give you this deal, we're gonna give you a preferred
return offer, also called a pref, of 7%. And then any money
that comes after that preferred above that preferred return of
7%, we are going to split 7030 70%, to you, investor, and
30%, to me as the syndicator. So then, let's, let's look at it
from the investor's point of view, and the sponsors. So let's
say that those rents are being collected. And let's say it's
about let we're getting, say 55 $550,000 annually on that
investment, so $550,000. So first, we take that $550,000,
and we need to give that preferred return this pref to
the investors first, that's the first thing that happens on all
those cash flows. So they first get 7% 7%. Right, which equals
$350,000. out why $350,000? Well, it's $505 million, that we
paid for it 7% of 5 million is $350,000. So that is their
annual preferred return amount that they're getting. On top of
that, there's still this bought this amount of money, this
$200,000. Right, so the 550 minus the 350 K is $200,000,
that still needs to be divided between investors and the
sponsors. So that 350k, the split is 7030. And so they get
another 140k, right 70% Of $200,000 goes to that goes to
the body of the investors. Now the sponsor, they get 30% of
that 200,000 that's leftover so they get 60,000. So out of that
those cash flows in you as a sponsor getting $60,000 Every
year, this is after fees have already been taken account, the
investor is getting 350 plus 140. So they're getting $490,000
paid out to them every year. So as part of their investment, so
pretty good deal. That's that's a nice return. So you've decided
to sell the property. Let's say you sell it in year five. So
year five, you are able to sell the property and let's use
$6,500,000 Is your sales price. Alright, so first, how do we
divide up that amount of money? So first we have to return so to
investors We have to give them their principal. How much they
initially gave you that was 5 million remember? After the
payment of their principal, we then need to get paid them the
preferred return, as I bet you're thinking, well, actually,
we don't. So let's say that sale is paid at the end of year five,
and we've been paying regularly, those preferred returns at that
7%. So the end of year on December 31, in the year, in
year five, that preferred return has already been paid that 7%
has already been paid. So now there's just the division of the
assets that are remaining. So that is leaves us with with, we
have to return their capital. So we then have $150,000, to
divide, I'm sorry, $1.5 million to divide between the investor
and the sponsor. And so 70% of that return is belongs to the to
the investor. And that is 105, or 1,000,500, I'm sorry,
1,050,000. gets paid out to them. And then the remaining
$450,000 gets paid out to the sponsor. So that's your money to
get there. So now they investor then gets this $6,050,000 At the
end of the investment. So is it just the is that just the the
total amount? So how do we with that amount? How do we figure
out what the internal rate of return is? So for this, you're
gonna need a calculator. And we draw what's called a T bar, a T
bar says we start at time zero, where they paid out $5 million.
Right. And then we held that for one year, one year, two year
three year flips to choose your three, year four and year five.
And remember, in those, we were making payments of $490,000.
In here, I'm going to write it off to the side because I'm
going to total it underneath. Plus, then we also have this
payment of the 6,050,000. Right, and so that total is six 540.
Oh, so let's just delete this. So it's easier to read. Right?
So that 6,000,500 Now what you do is you select this entire
range, you put it in Excel, it tells you what the answer is,
it's been a 13% annualized return that the investor has
gotten so not bad. So the IRR is 13%. Hope that explains a little
bit on how you do these waterfalls. And you do those
preferred return payments and you split out the cash for
typically in a real estate investment but really any kind
of syndication. This is how those the water, the water
flows. So if I can be of any assistance to you, my name is
Tilden Moschetti. I'm a syndication attorney with these
Moschetti syndication Law Group. We specialize in Regulation D
Rule 506b and 506c syndications and funds