commercial re private equity understand and navigating the options workshop primer

1

Private Equity Capital for Commercial Real Estate: Understanding and Navigating the Options

Primer on Private Equity

2

Objectives

• Understand the real estate private equity universe• Discuss investment strategies and vehicles used by

private equity • Become familiar with the capital raising process and

timeline• Understand the workings of a joint venture, including

fees, waterfalls and major terms• Learn how to define your value proposition for investors• Gain insight into current investor appetite from active

capital providers

3

Real Estate Private Equity Investors

4

Real Estate Private Equity Investor Universe

• Owner / developer personal resources

• Friends & family• HNW investors

• Family offices• Commingled dedicated real

estate equity funds• Hedge Funds• Pension funds, endowments,

foundations• Sovereign wealth funds• Life insurance companies,

banks, corporate investors• Listed and unlisted REITs

Traditional Sources Institutional Sources

5

Investment Criteria • Real estate private equity investors will consider the following in making

investment decisions:– Returns– Structure– Strategy (Acquisition, Development, Land Banking, Debt, Capital Allocation)– Property Type – Geography– Hold Period

• One size does not fit all– Certain investors constrained by very specific investment mandates dictated by

their investor base – Investor cost of capital will determine strategy

6

Investment Return Characteristics

• Class A assets or premier multi-tenant buildings• Primary markets• High occupancy/credit tenants/long-term leases• Stable cash flow investment• Modest leverage <50% when used• Unleveraged IRRs ~ 7.5% - 8.5%

• Class A and B assets• Recovering Primary markets or Secondary /

tertiary markets• Mid-high vacancy / releasing risk / obsolescence /

rents below market/repositioning• Balanced mix of cash flow and appreciation• Moderate leverage 60-70%• Unleveraged IRRs ~ 9.5% - 13%

• Variation on core investing• Primary markets• Fewer credit tenants• Some vacancy or releasing risk• Cash flow with some potential for growth through

increased cash flow• Slightly higher leverage 50-60%• Unleveraged IRRs ~ 8.5% – 10%

• Class A, B, or C Assets• Secondary/tertiary markets or new developing

markets• Land/Development/Redevelopment/Repositioning/

Turnaround potential• New or innovative product types• Dramatic increase in cash flow • Growth-oriented investment• Higher levels of leverage 70-80%• Unleveraged IRRs ~ 10% - 13%

Core Core - Plus

Value-AddedOpportunistic

7

Investment StructureSingle Asset Joint Ventures

Strategic / Programmatic Joint Ventures

Entity/GP Investment Commingled Funds

Joint ventures are individually negotiated and tailored transactions

A joint venture may be formed to:

Acquire a specific property, a portfolio of properties,

Make entity Level Investment

Recapitalize an existing partnership

Develop or redevelop a property

Widely used vehicle for sponsors who have a good reputation and track record

Establishes terms on which a series of investments may be made with a single investor or small number of investors

Terms vary widely and are individually tailored (e.g., discretion within a box vs. deal by deal approval)

Can offer a more certain funding source for projects within specified parameters

Investments by one or more investors at the operating company (entity) or sponsor equity (GP) level

Involves sale of a portion of all income streams generated by the entity or the GP

Investments can take form of common or preferred equity and can vary with respect to governance

Can provide permanent capital and a longer term/global solution for the sponsor

Creates alignment of interest; typically aids in raising additional JV capital

Group of investors pool their resources to create a larger investment

Money is gathered from various sources that is managed together in one account

Includes a wide variety of entities including insurance companies, group trusts, limited partnerships, LLCs and private or untraded REITs

8

A Closer Look at Joint Ventures

9

Structuring Joint Ventures• Joint Venture: Partnership between a private equity investor and real

estate sponsor to invest directly in real estate • Involves formation of new, special-purpose entity to own the properties

of the joint venture– Acquisition JV – Disposition JV – Development JV

• In a disposition JV, sponsor contributes assets at agreed upon value while institutional investor contributes cash

• Profit sharing based on value of equity contributed by the parties to the joint venture

• Increasingly popular alternative source of equity capital for public and private real estate operating companies (REOCs)

10

Structuring Joint Ventures• Single asset or programmatic joint venture

– Ability to attract programmatic capital largely determined by investor appetite, sponsor track record, investment parameters and visibility of pipeline

• Each joint venture is idiosyncratic; there are no pre-set terms and conditions

• Terms to be negotiated include:– Contributions– Preferred returns and “Claw-backs”– “Promotes”– Governance, guarantees (if any), fees, and transaction costs and expenses– Hold period– Winding-up, Buy/Sell

11

Structuring Joint Ventures• Example:

– Capital contribution: 95% investor / 5% sponsor– Sponsor returns subordinated to investor receipt of preferred returns

• Sponsor handles day-to-day operations; paid market rate fees (which increase return on investment)– E.g., asset management, property management, leasing, development,

construction, acquisition, disposition or financing fees• Exit may include buy/sell provisions where properties are liquidated

through acquisition by one JV partner or sale to a third party

12

Entity / GP Investments

13

Entity Level Investment Considerations

• Equity infusion at the operating company level is akin to selling a portion of the firm

• Sale of majority or minority stake in the company entitles investor to share in corporate level cash flow– May include net property income, fees, and carried interest– Investor would pay its pro rata share of expenses– Investor would expect control / governance rights commensurate with its

ownership stake in the company• May provide sponsor with global solution

– Capital raised typically used to recapitalize existing assets, provide corporate working capital or fund future growth

14

Entity Level Investment Considerations

• Enterprise valuation will take into consideration– Value of existing portfolio (legacy assets)– Value of existing and future fee streams– Underwriting of corporate assets and liabilities– Future value creation

• Company benefits from long term strategic alignment of interest• Requires a close relationship with the investor, with “fit” crucial

– Important to vet strategy, governance, mechanisms for conflict resolution and potential exit

15

GP Level Investment Considerations

• Equity infusion at the GP level is focused on future opportunities only– No valuation issues with respect to legacy assets

• GP level returns are enhanced– Sharing of GP level carried interest enhances underlying deal IRRs by 250 –

500 basis points for the investor. • Need to address key man provisions and management time commitments

to legacy assets• Investor will need to be comfortable with limited governance inherent

within GP structure

16

Commingled Funds: Investment Structure

17

Commingled Fund Structure• Pooled investment vehicle with defined strategy used for making

investments in various debt and equity positions • Funds are typically limited partnerships (or LLCs) with a fixed term of 7-10

years• Typically raised and managed by investment professionals of a specific

private equity firm (the general partner/sponsor/investment advisor)– Sponsor has greater discretion over deployment of capital

• Increasing institutional appetite for funds sponsored by established operators

18

Real Estate Commingled Fund: How It Works

19

Three Types of Fund G.P.s

Long standing relationships with high net worth clients who can help capitalize these funds

These banks, serving as frequent intermediaries, have access to proprietary deal flow

Skillful at corporate finance and complex structuring

Examples: Morgan Stanley, Goldman Sachs, Credit Suisse, and UBS

Volcker rule will limit participation by banks in the future

Investment Banks

Funds are generally stand-alone funds which are a part of a family of funds

The advantage of having multiple funds under the same umbrella is in fundraising and underwriting

Brand recognition is a huge factor in the investing business

Examples: Blackstone, Carlyle, Cerberus, Apollo, Angelo Gordon, and Oaktree

People who head these funds have worked in real estate most of their lives

Skilled at raising money

Comparative advantage is typically at the property level

Examples: Starwood, Lonestar, Westbrook, AEW, Lubert Adler, Walton Street, Colony Capital

Investment Houses Dedicated Real Estate Players

20

• Most private equity is invested via partnership of a limited duration

Follow-on fund Marketing

Commitments by investors in multiple ‘closings’

Cash Flows from investors

Cash Flows to investors

1 Year10 Years 3 Years

Marketing Divestments Extension Draw down/Investments

Fund Timeline

21

Investment Strategy

22

• Open-ended Funds– No limits on the number of properties in which the fund can invest– No limit on the number of investors– No limit on the duration of the investment– Unit certificates in the fund may be redeemed at any time at a set price,

usually at Net Asset Value.• Closed-ended Funds

– Raise a fixed amount of capital – Have a specified duration– Exits from the fund are limited– Exit prices can be predetermined

Open Ended v. Closed-Ended Funds

23

Fundraising Statistics

24

Fund Size

25

Accessing Private Equity CapitalConsiderations, Process and Timeline


ULI – January 11th, 2011

26

Joint Venture Indicative Process

Investor Timeline

Outline Objectives

Outline objectives Identify major

transaction issues Due diligence and

underwriting Develop returns

analysis Explore

structural / financing alternatives

Formulate key investment terms

Prepare Marketing Materials

Prepare Teaser Finalize investor

list Continue due

diligence and prepare other marketing materials/presentations

Begin assembling electronic data room and / or supporting information

Develop financial model

Pre-Marketing

Contact / screen potential investors

Complete and distribute Teaser

Incorporate feedback and refine marketing materials / presentation (and potentially term sheet) as necessary

Evaluate cultural “fit”

Formal Marketing Effort

Negotiate and execute CAs

Finalize and distribute Marketing Materials, financial model and open data room

Respond to investor requests/questions

Begin drafting Definitive Agreement

Receive proposals

Investor Due Diligence

Tier potential investors based on transaction criteria

Distribute draft Definitive Agreement

Facilitate due diligence process / respond to investor questions

Conduct management presentations / site visits (if applicable)

Final Proposals / Negotiations

Finalize due diligence

Negotiate proposals

Negotiate and sign Definitive Agreement

Closing / funds transfer

27

Diligence Request ListCompany and Management Information

Management biographies Organizational chart of asset-level management or any employees necessary to manage properties Transaction sourcing strategy Investment committee policies and procedures, if available

Market Analysis

Industry information / forecasts completed internally or by third parties, including any sub-market studies for each asset Strategy for investing in primary markets / market selection criteria Arial submarket photos, with contributed properties and land for development identified Detail of replacement costs for each submarket (i.e., land, bldg., site, interest, commissions, TIs, design, etc.)

Property-Level Information

Property detail for contributed assets, including address, size, age, physical details, etc. Current rent rolls Property level historical financial information for the past three years Abstracts of all leases Development pipeline and related contracts / documentation Property inspection / asset summary reports Copies of appraisals, environmental and engineering studies completed within last 2 years Land surveys and site plans for all properties Copies of title reports

Financing Information

Debt schedule, including amount, rate, terms, etc. Supporting debt documentation

Other Documents

Copy of standard tenant lease Significant tax information that may adversely impact the company or third parties Disclosure of any prior or pending litigation related to business dealings generally and portfolio specifically

28

Explore Structural Alternatives

Corporate and Legal Due Diligence• Articles of incorporation, board minutes, ownership structure,

legal entity list, etc.Business Due Diligence

• Financial model(s) and detailed rollup• Financing – debt abstracts / loan documentation• Estimate of defeasance and yield maintenance costs for in place

debt• 2011E and run-rate G&A detail • All executive employment agreements• Change of control analysis - tenant rights summary, ROFO’s,

ROFR’s, etc.• Lease abstracts• Vacancy guidance

Other• Tax returns• Employee benefit plans• Third party reports

Ultimate Deliverables• Confidentiality agreements and process documents• Dataroom• Purchase and sale agreement(s)• Updated Management Presentation

GP - WHOLE CO. PREPARATIONS LP - JOINT VENTURE PREPARATIONS

Diligence Items Loan documents Third party lease abstracts, documents and tenant data Review previously provided portfolio financial model Any third party reports on properties Appraisals, environmental, structural, etc. Supporting material used in current offering memorandum

provided Any document(s) previously gathered for data room Property photos All property-level Argus data Summary of property management operations

Ultimate Deliverables Dataroom Teaser Offering memorandum Confidentiality agreements and process documents Contribution agreement LLC agreement

29

3rd Party Management

Merchant Development Model - Illustrative

Sale of Property

Construction period: 22 Months

Equity investment: Month 1 or 22

Lease-up management fee: Months 12 - 23

Stabilized management fee: Months 24 - 35

Sale of property: Month 36

Return of equity: Month 36

3rd Party Management: Month 37

Management Fee: $9,000 (in 2011)

Lease-Up Period

Construction Period

Distribute Fees (as a % of Total Project Cost)A = 3.00% B = 3.65%

Stabilized Management Fee3% of Gross Effective Rent

Return of Equity

36

Stabilization Period

0 22

12 23

24 35

37

1

Equity Investment

Equity Investment

(Timeline in Months)

30

Crafting the Investment Thesis Business Strategy

Define investment focus (asset type) Acquisition v. development Determine investment strategy (core, core-plus, etc.) Narrow the focus of the transaction, as needed Consider industry trends & fundamentals

Portfolio / Pipeline Quality Footprint (major MSAs?) Mix of (re) development / stabilized assets Size and age of portfolio

Track Record and Performance Historical returns Cycle adjusted returns Deal activity and operating performance in past year

Internal and External Growth Story Upside from new projects brought online? Access to off-marketed deals? Anticipated returns

Management Team Experience Quality sponsor Depth of bench Ability to navigate current market environment Strong relationships

Well Established Scalable Platform Vertically integrated Platform to support larger scale business

Intensive Asset Management “Right-sized” organization Cost controls Revenue enhancement

31

Investment Highlights

Positioning

Simplified management

structure

Simplified management

structure

Proven investment track record

Proven investment track record

Strong industry fundamentals

Strong industry fundamentals

Significant internal growth driven

through intensive asset management

Significant internal growth driven

through intensive asset management

Premium quality asset portfolio

Premium quality asset portfolio

Experienced management team

Experienced management team

32

Two Scenarios – Diligence & Underwriting

- Small Developer – MF merchant builder run

by family for 75 years

- Large Owner – MF developer, owner,

operator

Comments

Size Team / Employees

20 people 200 people Market concerned about depth of bench and possible conflicts

Assets 5 stabilized multifamily

developments Own 100 assets

(½ multifamily, ½ office) Small size limits ability to contribute asset. Positive cash

flowing

Pipeline 3 “shovel ready” $500mm MF dev / acq, $500mm office dev / acq.

Can development pipeline be completed with existing financing? Guarantees? Are targets available at sensible pricing?

Motivation Financial Stress

Limited construction financing Recap existing Not all assets have same financial stress. Refinancing? CMBS / crossed?

Control 3 generations Discretion within a box Family unlikely to cede control

Tax 1031. Recycle capital (not REIT

eligible) Need simplified structure.

Low basis assets Different tax issues for each investor (individuals vs.

institutions)

Growth Need capital for construction

or continue to layoff Immediate acquisition

pipeline in current markets Willing to split business lines?

Markets Footprint Local “sharpshooter” National, coastal focus Positive fundamentals in markets?

Sector “A” quality MF “A” / “B” MF in Southeast

“A” MF CBD in Northeast MF demand is strong

Investment Investors Friends & family Friends & family and 7

institutions Existing institutional investors lend credibility but conflicts may

exist

Returns 50%+ asset level returns Hi teen / low 20% returns to

investors Stability of returns and at what leverage?

Offering Structure Development JV Acquisition JV including

possible GP investment Different investors choose different entry points

33

Teaser Outline• Teaser Overview

– 3-5 page summary of joint venture investment – Provided to interested, potential joint venture partners along with Confidentiality

Agreement– Enables potential joint venture partners to quickly determine preliminary interest

• Teaser Outline– Transaction Overview– Corporate Overview

• Company• History• Track Record• The Opportunity

– Selected Investment Highlights– Market Highlights– Portfolio Overview– Process & Timing– Contacts

34

Process Alternatives

34

Targeted BroadNarrow

Process

Number of Buyers

Structure / Process

Timing

Accelerated Limited information preparation

Investor returns model Teaser

Site visits Management meeting Due diligence

Key abstracts / documents

Somewhat accelerated Concise marketing materials

Investor returns model Teaser Management

presentation Straight from Confidentiality

Agreement to data room Small group of investors selected to

proceed to a close Provides competitive tension to

enhance value and optimize JV terms

Formal and elongated process Complete set of marketing materials

prepared and distributed to potential buyers

Preliminary term sheets with general transaction terms submitted in a first step

No access to management or properties in first step

Selected group of investors conduct detailed due diligence in second step

Final term sheets submitted Maximum value

Confidentiality High High / Moderate Moderate (risk of “leak”)

< 5 investors 5 to 20 investors > 20 investors

Several months to a year or more Fast Months

35

Sample Investor Universe

Fund ManagersFund Managers

Pension Fund AdvisorsPension Fund Advisors

OtherOther

Unlisted REITsUnlisted REITs

InternationalInternational

Family Office / Private Wealth

Family Office / Private Wealth

Investor

36

Description of Typical Fees

Description

of Services

Investment banking services: Screen and qualify potential investors Create and distribute marketing materials Contacting investors and solicit proposals Analyze investor proposal(s) Negotiate the transaction

Fees

Retainer fee Success fee based on sliding scale Reimbursement of out-of-pocket expenses

Other Engagement

Terms

Termination Tail Lock-up Indemnification

37


Understanding The Investor’s Financial Drivers/ Investment Framework

ULI – January 11th, 2011

38

Type of Fund Typical CharacteristicsPREA Unlevered IRRs

Core Well-diversified, low risk/return strategy Traditional asset classes (i.e. office, retail, industrial, multi-family) in

established locations Well occupied and well maintained assets with stable cash flows Generally little or no debt is employed (i.e. up to 30% levered) Income stream represents significant part of expected total return

7.5 – 8.5%

Core-Plus Moderate risk/return strategy Core-type assets, some of which may require some form of value-add

enhancement Assets located in either primary or secondary locations Moderate amount of leverage employed (i.e. up to 55% levered)

8.5 – 10%

Value-Add Moderate to high risk/return strategy Opportunity to add value through operating, re-leasing, and/or

redevelopment Leverage employed is higher (i.e. up to 70% levered) Value appreciation comprises significant part of expected total return

9.5 – 13%

Return Requirements by Investment Strategy

39

Type of Fund Typical CharacteristicsPREA Unlevered IRRs

Opportunistic High risk/return strategy Re-positioning of poorly managed, obsolete, and/or vacant assets Acquisitions of entire companies with portfolios of assets and operating

platforms in-place New-build development or conversion projects International focus pursing opportunities in established and emerging

markets Leverage employed is higher (i.e. over 70% levered)

10 – 13%

Mezzanine/ Debt

Originate loans at terms which are more aggressive than traditional lenders

May contain profit-sharing in addition to higher interest rates and fees charged

Acquire distressed loans from lenders at discount prices (i.e. below par value)

Participate in higher-yielding tranches of mortgages (i.e. non-rated CMBS; first-loss positions)

Generally not adverse to owning the assets in the event such loans default.

Return Requirements by Investment Strategy

40

Returns and Leverage

• Leverage Ratio (LR):– at the time of purchase

• = Acquisition Price/Equity

– thereafter • = Value/Equity

re – required return on levered equity

rp – required return on property without leverage

rd – return on debt (cost of

mortgage debt)

(rp – rd) – risk premium without leverage

LR – leverage ratio

re = rd + LR*(rp – rd)

41

Levered Returns Table

0% 25% 50% 60% 75% 80%7.5% 7.5% 8.3% 10.0% 11.3% 15.0% 17.5%8.0% 8.0% 9.0% 11.0% 12.5% 17.0% 20.0%8.5% 8.5% 9.7% 12.0% 13.8% 19.0% 22.5%9.0% 9.0% 10.3% 13.0% 15.0% 21.0% 25.0%9.5% 9.5% 11.0% 14.0% 16.3% 23.0% 27.5%

10.0% 10.0% 11.7% 15.0% 17.5% 25.0% 30.0%10.5% 10.5% 12.3% 16.0% 18.8% 27.0% 32.5%11.0% 11.0% 13.0% 17.0% 20.0% 29.0% 35.0%11.5% 11.5% 13.7% 18.0% 21.3% 31.0% 37.5%12.0% 12.0% 14.3% 19.0% 22.5% 33.0% 40.0%12.5% 12.5% 15.0% 20.0% 23.8% 35.0% 42.5%13.0% 13.0% 15.7% 21.0% 25.0% 37.0% 45.0%

LTV

Requ

ired

Retu

rn U

nlev

ered

Assumes 5% cost of debt

42

Median IRRs

43

Venture Cash Flow Sharing Arrangements

44

Joint Ventures

• Two types of partners that combine expertise with capital

• Cash flow sharing arrangement made between these two partners

Developer/ Operator/Sponsor Investor

45

Joint Ventures: Cash Flow Sharing• Sharing Cash Flow – Operating Cash Flows

– Typically pari passu or at predetermined percentages• Sharing Cash Flow – Property Sale/Refinance

– Repay any debt– Return of initial investment (return of invested capital remaining)– Remainder Distributed (return on capital)

• Split of Cash Flow (often a waterfall arrangement)• Predetermined portions/percentages• Preferred returns and return hurdles

– Hard Hurdle– Soft Hurdle

• IRR lookback (clawback) or catch-up with soft hurdle

46

Example JV Waterfall Distribution

• First, to repay capital contributions made by each partner (typically 90%/10%) pari passu

• Second, to pay each partner a 9% cumulative annual return on capital

• Remaining proceeds split 50% to Institutional Investor and 50% to Developer/Sponsor

• Target IRR 18% to Capital Investor

47

Hard vs. Soft Hurdles

• The difference between a hard hurdle and a soft hurdle is like the difference between a deductible and a threshold.

Source: Real Estate JV Promote Calculations: Catching up with Soft Hurdles, by Stevens Carey

48

Hard Hurdles• A hard hurdle functions like a deductible:

– Operator would not receive any promote unless and until capital investor were to receive IRR hurdle and then operator would received a predetermined percentage of the incremental cash flow.

– In effect the profit distributions required to achieve the hurdle would be deducted from all profit distributions in determining the portion that is shared by Operator.


49

Soft Hurdles• The soft hurdle is a threshold that must be reached as a condition to

operators retention of any promote: – If the profit distribution is sufficient to achieve the IRR hurdle, then

• The threshold would be reached • Operator would get a predetermined percentage of all profit distributions

– Catch up if preferred returns are met first• In that sense, the soft hurdle would go away

– If the profit distributions are not sufficient to achieve the IRR hurdle, then• The threshold would not be met • Operator would not get a predetermined percentage of all profit distributions • Operator must forfeit distributions (lookback or clawback if preferred returns are

not met first) to the extent necessary to meet the threshold


50

Uncertainty of Soft Hurdles• A hard hurdle always reduces the amount of profit distributions that may

be shared by Operator (if there are profit distributions to share), whereas a soft hurdle is contingent and may not result in any reduction at all.


51

Look back vs. Catch-up• Look-back for Investor: one approach is to give Operator 50% of the profit

distributions from the outset with a so-called “Look-back”:– The parties look back at the end of the deal and to the extent Investor hasn’t

achieved a 9% IRR, Operator must turn over to Investor its promote distributions (in this case, all of Operator’s distributions)

• Catch-up for Operator: another approach is to give Investor 100% of the profit distributions until Investor achieve IRR hurdle, and then give Operator its share with a so-called “Catch-up”:– After Investor achieves a 9% IRR, Operator gets 100% of all subsequent profit

distributions until profit distributions are in 50/50 ratio


52

Return Multiples

53

Net Multiple

• The net multiple return is used by investors to determine how much they have received in cash relative to how much they paid in– It does not take into consideration the timing of

capital call-ups and distributions– It does provide a good indication of fund

performance• Calculated as a Ratio: Total Cash Inflows/Total

Cash Outflows

Source: 2010 Preqin Private Equity Real Estate Review

54

Net Multiple (cont.)

55

Investment Horizon in Years

Assumes capital contribution made at time zero and also assumes 8% cash distributions per year

IRR Multiple Table

3 5 7 108.0% 1.24x 1.40x 1.56x 1.80x

10.0% 1.31x 1.52x 1.75x 2.12x12.0% 1.37x 1.65x 1.96x 2.50x15.0% 1.48x 1.87x 2.33x 3.22x17.5% 1.58x 2.07x 2.70x 3.98x20.0% 1.68x 2.29x 3.11x 4.92x25.0% 1.89x 2.80x 4.12x 7.45x30.0% 2.12x 3.39x 5.43x 11.18x35.0% 2.37x 4.09x 7.09x 16.54x40.0% 2.64x 4.90x 9.19x 24.14x

IRR

56

2. Sponsor receives a 30% promote until a 15% IRR hurdle


1. Cash flow split pari passu until an IRR of 10% is generated

4. Sponsor receives a 50% promote thereafter

Cash Flow Waterfall

Period Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Annual Net Cash Flow (15,000,000) 600,000 700,000 800,000 900,000 40,750,000

1. All cash flow split pari passu until each Member has reached a 10.0% IRRJV Investor (13,500,000) 540,000 630,000 720,000 810,000 18,197,242 90.0% of cash flowJV Sponsor (1,500,000) 60,000 70,000 80,000 90,000 2,021,916 10.0% of cash flow

2. JV Sponsor receives a 30.0% promoted interest until the JV Investor receives a 15.0% IRRJV Investor - - - - - 4,922,157 63.0% of cash flowJV Sponsor - - - - - 546,906 JV Sponsor 1st Promote- 30.0% - - - - - 2,343,884

3. JV Sponsor receives a 40.0% promoted interest until the JV Investor receives a 20.0% IRRJV Investor - - - - - 5,900,233 54.0% of cash flowJV Sponsor - - - - - 655,582 JV Sponsor 2nd Promote- 40.0% - - - - - 4,370,543

4. JV Sponsor receives a 50.0% promoted interest on all remaining cash flowJV Investor - - - - - 806,192 45.0% of cash flowJV Sponsor - - - - - 89,576 JV Sponsor 3rd Promote- 50.0% - - - - - 895,769

Total DistributionsJV Investor (13,500,000) 540,000 630,000 720,000 810,000 29,825,824

IRR: 20.6%

JV Sponsor (1,500,000) 60,000 70,000 80,000 90,000 10,924,176

IRR: 51.5%

37.0% of cash flow

46.0% of cash flow

55.0% of cash flow

JV Waterfall Examples• Typical JV Promote Structure: The Sponsor invests a small portion of the equity, with a Limited Partner

(“LP”) providing the balance. The Sponsor is generally entitled to received performance incentives in the form of promotes (a greater portion of the cash flow) upon achieving certain return hurdles

57


3. Sponsor receives a 40% promote until a 20% IRR and a 2.50x equity multiple

1. Cash flow split pari passu until an IRR of 10% is generated

4. Sponsor receives a 50% promote thereafter

Cash Flow Waterfall



1. All cash flow split pari passu until each Member has reached a 10.0% IRRJV Investor (13,500,000) 540,000 630,000 720,000 810,000 18,197,242 90.0% of cash flowJV Sponsor (1,500,000) 60,000 70,000 80,000 90,000 2,021,916 10.0% of cash flow

2. JV Sponsor receives a 30.0% promoted interest until the JV Investor receives a 15.0% IRRJV Investor - - - - - 4,922,157 63.0% of cash flowJV Sponsor - - - - - 546,906 JV Sponsor 1st Promote- 30.0% - - - - - 2,343,884

3. JV Sponsor receives a 40.0% promoted interest until the JV Investor receives a 20.0% IRR and a minimum 2.50x equity multipleJV Investor - - - - - 6,867,663 54.0% of cash flowJV Sponsor - - - - - 763,074 JV Sponsor 2nd Promote- 40.0% / 2.50x equity multiple- - - - - 5,087,158

4. JV Sponsor receives a 50.0% promoted interest on all remaining cash flowJV Investor - - - - - - 45.0% of cash flowJV Sponsor - - - - - - JV Sponsor 3rd Promote- 50.0% - - - - - -


IRR: 20.7%

JV Sponsor (1,500,000) 60,000 70,000 80,000 90,000 10,762,938

IRR: 51.0%

37.0% of cash flow

46.0% of cash flow

55.0% of cash flow

JV Waterfall Examples• JV Promote Structure with Minimum Equity Multiple Hurdle: The scenario below is similar to the previous

structure, with an added return hurdle. The investment must generate a minimum equity multiple for the LP before the second promote can be paid out to the Sponsor

58

2. Sponsor gets a catch up (receives all cash flow) until a 12% IRR is reached

3. All remaining cash flow is split 50%/50%

1. JV Investor receives a 12% preferred return

Cash Flow Waterfall



1. JV Investor receives all cash flow until a 12.0% IRRJV Investor (13,500,000) 600,000 700,000 800,000 900,000 19,792,141 100.0% of cash flowJV Sponsor (1,500,000) - - - - - 0.0% of cash flow

2. JV Sponsor receives all cash flow until a 12.0% IRRJV Investor - - - - - - 0.0% of cash flowJV Sponsor - - - - - 2,642,214 100.0% of cash flow

3. All remaining cash flow is split 50.0% / 50.0%JV Investor - - - - - 9,157,822 100.0% of cash flowJV Sponsor - - - - - 9,157,822 0.0% of cash flow


IRR: 20.0%

JV Sponsor (1,500,000) - - - - 11,800,037

IRR: 51.1%

JV Waterfall Examples• Preferred Return: In the scenario below, the Sponsor’s return is subordinated to the LP’s (the Sponsor does

not receive any cash flow until the investment generates a set return for the LP). After this hurdle is achieved, the Sponsor may be entitled to a catch up payment sufficient to generate the return already received by the LP. Afterwards there may be additional promotes or a set cash flow split

59

2. All remaining cash flow is split 65%/35% in favor of the Sponsor

1. Cash flow split pari passu until all invested capital is returned

Cash Flow Waterfall



1. All cash flow split pari passu until invested capital is returnedJV Investor (13,500,000) 540,000 630,000 720,000 810,000 10,800,000 90.0% of cash flowJV Sponsor (1,500,000) 60,000 70,000 80,000 90,000 1,200,000 10.0% of cash flow

2. All remaining cash flow is split 65.0%/35.0% in favor of the JV SponsorJV Investor - - - - - 18,687,500 65.0% of cash flowJV Sponsor - - - - - 10,062,500 35.0% of cash flow


IRR: 20.4%

JV Sponsor (1,500,000) 60,000 70,000 80,000 90,000 11,262,500

IRR: 52.4%

JV Waterfall Examples• Cash Flow Split after Return of Capital: In this scenario, once the total invested capital has been returned

to the Sponsor and the LP (on a pari passu basis), all of the profits are distributed based on a pre-determined split

60

Return Summary

JV Promote StructureJV Promote Structure with

min. Equity MultiplePreferred Return with Catch

up to SponsorProfit Split After Return of

Capital

JV Investor ReturnsNet Profit 19,025,824 19,187,062 18,449,963 18,687,500 Levered IRR 20.62% 20.74% 20.03% 20.37%Equity Multiple 2.41x 2.42x 2.37x 2.38xProfit % Split 66.18% 66.74% 64.17% 65.00%

JV Sponsor ReturnsNet Profit 9,724,176 9,562,938 10,300,037 10,062,500 Levered IRR 51.48% 51.05% 51.06% 52.41%Equity Multiple 7.48x 7.38x 7.87x 7.71xProfit % Split 33.82% 33.26% 35.83% 35.00%

JV Waterfall Examples• Each scenario produces similar returns

– IRRs ranging from 20.03% to 20.74% for the Investor and 51.05% and 52.41% for the Sponsor– Equity Multiples ranging from 2.37x and 2.42x for the Investor and 7.38x and 7.87x for the Sponsor– Profit ranging from $18.45m to $19.19m for the Investor and $9.56m and $10.30m for the Sponsor

61

More on Commingled Funds

62

Commingled Fund Customary Terms

• Minimum investment commitment in these funds is at least $1 million• A typical return target for these funds is a 20% IRR and a 2x equity

multiple over the life of the investment – However in light of the financial crisis, these returns have crept down

significantly• Fund sponsors hope to raise new funds seamlessly and are generally

permitted to raise a new fund after 85% of the fund’s capital is invested • The sponsor also invests its capital in the fund• The amount invested by the sponsor can range from 1-3% for first time

fund managers, to 25-50% of total equity commitments

63


• A return waterfall details how cash is split between the investors and the sponsor

• These preferred returns range from 8 to 10% • If the returns exceed the preferred return than these additional profits are

split 80/20 – With 80% of the profits going to the investor– The 20% of the profits given to the sponsor is called a carried interest or

promote• In addition to their promote, fund sponsors also receive an annual

management fee

64


• Management fees – an annual payment made by the investors in the fund to the fund's manager to pay for the private equity firm's investment operations (typically .50% to 2% of the committed capital of the fund)

• Management Fees are fees paid to the fund’s manager based on a variety of measures which include: – Total equity commitment– Total equity invested to date – Gross or Net asset value – Percentage of income– Or combinations thereof

65

Carried Interest or Promote• Carried interest - a share of the profits of the fund's investments (typically

up to 20%), paid to the private equity fund’s management company as a performance incentive (also called a promote). The remaining 80% of the profits are paid to the fund's investors

• Hurdle Rate or preferred return– a minimum rate of return (e.g. 8 - 10%) which must be achieved before the fund manager can receive any carried interest payments

• Fees are calculated based on a set hurdle rate (IRR) and often include claw back provisions if funds hurdle rate is not achieved

commercial re private equity understand and navigating the options workshop primer

Documents

commercial real estate

active capital providers

potential investors

fit allcertain investors

investment decisions

current investor appetite

specific investment

maintained assets