Today, we'll be delving into the realm of real estate fund mathematics. Our main focus will be on GP fees and how they flow through to the waterfall. I've already provided a rough sketch, and we'll now go through the calculations and discuss the process. For more real estate waterfall models, navigate to the real estate tab at the top.
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Now, let's dive into the model itself. Here, we have a basic real estate model that includes rental income, operating expenses, net operating income, and the possibility of debt service if a loan is acquired for acquisition or development purposes. We'll simplify things by focusing on GP fees and their impact on the cash flow, which we'll examine at the bottom.
In real estate syndication deals, the structure can vary significantly. However, in this demonstration, we're illustrating a scenario where the GP, or the sponsor of the fund, manages all operations and takes various fees such as acquisition and underwriting fees, as well as assets under management fees and exit fees. It's crucial to understand that these fees, regardless of their nature, will always affect the project's cash flow before determining the contributions between the LP and GP.
Let's analyze the cash flow step by step. We start by adding rental income, subtracting operating expenses to calculate the net operating income (NOI). Next, we subtract debt service and add debt proceeds. Afterwards, we subtract the acquisition fee, followed by other fees specific to the project, such as disposition fees and the purchase price. By performing these calculations, we arrive at the project cash flow.
Now, we need to determine how the profit and cash flow will be distributed among the LP and GP. Sometimes, separate agreements govern the distribution of profits during the exit compared to regular cash flow. These agreements may include preferred returns, hurdle rates, and other elements. In this particular structure, the LP is responsible for contributing 100% of the required investment and will receive 80% of any future cash flows. To keep things simple, the GP will receive the remaining 20%. It's worth noting that the GP will also receive fee income from the project.
To ensure accuracy and avoid double counting, a sanity check is necessary. By comparing the LP cash flow, GP cash flow, and zeroing out the fee income, we verify that the numbers match. In other words, the LP's and GP's cash flows, excluding fee income, should align with the project cash flow. This confirms that no double counting occurs.
In some cases, the GP may contribute a portion of the initial investment, let's say 5% or 10%. In such instances, we still calculate the total cash flow, but the GP's contribution is deducted accordingly. However, the GP's fee income offsets this contribution a bit and could mean no actual cash invested when you net it out. Again, the sanity check helps confirm that the numbers remain accurate.
That concludes today's presentation. Whether you're involved in real estate syndication as an LP or GP, it's important to understand that this structure is not the only way to do it. However, it is a commonly observed deal structure when building logic for clients. Each individual or organization may adopt different approaches, but when it comes to fees, they are typically deducted from the project and accounted for as fee income for the GP. It's unlikely that fees would be handled differently. Although waterfall structures can be intricate, considering factors such as preferred returns and hurdle rates, we have focused solely on the flow of fees through the fund in this discussion.
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I've recently build a preferred return template that has multiple GP catch-up options.
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