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In multifamily real estate investments, the IRR-based waterfall structure is a common method for distributing profits between General Partners (GPs) and Limited Partners (LPs).

This structure aligns interests and rewards performance while protecting LP capital.

Here's a typical breakdown:

1. Preferred Return: LPs then receive all distributions until they achieve their preferred return (often 6-8% IRR).

2. Return of Capital: LPs receive their initial investment back.

3. Promote/Carried Interest: After preferred return is met, remaining profits are split according to predetermined percentages (e.g., 80/20 LP/GP).

In our Value-Add Model, you will see the waterfall hurdles organized as follows.

The first hurdle is set as the preferred return, which means the limited partners must receive an 8% IRR before the general partners earn a promote.

The second hurdle states that after the LP receives an 8% and up to a 15% IRR, those profits will be split with 70% / 30% to the LP and GP respectively.

And so on...

Important: In an IRR-based waterfall, this does not mean 8% on their capital.

I had an investor who purchased our Value-Add Model ask me: Why does the model show the general partners not getting paid until the sale year?

My response: This is exactly how a true IRR based waterfall works.

Take a look at this example:

It's crucial to note that GPs usually don't earn their promote until the property is sold or refinanced. This is because the preferred return to LPs is often not met through ongoing cash flow alone. The sale event typically provides the bulk of returns, allowing the waterfall to "catch up" and flow through all tiers.

As you can see below, the LP IRR only turns positive after a full return of capital has been returned (which usually only happens at a sale or refi).

In this example, if the LP had a preferred return of 5%, it would only be met in Year 3.

This structure incentivizes GPs to maximize property performance and value, as their promote is directly tied to exceeding the preferred return hurdle.

For LPs, it offers downside protection through the preferred return while still allowing for significant upside potential.

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