70/30 split in MF Syndication

[Mike Iger]

I was looking at investing in a multi family syndication with a large reputable company.

They are offering investors the following:

min 100k

8% preferred return on all unreturned capital

70% of all CF after paying investors their preferred returns, BUT THAT COUNTS AS A CAPITAL PAYDOWN.

70% of all CF after that.

They were also taking an acquisition fee, a management fee and a fee when they refi or sell btw.

So my question is:

If the CF investors receive after their pref returns is counted as a capital paydown, the investors aren't really gaining. While they are getting their money back sooner, they aren't profiting when the building makes more than 8%.

Is this standard?

[Brian Burke]

It's not unheard of for return of capital to be the next step in a waterfall after the preferred return hurdle is satisfied.  In fact, if the preferred return is 8% IRR, return of capital MUST occur in this tier by definition. You can't reach a positive IRR without returning the capital.

Not all waterfalls specify hurdles to an IRR, however. Many use an annualized return, which sounds like it is the case in your example. In that case, return of capital can happen a number of different ways depending on how the operating agreement specifies. Return of capital could happen first (meaning every distribution is a return of capital until all capital is returned), or it could be after the preferred return hurdle is fully satisfied (and before the profit split tier(s)), or it could be returned only upon a capital event, such as a refinance or sale. The order in which return of capital is specified will have some impact on the investment performance, but probably to a lesser degree than many people would think.

Be sure to review the operating agreement language carefully, because nuances are important.  I haven't seen the agreement but using the structure as you outlined, here is what would normally happen (barring any surprises in the language):  You would receive 100% of all distributions until you have been distributed an 8% annualized return on your investment.  Then, you would receive 70% of all distributions until you have received all of your capital back (but you would still receive 100% of the first few dollars to satisfy the preferred return that has accrued since the last distribution).  Bearing this in mind, the 8% preferred return accrual going forward is less after each distribution because the amount of your unreturned capital reduces with each distribution.  Next, you would receive 70% of all capital thereafter.  During the hold period, it is unlikely that the operating cash flow will return all of your capital, so when the property sells the first thing that happens is the balance of your capital is returned.  Then the rest is split 70/30.  So you would, in fact, receive greater than an 8% return if the property produces asset-level cash flow in excess of 8%.