Questions on Preferred Rate of Return in Syndication Deals

[Brian Lucier]

Hello BP Multi-Family Peers,

Quite a few books ago I read @JoeFairless "The Best Ever Apartment Syndication Book". Fabulous book with step-by-step checklists and procedures to create a syndication business from the ground up. Took a lot of notes and enjoyed the journey. Well on my way down that road but there was a nugget from the book I have still yet to crack open.

There was a specific topic in the book that I researched from cover to cover and cannot seem to wrap my head around. I finally got around to posting my question here on the Multi-Family Forum and would love to get some guidance and clarification.

I understand the concept of a "Preferred Rate of Return" to the Limited Partners. This is a pre-designated rate of return the LP investors will receive before any other distributions will be paid to the General Partners. This seems like a great perk to entice LP investors into the deal and in alignment with our goals to protect our their investment in the deal, and make more money.

What is unclear to me is the actual "terms" of the Preferred Rate of Return? Could not seem to find clarification for the length of the term in the book? A few questions to help clear up my confusion...

Let's go with an 8% preferred rate of return for a simple example.

On a $100K investment this would represent an $80,000 PRR to the LPs before any other distributions are allowed. But what is the exact length of time for this term? Is this in effect until the entire $80,000 is paid in full? For example, if the distribution was $8,000 a month (or whatever the distribution schedule predetermined), it would take 10 months to pay back the PRR. Then, does is the PRR satisfied and the term end?

Is that how the term PRR works?

Again, are the distributions paid to accumulate until the PRR is reached, then the normal GP/LP split kicks in? Or does the term of the PRR work differently? Other online definitions imply per annum PRR. Does this mean the 8% has to be achieved year after year, then the normal GP/LP split resets each year? 

We currently are not offering PRR in our deals, but it seems it would be an attractive option to our investors. Can anyone shed some light on this and help our investors make more money?

Greatly appreciate your help in advance!!

[Arn Cenedella]

@Brian Lucier

There’s a math error in your question. 
8% of $100,000 is $8,000 a year not $80,000. 

The preferred return is paid for as long as the capital is in the deal. 

So if it is a 3 year deal the total pref paid on $100,000 investment is $8,000 per year times 3 years equals $24,000. 

If it is a 5 year deal the total pref paid on $100,000 is $8,000 a year times 5 or $40,000. 

The pref is paid on the capital invested for as long as that capital is in the deal. 

The other thing to Note is that often the pref is not paid current. Any unpaid pref is caught up at the end when the deal is sold or property refinanced. 

So if property produces enough enough to pay 5% current the unpaid 3% is caught up at the end of the deal. 

Hope this helps. 

Arn