What Is The Real Estate Sponsor Promote?
In the real estate private equity world, there’s a key concept called the “sponsor promote.” This is a fancy term for the extra profits the sponsor gets after reaching a certain return level in a deal.
If you’re not sure what a real estate sponsor or syndicator is, then check out this article: What Is a Syndicator In a Real Estate Syndication?
The promote is similar to “carried interest” in other investment types.
Understanding the promote structure is important for both sponsors and investors (limited partners), as it can significantly impact the distribution of profits and returns on investment.
It’s commonly structured as a “waterfall” model, where cash flows from the project are distributed among stakeholders in sequential stages. This ensures that the limited partners (LPs) or investors receive their preferred returns first before the sponsor begins to receive a promoted share of the profits.
If all of this seems confusing to you, then you’re not alone. In this article, we’ll discuss what you need to know about the real estate promote.
- A real estate promote is a sponsor’s disproportionate share of profits in a real estate investment above a specific return threshold.
- Understanding the promote structure is essential for both sponsors and investors to determine profit distribution and return on investment.
- Promotes are typically structured like a “waterfall,” ensuring that investors receive their preferred returns before the sponsor begins to receive their promote share.
What Is a Real Estate Syndicator (Sponsor)?
Before we discuss what a real estate sponsor promote is, I think we should start with first defining what is a real estate sponsor.
A real estate sponsor or syndicator is an individual or group that brings together multiple investors to pool their capital to invest in a large real estate project (real estate syndication) like RV parks.
The primary responsibility of a syndicator is to identify and secure investment properties. They conduct extensive research and due diligence on potential acquisitions, ensuring they align with the business plan and overall investment strategy. Their expertise extends beyond property selection, encompassing negotiations with sellers, arranging financing, and closing the deal.
Aside from acquisition, a real estate syndicator is also responsible for property and asset management. They develop and oversee a comprehensive strategy encompassing everything from day-to-day administration to long-term growth.
This may include:
- tenant relations
- property maintenance
- financial management
- ensuring compliance with local regulations
What is a Real Estate Syndication?
As previously mentioned, a real estate syndication is a method of pooling resources and capital from multiple investors to participate in real estate projects they would not be able to tackle individually.
This strategy is prevalent in commercial real estate investing, where large-scale properties and projects require significant capital and resources.
If you want to know more about my favorite real estate investment, check out this video:
What is the Promote in a Real Estate Investment?
The promote is a performance-based incentive in a real estate deal that motivates the sponsors to strive for success of a project. In other industries, this might be called “carried interest.”
This structure typically involves a tiered distribution system, often called a “waterfall” (even though TLC told us NOT to chase any waterfalls!)
In a waterfall structure, the cash flow generated by the investment is distributed among the parties involved. The priority of distributions typically follows this order:
- Return of capital to the investors (Limited Partners or LPs);
- Preferred return to the investors;
- Catch-up distribution to the real estate sponsors;
- The remaining profits are divided between the investors and sponsors based on an agreed-upon percentage.
For example, the promote could be structured as follows:
How Real Estate Sponsors Make Money
Due to the sponsor’s significant role in a project (i.e., identifying investment opportunities, conducting due diligence, arranging financing, and overseeing property management), they typically receive fees.
- acquisition fees
- incentive fee
- development fee
- asset management fees
- disposition fees
- the promote
The promote serves as an added incentive, as it becomes more valuable when the investment performs better, aligning the interests of both the GPs and LPs.
What is promoted interest?
Promoted interest, the share of profits received by the sponsor, increases as the investment reaches higher levels of return.
This encourages the GPs to strive for the highest possible returns, benefiting both the sponsors and the investors.
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Investment Strategies for Promote
What is the Equity Waterfall?
An equity waterfall is a distribution method for allocating profits between the real estate sponsor and equity investors. This structure is essential in organizing the payout scheme based on different tiers of investment returns.
The first component of the equity waterfall is the preferred return hurdle. This threshold, often expressed as a percentage, is the minimum required return for equity investors before the sponsor starts receiving their promote.
The preferred return hurdle works as a safeguard for your investment and serves to align the interests of both the sponsor and equity investors.
For example, most of our passive investors for our RV Park syndications receive a preferred return hurdle set at 8%:
- If the project generates a 10% internal rate of return (IRR), the first 8% goes to equity investors.
- The remaining 2% is then distributed among the sponsor and equity investors according to the agreed-upon promote structure.
Determining Carried Interest
Carried interest is also known as the sponsor’s share of profits.
A typical promote consists of tiers, with each tier having a specified distribution of profits between the sponsor and equity investors. The use of carried interest aligns the interests of both parties, as the sponsor will earn their promote only after achieving certain performance targets.
For instance, a basic real estate investment fund promote structure may have three tiers:
- First, the sponsor receives an acquisition fee, which is a predetermined amount payable from the fund once an investment is acquired.
- Next, the sponsor earns their promote only after equity investors have received their preferred return hurdle (e.g., 8%).
- Lastly, the sponsor and equity investors split the remaining profits according to a predetermined ratio (e.g., 80% to equity investors and 20% to the sponsor).
Key Terms in Transaction Deals
Here is a list of some of the key terms you should become familiar with:
|Method of splitting profits among partners, allowing for uneven distribution through tiers or pools.
|Sponsor’s share of profits in a deal, generally above a predetermined return threshold.
|Minimum rate of return required for the sponsor to receive a promote or carried interest.
|Allocation of profits between the sponsor and other investors, often determined by the waterfall structure.
|Non-binding documents outlining the framework of a partnership agreement.
|Private Equity Deal
|Investment deal involving private equity in real estate properties.
|Legally binding document governing the terms of a joint venture.
|Fee earned by the sponsor based on investment performance.
|Hierarchy of capital sources in an investment, representing risk and profit-sharing order.
Stakeholder Interests and Returns
Preferred Return vs. Excess Profits
As a passive investor in a real estate syndication, you’ll encounter two primary concepts that may impact your returns:
- preferred return
- excess profits
The preferred return is a predefined percentage of profits allocated to preferred investors, typically based on their initial capital contributions.
This return is paid out before any other profits are divided among the various stakeholders.
On the other hand, excess profits represent any additional income generated by the investment after the preferred return is paid. These profits are usually split between the fund sponsor and the passive investors according to predetermined ratios.
This is where the “promote” comes into play, which is an agreement to allocate a portion of excess profits to the fund sponsor as additional compensation for their management and expertise.
|Predefined profit percentage allocated to preferred investors
|Additional income generated after preferred return is paid
Hurdle Rates and Return Expectations
The hurdle rate is a predetermined target return that passive investors are expected to achieve before the fund sponsor begins receiving their promote.
To illustrate this, let’s assume a cash flow distribution structure with an 8% hurdle rate.
Here’s a breakdown of the distribution structure:
- All cash flow goes to passive investors until they receive their 8% preferred return.
- Profits beyond the 8% preferred return get split, with maybe 70% going to the passive investors and 30% to the sponsor (the promote agreement determines this ratio).
Waterfall Calculation Example
To help you understand this concept, let’s take a look at an example of a waterfall with a simple split and a 7% preferred return:
Dr. BA invested in an RV Park syndication with three other doctors and has an annual cash flow of $100,000.
In this example, the four limited partners take 7% off the top. So $7,000 goes to each one, paid out every quarter ($1750/quarter).
This leaves $93,000 to be distributed with a 70/30 split between Dr. BA and his three colleagues and the sponsor.
In this case, the sponsor would take 30% and the passive investors 70% of the remaining $93,000.
Frequently Asked Questions
How can real estate promotion companies enhance property visibility?
Real estate promotion companies can enhance property visibility by adopting various marketing strategies, such as search engine optimization, social media marketing, and content marketing. These strategies help to reach a wide audience, showcase property listings, and keep potential buyers engaged. Additionally, virtual tours, professional photography, and well-crafted descriptions can improve the overall presentation of the property.
What is a real estate sponsor promote and how does it work in the context of fund sponsors and their own capital?
A Real Estate Sponsor Promote is a key term in real estate finance, especially relevant to fund sponsors. It refers to the additional profits that sponsors (typically real estate agents or companies) earn above their own capital investment. In a typical arrangement, fund sponsors invest their own capital into a project and are entitled to a profits interest. The promote is often structured in tiers, with the first tier ensuring the initial investors receive their expected returns. Only after meeting these returns do the sponsors claim their promote fees, which are additional profits earned from the investment.
What models are commonly used for structuring real estate promotions?
Real estate promotions are typically structured using a waterfall model, which divides profits among investors and sponsors based on a series of return thresholds. The promote, which is the sponsor’s share of the profits, is tiered based on the internal rate of return (IRR) achieved by the investors. The promote increases as the return thresholds are surpassed, incentivizing the sponsor to maximize the project’s success.
How do you calculate promote in real estate using Excel?
To calculate the promote in real estate using Excel, follow these steps:
- Create a table that outlines the project cash flows, including property income, expenses, and projected sale proceeds.
- Calculate the internal rate of return (IRR) for each investor based on their investments and expected share of profits.
- Define the waterfall tiers (e.g., IRR thresholds) and the corresponding promote percentages to be received by the sponsor.
- Use Excel formulas to allocate the profits among investors and the sponsor based on IRR and waterfall tiers.
- Confirm that the total profits allocated to investors and the sponsor equal the total project profits.
What constitutes a real estate sponsor’s role in project promotion?
A real estate sponsor’s role in project promotion involves managing the property investment, overseeing the project’s development, and ensuring the project’s success. This includes identifying potential investment opportunities, securing financing, handling legal and regulatory requirements, and coordinating with property management teams. The sponsor also works to maximize returns by strategically promoting the property, negotiating favorable deal terms for investors, and making informed decisions on leasing and property management.
How does a double promote structure impact real estate investments?
A double promote structure in real estate investments introduces a second tier of promote, shared between the general partner (GP) and limited partner (LP). This results in a more complex waterfall model, with multiple tiers of priority profits and promotes for both partners. The double promote structure can benefit the LP by providing an additional layer of risk-sharing and can incentivize the GP to accomplish project milestones that exceed investor expectations. However, this structure can also lead to conflicts of interest and misaligned incentives if not carefully negotiated and managed.