When people are thinking about investing in private real estate, they often are confused about how real estate deals work from a financial perspective. In this blog we’ll talk about how real estate syndications are structured and provide an overview of all the major components that an investor should be familiar with.
Before we get started, my name is Logan Moore.
I’m a due diligence analyst for private real estate transactions. I work with financial advisors, family offices, and high net worth individuals to help them identify alternative investments that align with their values. For a couple of past interviews I did on the topic of evaluating private investments, check out the links below.
And now – let’s get on with it!
How real estate deals are structured
One of the more common ways to invest in private real estate is through a syndication. This is where a group of investors pool their capital together to invest in one real estate asset. A real estate syndication usually is organized as a legal structure called a partnership. In this setup, there are two major categories of investors involved: General Partners and Limited Partners.
- The General Partner (GP) finds a property, buys it, manages it, and receives a cut of the profit for their efforts. While they may co-invest alongside the LPs, their primary contribution to the project is sweat equity.
- Limited Partners (LPs) pool their capital together and invest in the property that the GP bought, in exchange for a pro-rata share of the profit. Limited Partners are typically required to be Accredited Investors in order to participate in the deal.
The financial structure of a real estate deal
Here’s a high-level view of the two parties that are generally involved in a real estate transaction.
- The General Partner is paid a one or more fees (such as asset management, property management, etc.) for looking after the investment, as well as carried interest (“carry”). A common arrangement would be 2% management fee and 20% carry (“two and twenty”).
- The Limited Partners are paid a preferred return (“pref”), which is paid to them before the GP gets their carry. It is usually based on a target IRR (a term we’ll define later).
Wait a second, isn’t it more specific than that?
Well, yes.
Like most things, it’s way more complicated than would appear at first. That is why it is so critical to work with a real estate due diligence analyst, someone who is familiar with the ins and outs of how these deals work.
Let’s take a closer look.
What is a cash flow waterfall?
The distributions from a real estate syndicate are made in a very particular way that is established in the partnership agreement. There is a pecking order dictating how payments are issued, which is commonly referred to as the “cash flow waterfall” or “equity waterfall.”
In a cash flow waterfall, proceeds are paid out in a series of tiers. Each tier has its own guidelines for the hurdle rate, which determines who gets paid, and up until what point they receive payment, etc. Once the hurdle rate for one tier is reached, the payouts are made from that tier. The payouts from any subsequent tiers do not occur until the preceding tier has been paid out.
These are how the tiers in a cash flow waterfall typically go.
- Typically, the first tier is a return of capital. The LPs are paid distributions until they recoup what they put in.
- In the second tier, profits are paid to the LPs according to the stated preferred return rate, which must be met before moving on to the third tier. While it is required for this to be paid before the next tier receives any money, it is not a guaranteed payment and/or may not pay out on a consistent basis, depending on the nature of the underlying project.
- The third tier might include a “sponsor catch up tranche.” At this point, the cash flow waterfall turns to the point of promoted interest, and cash flows start going to the GP until they have received an amount that makes them whole vs. the LPs. For example, if the LPs have received an 8% preferred return, and the GP has a 20% carry, the GP would receive the next 2% of profits (8% to LPs + 2% to GP = 80/20).
- In the fourth tier, the LPs and the GP get paid based on the split amount (i.e. 80% to LPs and 20% to GP using the numbers from above.).
In some cash flow waterfalls, there can be a “claw back” provision that allows the LPs to take back promoted interest from the GP if there is negative performance below the LPs’ preferred return at the time of fund liquidation. (This typically happens when an investment performs well in the early years and distributes excess cash, but thereafter the project experiences a decline in performance with distributions being stopped.) This prevents the LPs from losing capital while the GP gets their interest payment if a deal goes south, but there is a risk that the GP no longer has the cash they were paid.
It’s important to have a clear understanding of the priority of payments before investing. Any indication that the sponsor is not comfortable providing clarity as to how the deal is structured should be seen as a red flag (and may be a violation of legally required disclosure when raising capital). Refer to the prospectus, private placement memorandum, and partnership agreement for this information.
Real estate deal metrics
When evaluating the performance of a real estate deal, we use metrics that express how well the investment performed relative to the capital invested. This can be assessed for both the GP and the LP. Each metric has positives and negatives so a combination of them should be considered instead of relying on a single metric. Here are some of the more common terms you are likely to hear.
Internal Rate of Return (IRR)
The IRR is the internal rate of return which expresses the annual growth rate of the investment, taking the amounts and timing of all cash flows into account. It is the most commonly used return metric for determining when the LP has met certain return thresholds and the GP gets paid its carry. One downside to the IRR calculation is it is extremely sensitive to outsized cash flows and can be manipulated by the timing of a refinance or sale.
Average Annual Return (ARR)
Similar to IRR, the ARR is a return metric that tells you what percentage return your investment capital generated annually. While the IRR accounts for timing of cash flows, the ARR is a simple average of the percentage returns over the total holding period and does not consider when the cash flows were received (i.e. consistently over three years or one lump sum at the end of the three-year holding period).
Multiple on Invested Capital (MOIC)
This is calculated as the total cash you received as payout over the life of an investment divided by the cash you invested. It captures how many times you earned back, or did not earn back, the money you put in. If you got a 3x MOIC, you received three times as much cash out of the deal as what you put in. The downside to MOIC is that it does not account for the time period over which the returns were generated (i.e. did it take two years or ten years to triple your investment). The MOIC is sometimes referred to as the Equity Multiple (EM).
Cash-on-Cash Return
Like the equity multiple, cash-on-cash return compares the cash you received against what you invested. It is calculated annually and is expressed as a percentage rather than a ratio. If you earned a 10% cash-on-cash return, you got back 10% of the cash that year that you initially invested.
Are you looking to get started?
Thanks for reading to the end of this blog about what real estate due diligence is. Did you decide that private real estate investing is worth it for yourself or your clients? If so, let’s set up a time to talk.
I am a due diligence analyst and financial advisor with over eleven years of experience evaluating investments and would be happy to provide insights that can help you get started.
Sources
Ganti, Akhilesh. 22 August, 2025. Investopedia. Distribution Waterfalls in Private Equity: A Comprehensive Guide. https://www.investopedia.com/terms/d/distribution-waterfall.asp
Wall Street Prep. (1 March, 2024). Real Estate Waterfall. https://www.wallstreetprep.com/knowledge/real-estate-waterfall/
