Promoted interest with annual distributions workout. In this problem, we're going to calculate the total distributions from a real estate transaction to the LPs and the GPs. The LP and GP investment will be a pari-passu investment and there will be a preferred hurdle rate offered to the investors for that investment and in pari-passu meaning that the investments are treated the same until that preferred hurdle is met. This transaction also has annual distributions from the real estate asset, which is not uncommon. The preferred return is 12%. That's the hurdle that must be met before any additional profit sharing can be calculated. The pro rata investment allocation is 85/15 LP to GP, and the GP promote is 25%. So they're gonna get 25% of the LPs profits once we get to that point. It's a 4 million acquisition price, 1 million of equity, 3 million of debt, and the sale price will be be 5 million. The annual distributions are 50, 70 and 100. So the first thing that we're going to do is calculate our entry investment amounts and that's gonna be equal to the equity value of 1 million times the pro rata invested amounts of 85 and 15. And that gets us to the million total. So that's the money that goes in in year zero. Now in year one, they begin to see cash flows, and the cash flows are equal to the 50, the 70 and the 100. So what we have to start doing is since the cash flows are being distributed, we have to start keeping track of where we are with the hurdle that each of these investments is entitled to. The hurdle is going to be the 12% on top of the capital invested annualized over three years. So what we're gonna do to keep track of it is we're gonna calculate that annual return that they are in fact entitled to and that'll just help us track sort of what they're owed versus what they're actually getting and then what they're still entitled to at the end. So the annual preferred return for the LP is going to be equal to the opposite of the 850 times one plus the 12% raised to the first year that we are in. And what that tells me is if I invested 850 at 12%, how much is the whole thing worth at the end of year one? I don't wanna deal with the return of capital yet. I will deal with that later. I just want to know what the actual profit on that amount is. So I'm gonna back out the capital invested and that's my the amount for the LP in terms of what they are owed in year one. So if I anchor the original investment and then I anchor the return, I can go ahead and copy this over. And what that tells me in year two is the cumulative amount of the hurdle. And so because I wanna look at this really on an annualized basis, it's just easier. I'm gonna go ahead and I'm gonna back out the previous year's return and then that leaves me with just the year two amount. And I'll do the same thing for year three. Here, I'm gonna back out the first year's amount. So what this tells me again is the sum of these three and the original investment represent the amount that the limited partners would be owed on a three year annualizing 12% preferred return. And we can check that simply by taking that 850 and multiplying it by one plus the hurdle raised to the three for third year.

And that is the exact same amount. So all we've done is break this down on an annual basis. So I'll delete that, just shows our numbers are working, and I'm gonna put my formulas out here. But this formula does change each year. So you might wanna look if you wanna see the formula up close, you might wanna look at the full file, full version of the file.

So now what I need to do is the same exact thing for the GP. That's going to be the original amount anchored times one plus the preferred return anchored raised to the first year in this case plus the original investment anchored. If I copy that into year two, I simply need to go back out the previous year. If I copy that into year three, I need to back out the two years prior.

And that tells me again what I am entitled to with this 12% preferred return.

So now we can actually turn our attention to what is in fact being paid out to us. So what's being paid out to us as the investors is the 50,000 broken down in the pro rata share because remember at this point we're still pari-passu because we haven't met that hurdle yet. And this is the whole point of keeping track of this is that if we're going to share these profits pari-passu we need to know where we are in the calculation of the hurdle. So it's going to be equal to the 50,000 times for the LP, the 85% pro rata share.

And what I'll do here is I will anchor column of the pro rata amount so I can copy this over to show my distributions by pro rata invested amount for the LP and then as well for the DP. Now, because these are actual distributions, I think what I'd like to do is show them as negative. So I'm actually gonna go ahead and show these as negatives 'cause this is cash that is at this point kind of coming it's kind of coming out of the the calculation here because it's gonna help us calculate the carry forwards. So I do go back and forth between positive and negative a lot in the waterfalls and it just really depends on what I'm trying to show. I just try to be consistent and obviously there's a lot of different ways to set these up, but these are cash distributions. When it comes time to actually count the cash at the end they will be positive. But for right now for this calculation they're going to be negative because what I'm showing here is this is the amount the 102 for the LP is what they were in fact sort of contractually guaranteed. To date, they've only really been able to collect on 42.5 of that. So what's left is actually a carry forward amount that they're still owed on the hurdle. And the carry forward amount must be ultimately satisfied again before we can get into the promotes and other profit sharing. So I'm going to take the sum of these two amounts and that's going to be the carry forward amount in year one. And it's gonna be the same thing for the GP. I'm gonna track this cumulatively so that by the time I get to year three I know exactly what I am owed. So I will copy this formula into the next year and that again tells me the amount that I'm short in year two, but I also want to go and add year one to that as well. So now I'm just taking the previous amount that I was owed and adding it to any new amount that I'm owed. And the same thing here. I only have to go and add the previous year because that previous year already includes two years prior. So that gives me, as of year three the amount that I am still owed as a result of these distributions and the hurdle rate that I was promised as an investor.

And you know we are in still in year three here, right? So let's now turn our attention to the asset sale and then we'll come back to these distributions and see how they play into the total return. So the asset is sold in year three for 5 million. We have to pay off some debt, and I'm assuming that we didn't actually pay down any debt just to be simple. That leaves us with 2 million of profit to share in year three.

So in terms of how the waterfall is going to work here, we kind of know...we know what we need to know about what we're owed from our calculations above. So the first thing we need to do is we need to get the return of capital out of the way because remember we backed that out of those calculations above and that would start to get complicated again if this were, you know, a very kind of thin deal profit wise and perhaps you know, the capital didn't get returned.

But just to kind of keep it simple for teaching purposes, we're going to now pay back the 850 and the 150 and that tells us sort of what the profits are that need to now be split. So this is kind of our first waterfall. So the first thing we need to do is deal with the carry forward.

So at this point we've already, we've been paid some cash based on year one, two and three distributions. But despite that cash being paid to us and that cash amount is in this, these two rows here, we're still owed cumulatively 157,188 for the LP and 27, 739 for the GP in order for us to make our 12% preferred hurdle. So I need to take that money out of the profits first. So I'm going to go ahead and link to the 157, 188 as well as the 27,739.

And I have to make this a negative to show that it is cash coming out of the waterfall being paid out. And now I have my profit that I can start dealing with the promote. So in at this point in time and we'll see this further down, we've paid the annual distributions they've counted toward the hurdle. We've gone back and we've paid back what we still needed to pay back to meet the 12% hurdle which is the 184,928 sum of these two numbers. And now that I've satisfied the hurdle on a pari-passu basis I have profits that I can begin to deal with the promote. So again, the promotes gonna work at that... they're gonna get 25% of the LPs share. The LPs share is 85% of the profits. So the first thing that we're gonna do is get the GPs 15% of the profits out of the way. And I'll do that by taking the 815, 072 and multiplying it by the 15% pro rata. And that tells me again what the GP has to be paid. So I get that out of the way. And now what I can do here is I can actually calculate the promoted interest and the promoted interest is what's left 'cause that's the 85%. So that's the sum of these two figures times the promote of 25%, and I will flip that around to make it negative as well. So here we have the GP getting 25% of the remaining profits and the remaining profits are 692, 811.2.

That now leaves us for the LP, the 519,608, and they are entitled to all of this that's gonna be equal to the 75% of the LPs profit share times the net of the profits and the GPS pro rata share, which is the same amount we have left. And that gives us zero remaining profit. So I will put my formulas here off to the right so we can see them.

And again, just to go over this again, we had a million in profit. We had to go back and make sure that we fulfilled the hurdle rate that this is the amount that had not yet been paid out through annual distribution. So we had to fulfill that. That left us with 815, 072. We took the pro rata share for the GP out. The GP then arranged to get an additional 25% of the LPs profits as well. So now what's left, the GP gets 25% of which is the 173,202. And what's left of that is all gonna go to the LP. That's 75% of the profit, less the GP pro rata interest.

And now we can look at the total distributions for the LP and the GP. And this is going to be, again, we need to make sure that we've included everything here including the annual distribution. So for the year zero, I'm just gonna go back and link to my capital invested. This will give me a nice table to use for the IRRs. And then in terms of the distributions in years one two we can go up and link to the actual cash distributions in row 36 and 37. Those are going to be positive here for both years one and two. And now we need to for year three, we don't wanna forget about the cash distribution from year three, but we've also got all the cash flows from the sale of the asset. So we've gotta just kind of go cell by cell and make sure we get them all. So we're gonna take the opposite of the sum of the LP pro rata interest at 75%.

That's the final waterfall distribution as well as the LP carry forward which they were owed under the hurdle return provision. We also need to get their capital back that was the 850 of original capital. And then we also need to go up here and get that last distribution, which is 85. And that gives us a total LP distribution of 1,611,7970.2.

We can do the same thing for the GP. We'll start with their promoted interest. We'll then get their 15% pro rata interest. We'll get their carry forward, what they were owed. We'll get their return of capital, what they invested and then we'll go up and get their last distribution. If we look at the sum of these three, it's 2,220 and that's going to match the sum of the 220 of the distributions plus the 2 million of the profit.

So 2,220,000 is our check in effect that tells us that we've distributed the right amount of money. And now calculating the IRRs will be very easy 'cause we have this nice table, and they'll be nice and fat 'cause of the high profits and annual distributions as well. So we'll take the IRR first for the LP. We'll take it for the GP and then we'll take the overall.

And then we'll take the multiple of money which is going to be the sum of all of the distributions over the initial investment.

And that has to be flipped around to be positive, and we'll go ahead and copy that down as well. And that shows our MoMs for cash on cash for the three different groups. And then we'll look at the splits. And the splits here they're gonna be calculated a slightly different way because what we have to do here is we have to take the sum of the sum of all the distributions for each group over the sum of all the distributions for the total deal. And so it's the top three distributions over the bottom three distributions. And that gives us a 77.2% split for the LP. And we can do the same thing for the GP and that should give us a hundred.

So slightly more complicated but definitely something that is done quite frequently in real estate given the ability of these kinds of assets to generate yearly cash flows. It's one of the reasons why investment in real estate is so liquid and you know, such a you know an in-demand thing because of the ability of these assets to throw off yearly cash.