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Leveraged Breakdowns

Real Estate Private Equity Model 101: The Waterfall

When you hear talk about the waterfall, understand that this simply means how the profits are divided between the parties involved in the deal. Generally this means how profits are split between the GP (General Partner, your employer) and the LPs (limited partners, or investors in the deal). But in some instances, there may be other parties that sneak into the waterfall.

Why is it called a waterfall? The visual image is helpful in understanding what is happening. Imagine a series of buckets stacked in a pyramid. If you poured water into the top bucket until it overflowed, the overflow would begin to fill the buckets below it. Once those buckets were filled, the overflow would continue to the next level down. That’s a waterfall. Cash flow fills the top bucket, and once that bucket is filled, the excess spills over to the next level, and the next level, until the money is gone.

Defining the size of the waterfall buckets is a negotiation between the GP and the LP’s, and will require your best real estate private equity skills to create a model that supports those negotiations.

Say What?!

Perhaps the easiest place to start is to dive right into the lingo. Let’s say you need to build a real estate private equity model for a project that has the following waterfall:

  • 9% pref, 80/20 to a 12%, 70/30 to a 15%, 60/40 to an 18%, then 50/50.

There are really only three concepts embedded in that waterfall: a preferred return, the splits, and the hurdles.

Preferred Return

A preferred return is paid to the LP’s before any funds go to the GP, hence, they receive “preference.” The term is usually shortened to “pref” in normal conversation but spelled out in its entirety in legal documents like a joint venture agreement or operating agreement. The number associated with the term is the hurdle (or hurdle rate). In this case we used nine percent, which indicates the internal rate of return that the LP’s will receive before moving on to the next “bucket” of the waterfall. Not every deal will include a pref.


The hurdle, or hurdle rate, is the internal rate of return (IRR) that must be achieved before moving down the line in the waterfall. It’s the size of the bucket, if you will. It is always calculated on the LP’s investment. In the example above, 9% is the hurdle rate for the preferred return, 12% is the hurdle rate for the 80/20 split, and so on. The LP’s must achieve a 9% IRR on their original investment before moving to the next split.


The final term, splits, refers to the ratio of LP allocations to GP allocations. An 80/20 split would mean 80%, or 80 cents of every dollar paid goes to the LP’s, and the other 20% or 20 cents of every dollar goes to the GP.

As mentioned earlier, there may be instances where another party is part of the waterfall, such as a project sponsor or a developer. That third party may have little to no equity invested. In those cases the split would be LP/GP/Sponsor (80/15/5, for example).

Building an accurate real estate private equity model that incorporates waterfalls is complicated. Your goal should be to build a model that allows the terms of the waterfall to be input on the assumptions page, and the model will handle all of the calculations. With all of the other variables built into a model, you can imagine the type of real estate private equity skills you will need to accomplish this feat. Let Leveraged Breakdowns help you build those skills!

Watch us Build a Full Real Estate Private Equity Waterfall

Leveraged Breakdown’s REPE Starter Kit includes a full, two-hour walk-through of an equity waterfall. Join us today to watch us build an entire LBO waterfall from scratch in Excel. Better yet, this waterfall is applicable to more industries than just real estate, since the cash flows being divided could conceptually come from any investment.

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