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Leveraged Breakdowns

REPE Interview Prep: Waterfalls and Sensitivities

This series serves as a real estate private equity guide for live interviews. The response to each question is phrased exactly how we would recommend you respond during a live interview. After reading this article, you will have a high-level understanding of two concepts that are likely to appear on any real estate private equity case study: waterfalls and sensitivity tables. And make sure to check out our course, the REPE Starter Kit, where we actually build an Excel waterfall together in real time.

What is a waterfall returns schedule, and why do real estate investors use it?

The waterfall schedule is designed to align the financial interests of investors and sponsors, particularly when there is a significant difference in capital contributions. The waterfall returns schedule defines the internal rate of return hurdles that change the distribution of cash during the hold period. An example would be that the investors receive a 9% preferred return, then cash flow is split 90/10 to a 12% IRR (90% to the investors), 80/20 to a 15% IRR, 70/30 to an 18% IRR, then 60/40 above that. Because the sponsor can earn a higher promote as the investors earn a higher return, their interests are aligned and the sponsor has a strong motivation to return as much to the investors as possible.

Additional detail: for a development, the 90% equity fund LP (source of capital) would want to incentivize the 10% developer GP (steward of capital) to develop wisely. For a private equity megafund, the limited partners providing most of the capital (CalSTRS, Texas Teachers, KTPF, etc.) want to make sure the general partner fund manager invests their money wisely.

If you are building a sensitivity analysis for a stabilized multifamily property, which variables would you test and why?

I would test annual rental increase percentage, vacancy rate, and exit cap rate. The ability to increase rents over time can have a significant impact on NOI, driving annual cash flows and investor returns higher. On the flip side, vacancy can siphon away those gains, so understanding the interplay and impact of vacancy and rent increases is a valuable piece of information. I would also test exit cap assumptions, because the terminal value of an asset has a massive impact on the overall returns of a project. If cap rates increase enough, NOI gains from rent increases over the hold period could be entirely wiped out.

If you are building a sensitivity analysis for a development deal, which variables would you test and why?

Without question, the first variable I would sensitize is time. The sometimes unpredictable delay between commencement and sale can have an outsized impact on returns. Knowing the impact of a three or six month delay will help management understand the impact of extended lease negotiations, construction delays, or a quicker sale.

I would also test the impact of changes in the cost of construction, because change orders are pretty common with construction. Understanding the impact of a cost change will inform management’s response to it. Lastly, I would test rent or sale price per square foot. Helping brokers or sales staff understand the impact that negotiating an extra quarter or dollar of rent can have a meaningful impact on asset performance.


Make sure you practice these questions by speaking out loud as if you were in a live interview. And if you’re looking for a real estate private equity guide, look no further than the megafund investors at Leveraged Breakdowns. We have developed several courses to develop your skill set, along with free materials such as an interview format real estate private equity case study.

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