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Leveraged Breakdowns

Catch-Up Waterfall, Part One: The Prompt


This case study will focus on building a catch-up waterfall. Catch-up waterfalls will be fairly common throughout your real estate private equity career path. The other common waterfall is promote-based, which we build live in the REPE Starter Kit. Private equity analysts and associates must often model waterfalls, so pay close attention.

Keeping it Simple

Any waterfall just requires a set of cash flows. The source of these cash flows can be complex or simple. They can be monthly, or they can be annual. To reduce brain damage, let’s model a simple set of annual cash flows. If you wish to dive into the weeds of complex property-level modeling, check out our other real estate private equity guides. Regardless, the waterfall we build here can quickly be extended to accommodate a set of monthly cash flows from any source. Alright, onto the prompt.

The Case Prompt

This prompt is split into two pieces. First, you build a simple real estate LBO model for an acquisition. Second, you feed the JV cash flows into a catch-up waterfall for a separate account you have with an important investor.

First, you have identified a single-tenant warehouse whose owners are willing to transact at $30M. Assume the following:

  • This building is currently leased quadra-net to a below-market tenant
  • During your hold period, first year rent will be $1.5M with subsequent 3.0% contractual step-ups each year
  • This below-market lease will expire immediately after the fifth year of your hold period, and you believe a market tenant would pay $2.0M per year with similar contractual step-ups at the time the current lease expires
  • At exit, you plan to reposition this warehouse to a market tenant and quickly sell it at the same cap rate you went in at
  • Banks would be willing to offer you 60% LTV debt at a 3.5% fixed cost with no amortization

Question 1: What are the gross returns of this investment?

Question 2: Next, assume you source the equity for this investment from a separate account you have with an important limited partner, a state pension fund. For all investments out of this separate account, the LP has agreed to the following terms: 10% carry over an 8% hurdle with 100% catch-up and a 75bps asset management fee. What net return should the LP expect to earn?

Modeling the Cash Flows

If you’re a member, you can download the complete model by clicking the link at the end of this post. But only use the source files as a reference, not as a crutch. If you want to ace your interview, you must learn to model this investment from the prompt alone.

The next post in this series will work through the solution to the first question. In the meantime, make sure to check out all Leveraged Breakdowns has to offer, such as our real estate private equity guides and free case studies. Everything we teach is directly applicable to any real estate private equity career path, and it’s all created by megafund insiders!

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