Preferred Returns and Waterfalls in Real Estate, Explained
By Haven Senior Living Partners · · 2 min read
What an "8% target preferred return" actually means, and how cash is split between investors and the sponsor.
Key takeaways
- A preferred return is a target annual return paid to limited partners before the sponsor shares in profits.
- It is a target, not a guarantee. If cash flow is short, it may accrue or simply not be paid.
- The waterfall is the order in which cash is divided: return of capital, preferred return, catch-up (if any) and profit split.
- Two offerings with the same "8% pref" can produce very different results depending on the details.
What a preferred return is
A preferred return ("pref") is a priority on profits. If an offering has an 8% target preferred return, investors are entitled to the first 8% per year of profits on their invested capital before the sponsor receives its share.
The details matter:
If a year falls short, does the unpaid amount carry forward (cumulative) or disappear?
Does any unpaid amount grow over time?
Some deals pay the pref quarterly from operations; others accrue it until a refinance or sale.
A simple waterfall example
Imagine investors contribute $1,000,000, the target pref is 8% cumulative, and profits above the pref are split 70% to investors and 30% to the sponsor. After five years the property is sold.
| Step | What happens |
|---|---|
| 1. Return of capital | Investors get their $1,000,000 back first |
| 2. Preferred return | Investors receive any unpaid pref owed to them |
| 3. Catch-up (if any) | The sponsor may receive a larger share until it reaches its agreed split |
| 4. Profit split | Remaining profit is divided 70/30 |
This example is for illustration only. Every offering's terms are set in its own documents.
Questions to ask
- Is the pref cumulative? Is it compounding?
- Is there a sponsor catch-up?
- Are there multiple tiers (for example, the split changes above a certain return)?
- What fees are paid before the waterfall?
Haven's offerings target an 8–10% preferred return; terms are set in each offering's documents. Model different outcomes in our calculators, or schedule a call.
This article is for education only and is not an offer to sell or a solicitation to buy any security. Target returns are not guaranteed. Consult your own tax, legal and financial advisors.
