To visualize how the 8% Preferred Return and 70/30 Split works in practice, let’s look at a 5-year “Pro Forma” (financial projection) for an investor who puts in $1,000,000.
In this scenario, we assume the property is sold at the end of Year 5.
5-Year Cash Flow Projection ($1M Investment)
| Year | Cash Flow (After Expenses) | Tier 1: 8% Pref Payment | Tier 2: Capital Return | Tier 3: 70/30 Split | Total to Investor |
|---|---|---|---|---|---|
| 1 | $60,000 | $60,000 | $0 | $0 | $60,000 |
| 2 | $80,000 | $80,000 | $0 | $0 | $80,000 |
| 3 | $90,000 | $80,000 | $0 | $7,000 | $87,000 |
| 4 | $100,000 | $80,000 | $0 | $14,000 | $94,000 |
| 5 (Sale) | $1,800,000 | $80,000 | $1,000,000 | $504,000 | $1,584,000 |
| Total | $2,130,000 | $380,000 | $1,000,000 | $525,000 | $1,905,000 |
Analysis of the Results
- Year 1 Shortfall: In Year 1, the property only produced $60k. Since the 8% Pref is $80k, the investor gets all $60k, and the remaining $20k accrues (carries over).
- Year 2 Catch-up: In Year 2, the property made $80k. The investor gets the full $80k, but still has that $20k “IOU” from Year 1.
- Year 3 Profit: By Year 3, the property is performing well. The investor gets their $80k Pref + the $20k accrued from Year 1. Only after that is the remaining $10,000 split 70/30 ($7k to investor, $3k to you).
- Year 5 (The Exit): When you sell the building, the first $1M goes back to the investor (Tier 2). The remaining profit ($720k in this example) is split 70/30. The investor gets $504k, and you (the Sponsor) get $216,000.
Why this is a “Win-Win”
- Investor Safety: The investor received nearly $2M back on a $1M investment, and they were always “first in line” for cash.
- Sponsor Reward: Even though you didn’t put in the $1M, you walked away with over $225,000 in total “Promote” fees over 5 years (plus any acquisition or management fees you charged along the way).
Key Terms for your Operating Agreement:
- Cumulative: As shown in Year 1, the unpaid portion of the 8% must carry over.
- Non-Compounded: Usually, the unpaid 8% does not earn interest on itself (though some aggressive investors may ask for compounding).
- Capital Event: This includes a sale, a total refinance, or an insurance payout from a total loss.