Preferred Return
Also called: Pref, Preferred
A preferred return is a threshold rate of return that limited partners must receive on their invested capital before the general partner participates in profits above their pro rata share.
The preferred return is the first tier of nearly every real estate equity waterfall. It is a priority of payment, not a guarantee: if the deal does not generate cash, the pref is not paid, it simply accrues or is lost depending on the documents.
Two structural details change the economics substantially. A cumulative pref carries any shortfall forward to later years, while a non-cumulative pref does not. A compounding pref accrues interest on the unpaid balance, which in a slow deal can grow the limited partner's claim materially before the sponsor sees a dollar of promote.
Rules of thumb
- Market for multifamily syndication is commonly a 7% to 9% cumulative preferred return.
- Always read whether the pref is compounding and whether it is paid on invested capital or on unreturned capital. The two produce different outcomes after a partial return of capital.
Related terms
- Equity Waterfall
An equity waterfall is the contractual sequence of tiers that determines how a real estate deal's cash flow is split between limited partners and the general partner as return thresholds are met.
- Equity Multiple
The equity multiple is total cash distributed to investors divided by total equity invested, expressed as a multiple, and it measures how many times an investor gets their money back over the full hold.
- Internal Rate of Return (IRR)
The internal rate of return is the annualized discount rate at which the present value of a deal's cash flows equals zero, making it the time-weighted compound annual return on invested equity.