A three-tier JV waterfall solved year by year, with the gross-up most hand-built models miss and the hurdle definition that moves the promote.
A multi-tier IRR waterfall is solved one hurdle account at a time: roll the investor's balance forward at each hurdle rate, pay each tier until the investor's balance is cleared, and gross that amount up by the investor's share of the tier. On an illustrative $100 million joint venture returning $185.0 million, a 14.37 per cent deal IRR, hurdles of 8 and 12 per cent with promotes of 20 and 30 per cent pay the sponsor $8.85 million of promote and leave the investor 13.07 per cent.
Worked in full in Real Estate Joint Ventures by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Promote structures with two or three IRR hurdles are the norm in real estate joint ventures, and the arithmetic is where many term sheets and models quietly part company. A single 8 per cent hurdle with one promote is the simpler case, worked from the sponsor's side in the sponsor's IRR on its co-invest; a fund-style waterfall with a full catch-up behaves differently again, as what a 20 per cent promote actually pays shows. Here there is no catch-up, only stacked IRR tiers. Below, the waterfall is built year by year on a five-year hold, checked, and then pushed on the two points that move money: the exit value, and whether the hurdle is tested on the investor's cash or the deal's.
| Input | Value |
|---|---|
| Equity, contributed at closing | 100.0 |
| Investor / sponsor share of equity | 90% / 10% |
| Operating distributions, years 1 to 5 | 6.0, 6.5, 7.0, 7.5, 8.0 |
| Net sale proceeds, end of year 5 | 150.0 |
| Tier 1: to an 8% investor IRR, investor / sponsor | 90 / 10 |
| Tier 2: 8% to 12%, 20% promote | 72 / 28 |
| Tier 3: above 12%, 30% promote | 63 / 37 |
The splits are the promote layered on top of pro rata: in tier 2, 20 per cent goes to the sponsor as promote and the remaining 80 per cent is shared 90/10, which gives the investor 72 per cent and the sponsor 8 + 20 = 28 per cent. Total cash to the venture is $185.0 million, a profit of $85.0 million, a 1.85x multiple and a 14.37 per cent IRR.
Hurdle balancet = balancet−1 × (1 + hurdle) + investor contributions − investor distributions
Cash to tier k = min(cash left, investor shortfall to hurdle k ÷ investor share of tier k)
In Excel, per year and per tier: =MIN(Cash_Left,MAX(0,Hurdle_Bal-Inv_Paid_So_Far)/Inv_Split). The last tier takes whatever is left.
Two hurdle accounts run in parallel, one at 8 and one at 12 per cent, both opening at the investor's $90.0 million. In years 1 to 4 the operating cash is well below the 8 per cent accrual, so every dollar falls in tier 1 and is split 90/10. Everything interesting happens in year 5:
| Tier | Cash | Investor | Sponsor |
|---|---|---|---|
| 1: to 8% (90/10) | 114.32 | 102.89 | 11.43 |
| 2: 8% to 12% (72/28) | 32.70 | 23.55 | 9.16 |
| 3: above 12% (63/37) | 10.98 | 6.92 | 4.06 |
| Year 5 total | 158.00 | 133.35 | 24.65 |
Check it. The investor's cash flows through the end of tier 2, $90.0 million out and 5.40, 5.85, 6.30, 6.75 back, then 102.89 plus 23.55 in year 5, return exactly 12.00 per cent. If your model does not hit each hurdle to the basis point at the tier boundary, the gross-up or the compounding is wrong.
The investor receives $157.65 million, a 1.75x multiple and a 13.07 per cent IRR, 131 basis points below the deal. The sponsor receives $27.35 million on its $10.0 million: 2.74x and a 24.00 per cent IRR. Its pro rata share of the cash would have been 18.50, so the promote is $8.85 million, 10.4 per cent of the profit. The 30 per cent split sounds like the headline, but only $10.98 million of the $185.0 million reaches that tier.
| Sale proceeds | Deal IRR | Investor IRR | Sponsor IRR | Promote | Tier 3 cash |
|---|---|---|---|---|---|
| 120.0 | 10.17% | 9.75% | 13.67% | 2.46 | 0.00 |
| 130.0 | 11.65% | 10.96% | 17.16% | 4.26 | 0.00 |
| 140.0 | 13.05% | 12.10% | 20.36% | 6.15 | 0.98 |
| 150.0 | 14.37% | 13.07% | 24.00% | 8.85 | 10.98 |
| 160.0 | 15.64% | 14.00% | 27.24% | 11.55 | 20.98 |
| 170.0 | 16.85% | 14.91% | 30.17% | 14.25 | 30.98 |
Above the top hurdle every extra $10.0 million of sale proceeds adds $2.70 million of promote, 27 cents in the dollar after the sponsor's pro rata 10 per cent of the remainder is set aside. Between the hurdles it is less. That convexity is the point of a tiered promote, and also why a sponsor's incentives change sharply around the 12 per cent line: an equity multiple hurdle changes where that line falls in time.
Many agreements say "a 12 per cent IRR" without saying whose. Tested on the deal's cash flows at 100 per cent rather than the investor's, tier 2 ends when the whole venture reaches 12 per cent. By then the investor, which has been receiving 72 per cent instead of 90, is still below 12. On this case the deal-level reading raises the promote from 8.85 to 9.44, an extra 0.59, and cuts the investor's IRR from 13.07 to 12.98 per cent. The gap is small here and grows with the size of the promote and the number of tiers. Neither reading is wrong; leaving it undefined is.
Run one hurdle account per tier on the investor's cash, gross each tier up by the investor's split, and check that the investor lands exactly on each hurdle. On a 14.37 per cent deal the structure here pays $8.85 million of promote and leaves the investor 13.07 per cent. The free workbooks for this book carry the full waterfall with the catch-up solved in the cell, and the JV waterfall template runs the same tiers on a deal of your own.
It should be stated in the agreement, and it matters. Tested on the investor's own cash flows, the illustrative deal pays $8.85M of promote and leaves the investor 13.07 per cent. Tested on deal-level cash flows, the 12 per cent tier is reached earlier because the investor already receives only 72 per cent in tier two, so the promote rises to $9.44M and the investor falls to 12.98 per cent.
Roll the investor's hurdle balance forward at the hurdle rate, add contributions, deduct everything the investor has received, and divide what is still owed by the investor's share of that tier. In year five of the case the investor is owed $23.55M to reach 12 per cent and receives 72 per cent of tier two, so the tier takes $32.70M of cash.
Less than the headline numbers suggest unless the deal is very strong. On $85.0M of profit the sponsor receives $27.35M in total, 20.4 per cent of the profit after its own capital back, of which promote is $8.85M, 10.4 per cent of profit. The 30 per cent split applies only to the $10.98M that falls in the top tier.
This article is one calculation from Real Estate Joint Ventures. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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