An industry chasing waterfalls...
Real estate is the most entrepreneurial asset class. If you can generate strong returns, you can become spectacularly wealthy. You don’t even need to bring much money to the table.
How?
Investors with capital are always looking for operators who can deliver. They'll want you to put some “skin in the game” (say, 10% of total equity), but if you execute well, they’ll gladly pay you a multiple of your investment.
Blackstone example...
Blackstone launched a $21 billion real estate fund right before Covid. Two years in, they had already realized 13% of the fund with a 40%+ IRR. Blackstone's real estate platform was generating about $1 billion per year in promotes.
But you don’t have to be Blackstone to leverage a waterfall structure.
Let’s say you’re a sponsor in a typical joint venture promote structure (10% co-investment, 9% pref, 25% promote up to 15%, then 40%).
If you deliver 40% IRR with $5 million of "skin in the game," you could generate $16 million in promote fees.
But here’s the catch…
It’s really hard to generate 40% returns. In fact, it’s hard to generate 15%.
E.g., that same Blackstone fund (BREP IX) is now 29% realized, and its net IRR has dropped from 40% to 10%.
10% is still good, right?
Sure, but not good enough for big promote payouts.
A sponsor who once expected $16 million in promote might now be looking at $1 million or less.
---- Takeaways ----
1. Promotes make fortunes, but they are fragile.
A relatively small drop in IRR can wipe out nearly all of your upside.
2. Wide reaching effects
Sponsors from Blackstone to one-man shops are being affected by this downshift.
3. Impossible to overstate the magnitude
When your expected profits fall by 50-90% that existing mortgage starts to feel a lot heavier.
...small problems become big problems.
...you cut expenses.
...you explore new opportunities.
This dynamic is reshaping the real estate industry in real time.
PS -- Most early career professionals say they want to be owners but few actually understand waterfalls. We think the best way to learn is to marry modeling with negotiation in a real world setting; if this sounds interesting, DM us about our upcoming FastTrack cohort.
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