What is a waterfall?
A "waterfall" refers to the disproportionate sharing of partnership profits, relative to partners' equity contributions.
This arrangement usually surfaces in development and value-add real estate investments, where sponsors bring 5-10% of the equity, team up with a capital partner, and seek compensation for executing good deals.
Waterfall distributions allow sponsors to get a disproportionate share of upside in exchange for generating profits above hurdle rates.
----- Thinking vs. processing -----
Being able to build and manipulate a waterfall model is an important skill. However, we find that many young professionals spend too much time learning about the ins and outs of modeling without learning about joint venture principles and related tradeoffs. In other words, we find many young professionals spend more time thinking about cell AB21 and not enough time thinking about if they would trade more pref for more promote.
----- Our approach to joint ventures -----
We cover joint ventures in our FastTrack class by explaining the key 10 components in every joint venture, along with common trade-offs and problem areas.
We break our class into groups, led by working professionals with real estate and class experience. We give the groups a framework and a waterfall model for evaluating joint venture inputs, and they spend time getting familiar with the model's moving pieces. Then we match LP groups against GP groups, which leverage their models to negotiate a joint venture structure. One LP and one GP "win" and gets a cash prize.
----- Takeways -----
We don't think the most efficient path to learning about joint ventures is by reading about them or by building models in a vacuum. You don't learn about joint ventures by memorizing components; you learn by negotiating in realistic situations, making mistakes, and getting instant feedback. We don't pretend to have magic solutions, but we're proud of our FastTrack participants' progress...
"How confident are you in nailing a response to: What is a waterfall?"
Non-FastTrack alumni: 11% out of 100%.
FastTrack alumni: 94% out of 100%.
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