Real Estate Funds frequently offer a Preferred Return to investors along with additional participation in net cash distributions and capital event income.
A Preferred Return is very important in a real estate fund, especially from the perspective of investors (limited partners or LPs). Here’s a breakdown of why:
What Is a Preferred Return?
A preferred return is a minimum annual return (typically 4–8%) that investors are entitled to receive before the fund sponsor (general partner or GP) can participate in profit sharing (a.k.a. the promote or carried interest).
Why It’s Important
For Investors (LPs):
- Risk Mitigation
- Ensures investors get paid first, reducing their downside risk.
- Incentive Alignment
- Encourages the GP to deliver strong returns above the preferred threshold.
- Capital Protection
- Provides a cushion before the GP earns extra profit, prioritizing the return of capital and a basic yield.
- Market Standard
- LPs expect a preferred return; lack of it can be a red flag.
For Sponsors (GPs):
- Barrier to Promote
- The GP doesn’t earn a share of profits until investors receive their preferred return.
- Performance Pressure
- Requires careful underwriting and execution to exceed the hurdle and share in profits.
A preferred return is crucial in a real estate fund structure because it:
- Protects investors
- Incentivizes performance
- Reflects market norms
Interested in raising capital for a new or existing real estate fund? Call us today to discuss! (720) 586-8610
