Before you invest in any real estate deal, you need to understand this number.
A preferred return (usually expressed as a percentage, like 8%) is the minimum annual return investors receive before the sponsor earns anything.
Think of it as a hurdle the sponsor has to clear before they get paid. Here is why it matters:
Without a preferred return, a sponsor can collect promote even if you barely broke even. With one, they do not participate in the upside until you have been made whole and received a return on your money first.
At Westlake Realty Group, we typically structure our value add deals with an 8% preferred return to investors for value add deals. That means if the deal does not generate at least an 8% annual return, we do not see a dollar of promote. Period.
When evaluating any real estate investment, ask three things:
1. Is there a preferred return, and what is it?
2. Does it accrue if it is not paid in a given year?
3. What does the sponsor earn after the hurdle and does that structure reward them for hitting a home run?
The preferred return tells you a lot about how a sponsor thinks about alignment.
What questions do you always ask before you invest in a real estate deal?
Wednesday Real Estate 101: The preferred return
