Multifamily real estate investing offers tax benefits, passive income potential, and plenty of terminology.
One particular bit of lingo that often trips up newer real estate investors is the term “promote.” In this article, we’ll show you what the promote is in a real estate investment deal, how it works, and who gets it.
What is The Promote in Real Estate Investing?
There are two roles in a real estate deal:
- The sponsor/GP (general partner). The sponsor oversees sourcing, managing, and selling the property.
- The passive investor/LP (limited partner). Passive investors are invited to invest in the deal and receive distributions and a share of the return.
Learn more about the GP and LP’s roles in a real estate deal here.
A promote (also called “carried interest”) is an additional share of profits that real estate sponsors earn above their standard ownership percentage as a reward for exceeding certain performance thresholds.
In other words, the promote is a performance-based bonus designed to incentivize sponsors to maximize property value and investment returns. This aligns the sponsor’s interests with the investors’ as the better the deal performs the larger the promote will be for the sponsor.
Why Does the Sponsor Get a Promote?
As we alluded to earlier, the sponsor is in charge of the multifamily deal. But beyond more responsibility, why should they get an outsized share of the return? Here are a few reasons:
- Compensation for value creation: Sponsors typically do all the heavy lifting in a real estate deal. They find the property, negotiate the purchase, develop the business plan, manage the asset, and execute the value-add strategy. The promote rewards them for successfully increasing the property's value beyond basic expectations.
- Risk/Reward alignment: Most sponsors invest significant time and resources upfront with no guarantee of success. The promote helps offset these risks and incentivizes them to take on challenging projects.
- Performance incentive: Since sponsors only earn the promote by exceeding certain return thresholds, it motivates them to maximize property performance and investor returns rather than just collecting a management fee. This aligns their interests with their investors - the better the deal performs, the more everyone makes.
Multifamily deal sponsors (like Colony Hills Capital) work hard to source, manage, and sell properties. The promote is a way to reward the sponsor for their hard work–and ensure they work hard to generate strong returns.
How Does the Promote Work? An Example Waterfall
The promote typically works through a "waterfall" distribution structure that determines how cash flows and profits are distributed between investors and sponsors.
The waterfall structure outlines a hierarchy or sequence in which returns are paid out. Returns will be split pro-rata until the deal hits an IRR hurdle, then the GP will earn a disproportionate share of the returns.
The concept is akin to water flowing down through a series of steps or tiers—only after filling one tier does the water (or in this case, the profit) flow down to the next.
- Return of Capital: The first tier usually ensures that both the GP and LP receive back their initial capital investment.
- Hurdle 1: The second tier often involves paying a predetermined rate of return (7%-9% IRR) that investors are promised before the GPs receive any share of the profits.
- Hurdle 2: This tier is where the GP begins to earn a disproportionate share of the upside. As the deal reaches new IRR hurdles the GP will earn a higher share of the returns.
- Hurdle 3: After the above tiers are satisfied, any remaining profits are split between the GPs and LPs according to a predetermined ratio. The GPs' share at this stage is often referred to as "carried interest" or "promote," and is meant to incentivize the GPs to exceed performance thresholds and maximize the project's profitability.
The exact percentages and hurdle rates vary by deal, but this tiered structure incentivizes sponsors to maximize returns since they earn progressively larger shares of profits at each tier. Each tier's hurdle rate can be based on IRR, equity multiple, or other performance metrics.
Learn more about how waterfall structures in multifamily real estate deals work in this guide.
Do Passive Investors Ever Share in the Promote?
Yes, passive investors can sometimes share in the promote, though it's less common.
This typically happens in two scenarios:
- A Co-GP Deal: Some sponsors offer passive investors to invest as a Co-GP rather than as an LP. This means that you can invest passively (like an LP) but earn from the GP’s share of the return, which includes the promote.
- Limited Promote Participation: Some deals structure a "tiered" promote where certain LP investors (often early investors or those meeting higher investment thresholds) receive a portion of the promote.
At Colony Hills Capital, we specialize in Co-GP multifamily investments and invite all investors to join us as a Co-GP.
Whether you invest $100,000 or $1,000,000, whether you are the first investor in a round or the last, we invite you to invest passively alongside our expert team and earn a disproportionate share of the return.
Browse our transactions to see examples of our returns, and check out our latest acquisition to join us as an investor.
Learn More About Multifamily Real Estate Investing: Download Our Free Guide
Between selecting where to invest, which firm to choose, and how much, we understand if you have questions. That’s why we created a free guide to show you the ins and outs of investing in multifamily real estate. Fill out the form below to get your free guide. In it, you’ll learn:
- The tax benefits of investing in multifamily real estate
- How to choose a firm
- The best markets to invest in
And more!
