A deal can report a higher IRR and return less money to its limited partners.
The structure behind most multifamily syndications is simple. LPs receive an 8 percent preferred return, and profits above it split 70 percent to the LPs and 30 percent to the sponsor. That 30 percent is the promote. It is the sponsor’s compensation for outperforming, and it is a reasonable trade for the work of finding, financing, and running the asset.
Where I slow down is the tier. Many offerings add a hurdle: once the LPs reach a set IRR, say 15 percent, the split moves to 50/50. The logic is sound. The sponsor earns more only after investors have done well, which gives them a reason to push past the business plan. The trade-off is less visible. The LPs typically fund the large majority of the equity and carry most of the front-end risk. The tier then reduces their share of the upside at exactly the point where the deal is succeeding.
What the Tier Pays For
Look at the sponsor’s payoff as outcomes improve. Below the pref, their share of profit is zero. Between the pref and the hurdle, it is 30 percent. Above the hurdle, it is 50 percent. Meanwhile the fees are collected either way, and a loss falls mostly on the people who funded most of the equity. Each tier makes the sponsor’s upside steeper without changing who holds the downside.
That is acceptable when the hurdle can only be reached through performance. A 15 percent IRR over a five-year hold, with most of the return arriving at sale, works out to roughly 2x the LPs’ money. At that level, the tier is typically reached only at a capital event and only if the property succeeded. The sponsor earned it.
The complication is that IRR measures speed as well as size. The tier can also be reached through timing.
A Deal Example
Consider $10 million of equity, an 8 percent pref, a 70/30 split, and a tier that moves to 50/50 once LP IRR crosses 15 percent. Assume the property generates the same $7.6 million of total profit over five years under two different paths. Fees, co-invest, and taxes are left out so the mechanics stay visible.
In the first path, the sponsor holds and sells in year five. The LPs receive their $10 million of capital back, their accrued pref of $4 million, and 70 percent of the remainder of $3.6million: about $16.5 million in total, or 1.65x. Their IRR lands near 10.5 percent. The tier never activates, and the sponsor’s promote is about $1.1 million.
In the second path, the sponsor completes a cash-out refinance in year two that returns the LPs’ $10 million plus their two-year accrued pref. That early return does most of the work for the IRR. From there, the LPs cross the 15 percent hurdle at roughly 1.4x their money, and every profit dollar after that splits 50/50. At the year-five sale, the LPs finish with about $15.3 million, or 1.53x, at an IRR near 18 percent. The sponsor’s promote more than doubles, to about $2.3 million.
Same property. Same total profit. The LPs receive roughly $1.2 million less in total, while their report shows a better IRR. To be fair to the refinance, the LPs also have their capital back three years early, with no principal left at risk and cash free to redeploy. That value is real, and it is exactly why the IRR rises. The question is price. The refinance moved every remaining profit dollar to 50/50 when the LPs had received about 1.4x, well short of the 2x the hurdle was meant to stand for.
None of this requires bad intent. The issue is structural. When the hurdle is measured in IRR alone, the tier can reward the calendar as generously as the result.
Where the Guardrails Belong
Two terms change the picture.
The first is the level of the hurdle. A tier that activates at 12 percent can be reached by an ordinary deal with a well-timed refinance. At 15 percent or higher, the property has to perform before the split moves.
The second is a multiple floor. A tier that requires both a 15 percent IRR and a 2x equity multiple pays the sponsor more only after the LPs have doubled their money. That keeps the incentive to outperform intact and closes the timing gap.
What Changes the Decision
Before you react to a projected IRR, read the waterfall for where the split changes. Ask what triggers the tier, and whether it is measured on IRR alone or on IRR and an equity multiple together. Ask how refinance proceeds count toward the hurdle. Ask what LP multiple the sponsor’s own model shows at the moment the tier activates. If that number sits well below 2x, the tier can be reached through timing.
Then look at the downside: what the sponsor collects in fees if the deal returns only your capital, and how their co-invest compares to that number. Finally, test behavior. Ask about a past refinance. Show me the LP multiple on that deal at exit, next to the IRR.
Closing Thoughts
A promote tier is a reasonable way to pay a sponsor for outperformance, provided outperformance is what it measures. The split tells you how profit is divided. The hurdle definition tells you what the sponsor is paid to deliver: your money back twice, or the same money back sooner.
Vessi Kapoulian
Breaking down multifamily underwriting one step at a time to create educated and empowered investors
P.S. If you would like a second set of eyes on a deal or want to sharpen your underwriting through a risk lens, feel free to connect with me.
P.P.S. And if you want to go deeper into analyzing multifamily investments step by step, my Mastering Multifamily Underwriting book and the Mastering Multifamily Underwriting program walk through this process in plain English, from acquisition to exit.