What is an appropriate promote for the sponsor to take on a deal?

I get this question all the time. But, to be honest, there is no right answer.

What you will typically see in the market is the following:

For Retail Investors Writing Small Checks

7% or 8% preferred return followed by a 70/30 split in favor of the LP investors after the preferred return is met

For Institutional Investors Writing Larger Checks

8% to 9% preferred return with an 80/20 or 75/25 split in favor of the JV partner after the preferred return is met

This is simple. And it’s what is found in the market.

Sidenote: I’m not including a multi-tiered waterfall, but that happens too. Multitiered waterfalls would consist of a further split after the initial promote, one that breaks even MORE in favor of the sponsor. An example would be 8% to 9% preferred return with an 80/20 split in favor of the JV partner up to a 16% IRR and then a 60/40 in favor of the JV partner after a 16% IRR is delivered.

Going Beyond the Norm

However, just because this structure is commonly found in the market, it does not mean this is the only fair promote a sponsor could and should take.

The promote a sponsor will take his highly dependent on the type and strength of the deal.

If the sponsor found a vacant net lease deal and signed a 10-year credit tenant lease prior to closing, you better bet they could charge much more than a standard 30% promote.

Such deals often show promotes like 50/50 after a 6% pref, and it is completely fair. Because the deal supports it. A deal that gets leased prior to closing is seen as an extraordinarily de-risked investment, and would be a classic deal type in which the sponsor could take an outsized promote.

I’ve seen developers charge a 6% preferred return and a 40% promote on pre-leased grocery anchored shopping center developments. Again, these pre-leased developments are seen as relatively de-risked investments, in which construction execution is the sole risk factor.

In light of all of this, the truth is that it’s never 100% clear what a fair promote is. Every deal is different. Every operator asks for something different, and a combination of factors will determine how much of a promote the investors will allow the sponsor to take.

The preferred return and promote should be decided between the respective partners, with an eye toward the quality of the opportunity at hand and the experience level of the sponsor.