Problem: A land seller for condominiums or detached houses wants you to sweeten your up-front cash offer for the site by allowing him to also partake in a certain percentage of the project profits above a certain level of cash equity IRR achieved.
REFM Solution: Calculate what cash flows to equity would be at the threshold IRR, and deduct these modeled amounts in each period from the actual levered cash flow. This is the “excess” return above the threshold. Then deduct the percentage of these excess amounts that go to the land seller.
Once you have these amounts deducted, you then pass the residual amounts into the JV partnership waterfall structure, if one exists.
Example: Land seller to receive $X up front, and in addition 10% of all profits above a 15% IRR
Detailed Line Items:
Hurdle Calculation In Each Month
Beginning Balance = Ending Balance from previous period
Project Equity Injections = Overall project-level equity investment
Accruals Based On Hurdle = Negotiated Hurdle Rate Monthly % * Beginning Balance
Accrual Distribution = Minimum of a) zero, or b) (maximum of negative (Beginning Balance + Project Equity Injections + Accruals Based on Hurdle) and (Net Revenue including Capital Events Before Financing Costs + Construction Loan Repayment))
Ending Balance = sum of lines above
Cash Flow Hurdle Test Amount = Minimum of a) negative (Project Equity Injections + Accrual Distribution), and b) Beginning Balance + Accruals Based on Hurdle
Remaining Leveraged CF after Hurdle = Levered Cash Flow – Cash Flow Hurdle Test amount
Land Owner Kicker = Land Owner Participation % x current Month # Remaining Leveraged CF after Hurdle
Project Levered Cash Flow After Kicker = Levered Cash Flow – Land Owner Kicker
You can access a FREE working example in Excel here. Enjoy!
5-Minute Video Tutorial: