The promoted return looks right but the waterfall timing is doing most of the work

The hold period assumption is doing the most work, and you have named it correctly. The second assumption almost nobody stresses is the refi proceeds percentage, because a partial-capital-return refi is where the two risks compound. The waterfall can look clean at disposition, but if a year-three refi returns 80 percent of LP capital and the structure treats that as a promote-triggering event, the sponsor gets paid on the remaining 20 percent that has not cleared the pref threshold. That residual 20 percent then sits in the deal through a longer hold, still accruing at 8 percent on paper, but the LP's effective IRR on that tranche is already damaged because the promote was extracted before full recovery.

On the modeling sequence: I stress hold to seven or eight first, before I accept the headline IRR, because the five-year projection is the sponsor's most optimistic operating assumption and the one with the least historical support in value-add multifamily specifically. A two-year extension at a flat or compressed exit cap relative to the projection can turn a structurally clean waterfall into a mediocre LP outcome even with no defaults.

The risk this thread has not addressed is catch-up provisions. Some waterfalls include a sponsor catch-up after the pref clears, meaning once LPs hit their 8 percent, 100 percent of subsequent cash flow goes to the sponsor until they reach their pro-rata share of the 75/25 split. On a deal that runs long, a catch-up can materially reduce LP distributions in the back half of the hold, and it often sits in the waterfall section of the PPM without appearing anywhere in the deck.

A licensed securities attorney needs to review the actual PPM language before any capital goes in. That part is not optional.

When you are modeling the refi scenario, are you haircut-testing the refi proceeds, or are you holding the refi return-of-capital percentage constant and only moving the timing?

The refi-triggered promote on a partial capital return is the one I almost missed on my second deal. The PPM said "look-back provision" and I nodded like I understood it, and I did not fully understand it until I talked to a CPA who walked me through a scenario where the sponsor pulls promote dollars at month 30 on a cash-out refi, the deal runs to year eight instead of five, and the LP is sitting there in years six through eight earning pref on a reduced capital balance because the refi only returned 60 cents on the dollar. The headline IRR in the deck assumed disposition at year five. Nobody modeled year eight. On a $200k position that gap was not two points, it was closer to four, because the pref clock on the unreturned capital kept running but the promote had already been partially paid out.

What I actually do now before I sign anything is ask the sponsor to send me a waterfall calculation in a spreadsheet, not a PDF summary, a live spreadsheet, and I manually extend the hold to year eight and see what happens to the promote trigger. Most sponsors will send it. The ones who push back on that request are telling you something. But what I have not figured out cleanly is how to evaluate a deal where the operating agreement has a clawback on the promote but the GP entity is thinly capitalized. The clawback looks protective on paper and is worth almost nothing if the GP cannot fund it. What does the GP entity actually look like on the deals you have been reviewing?

Running year seven before year five is right, that is exactly what I do too.

The part that got me on a deal I passed on last year was the split accrual math after a partial return. Sponsor sent a refi summary showing the cumulative pref balance like it was one clean number, but 55 percent of LP capital had come back at the refi so the accrual clock was already split. The remaining 45 percent was still compounding at 8 percent but the model in the deck was averaging it across the original full basis. On a $200k position that difference was about $6,800 in phantom pref credit the sponsor was essentially claiming had already been earned.

What does the operating agreement say about whether the pref keeps running at 8 percent past the original projected exit date, or does the sponsor have a reset or cap provision tucked in there?

@originalposter that line about the pref "stopping to accrue at a refi that returned only partial capital" is where I wanted you to slow down, because that depends entirely on whether the pref is cumulative and compounding or just cumulative simple, and a lot of decks say cumulative and mean the cheaper version.

On the 72-unit I looked at something similar last year, $3.8M raise, same 8 percent pref language, and when I finally got the actual waterfall schedule from the attorney draft it had a catch-up clause that let the sponsor pull promote at the refi if the IRR cleared 8 on the capital returned to that point, not on the full commitment. That is a different animal than what the deck implied. Two different things using the same sentence.

What I want to know before I put a number in is whether the operating agreement defines the pref base as contributed capital or as unreturned capital, because those diverge the second a refi returns 60 cents on the dollar and the sponsor starts arguing the remaining base is smaller. I have seen that fight play out and it is not fun at year four when you thought the paperwork was clean.

What does your actual OA say the pref accrues on after a partial return event?

I run year seven first because a five-year projection that hits five is the exception in my experience, not the baseline.

What nobody's pricing is the legal cost of getting the waterfall dispute resolved if the sponsor calls a refi at year three, returns 60 percent of capital, and books a promote. I've seen the operating agreement language get genuinely ambiguous on whether "cumulative" means cumulative on contributed capital or cumulative on remaining invested capital after a partial return, and that distinction alone can shift hundreds of dollars per unit to one side or the other.

@originalposter what does the actual LLC agreement say about the pref base after a partial capital return?