The refi never happened and the position still cleared 9.4 percent

Dumb question from someone outside this. When you say the sponsor's promote was close to nothing, does that mean they worked three years on this for free?

@plumb no, they'd have been collecting asset management fees and probably an acquisition fee at close. The promote is the upside piece. That's the part that went to zero. Which is roughly how it's supposed to work, and it's also why arbor asking about their 2018 deals mattered. A sponsor who has already lived through a zero promote and didn't torch their LPs to avoid it is telling you something.

The clause I want to see is the one governing the capital call, since you said they considered one. Was it dilutive or was it a loan? Most of the 2021 vintage docs I've read give the GP the option to fund the shortfall themselves as a preferred loan that sits ahead of the LP pref, which would have eaten your 9.4 alive. If yours was dilution only at a stated valuation you got a much friendlier document than average.

The part of this that generalizes is the sponsor diligence, and I want to say specifically what arbor did that most LPs skip.

He didn't ask for the track record. Every sponsor hands you the track record and it's the winners with a footnote. He asked what happened on the deals where the plan broke, and then asked for dates. Dates are the tell. A sponsor who can say "month 22 we knew the refi wasn't there, month 24 we told LPs, month 27 we listed" has a decision process. A sponsor who says "we worked closely with our lender and ultimately achieved a strong outcome for our partners" is telling you nothing and probably doesn't remember.

Second thing, and this one is quantitative. arbor's exit came in 11 percent below the modeled proceeds and he still got a 1.27x. That only works because the pref accrued and he sat ahead of the promote. Run that same 11 percent shortfall through a straight 80/20 pari passu split with no pref and the LP takes a real haircut. So when people here compare a 7 pref to an 8 IRR hurdle, this is the case that separates them. The pref is a downside instrument. It pays you most in the scenario the sponsor's model does not contain.

Third, 6 percent position size. Nine or ten positions like that and one going to zero costs you a bad quarter. Two positions and one going to zero changes your life. Nobody wants to hear that the sizing is more important than the deal selection, and it usually is.

One thing I'd push back on. arbor, you called this a win. It's a win against the outcome distribution. Against the original 16 percent target IRR you got about 60 percent of what you were sold. Worth holding both of those in your head when you re-up with them.

@fathom that's the right question and I'd add the extension mechanics on the bridge loan. If the sponsor had to buy a new rate cap to extend, that cost came out of reserves or out of a call, and the docs usually let the GP fund reserves in a way that's senior to everything you're owed. arbor, do you know whether the cap purchase came out of operating reserves or was funded fresh?

I want to test the 9.4. $85k in, 34 months, 1.27x means about $107,950 back total. If the pref was paying current at all during the hold your IRR is higher than a lump-sum-at-exit case even at the same multiple. arbor, were you receiving distributions during the hold or did the whole pref accrue to the exit? Because 1.27x over 34 months as a single terminal payment prices out closer to 8.7 percent by my math. The 9.4 implies you got cash along the way.

@ledger that's the right catch and it's the number I'd want too. The other thing I'd want is the actual rent achievement versus the $180 push. arbor, an exit 11 percent under model with the plan broken is one story if they hit the rents and got killed on cap rate, and a different story if they missed the rents. Cap rate movement is not the sponsor's fault. Renovation premiums they underwrote and did not deliver are entirely their fault, and it changes whether I'd put money with them again.

@canton the line about the pref being a downside instrument is the thing I've been missing. I've been reading pref versus hurdle as which one pays more in the good case, which is exactly backwards from how I should be thinking about it.

How did you find the prior LPs to talk to, or did the sponsor give you the list? Every time I've asked a sponsor for LP references I get three names and I assume those three are hand picked.

The bridge debt is doing most of the work in this story and I'd note that the LP took the full consequence of a financing decision they had no vote on. Fixed agency debt at acquisition and this deal probably still sells at a similar price, the sponsor just doesn't have a gun to their head at month 26. arbor, do you screen on debt structure at the point of subscription, or is it something you note and accept?

Following this mostly to learn the vocabulary. "Promote went to zero" is the clearest explanation of a waterfall I've read anywhere.

From the construction end, the $180 rent push on a 60 percent unit turn is the number I'd have interrogated hardest. Interior scope in 2021 was getting quoted at prices nobody could actually hold, appliance lead times were brutal, and turns were running long which means your renovated units sat empty longer than the model said. If they hit $180 in that environment they earned it. @sextant is asking the right thing, and arbor, if the answer is they hit the rents late rather than not at all, that's worth knowing separately.