
Wise women one said, "Don't go chasing waterfalls". However, in the real estate world, we highly suggest it!
If you've landed here, you're likely considering taking a dive into the multifamily sector, and I must say, you're about to make a potentially lucrative move. Multifamily investing stands out as a steadfast pillar in the real estate landscape, with an impressive track record of resilience, cash flow, and wealth generation. But, like any other investment avenue, it has its unique nuances and terminologies that can initially appear as murky as the deepest ocean. One such term is the ‘waterfall’ structure, an essential element in the multifamily investing ecosystem. This blog aims to shed light on multifamily investing and the pivotal role of the waterfall structure in it. Brace yourselves for a deep dive into the multifamily ocean!
Understanding the Multifamily Investing Landscape

Multifamily investing is a popular strategy that involves investing in properties with more than one unit, such as duplexes, triplexes, apartment buildings, and more. These properties have the advantage of being income-producing, thanks to multiple tenants paying rent. This sets the stage for a steady cash flow, one of the chief attractions of multifamily investing.
With the right property in a desirable location, multifamily investing can yield significant returns on investment. The nature of these properties allows you to spread the risk across several units, unlike single-family homes where a vacancy means no income. With multifamily properties, even if one or two units are vacant, the rent from the occupied units can help cover your expenses.
But what truly sets multifamily investing apart is the level of control investors have over the value of their properties. In the commercial real estate world, the value of a property is determined by its Net Operating Income (NOI). By making improvements that increase the property's income or decrease its expenses, you can directly boost its value. This principle, known as forced appreciation, is an incredible wealth-building tool in the multifamily sector.
Waterfall: The Flow of Profits

The term ‘waterfall’ might evoke images of cascading rivers, but in the multifamily investing space, it represents the flow of profits. Simply put, a waterfall structure is a legal and financial model outlining the process through which capital gains are distributed among investors after a property is sold or refinanced.
Waterfalls are crucial because they dictate how and when investors will receive their share of the profits, beyond the return of their original investment. A typical waterfall structure includes return of capital, preferred return, and profit splits.
The return of capital is straightforward. It means that the initial investment is returned to the investors first. Next comes the preferred return, which is a predetermined percentage return on the initial investment that investors receive before the sponsor (i.e., the deal organizer) gets any profit. The preferred return is often in the range of 6-10%.
Once the return of capital and the preferred return are paid out, the remaining profits are split between the investors and the sponsor. This is usually done based on an agreed-upon percentage, often following a tiered structure. For instance, the initial profit split might be 70% to the investors and 30% to the sponsor until a certain internal rate of return (IRR) is reached. After that, the split could change to 50/50, incentivizing the sponsor to maximize the project's profits, depending on the operating team and this varies from project to project.
Waterfall in Multifamily Syndications
In multifamily syndications, which are group investments where investors pool their resources to purchase a property, the waterfall structure plays an even more significant role. It becomes the key to understanding the potential profits you could earn on your investment.
When evaluating a syndication opportunity, understanding the proposed waterfall structure is critical. It directly impacts your potential returns and the risks associated with the investment. An ideal waterfall structure in a multifamily syndication is one that aligns the interests of the sponsor with those of the investors.
In a well-structured deal, the sponsor should earn a significant portion of their profits from the sale of the property, aligning their interests with those of the investors. This incentivizes the sponsor to work diligently to increase the property's value and ensures that they don't make their profits solely from fees.
Key Considerations for Waterfall Structures
When assessing the waterfall structure of a multifamily syndication deal, there are a few things you should consider. Firstly, understand the return of capital clause. Ensure that the full initial investment is returned to the investors before the profits are split.
Next, review the preferred return. Is it cumulative or non-cumulative? A cumulative preferred return means that if the full preferred return isn't met in one year, the shortfall will be added to the next year's preferred return. A non-cumulative preferred return doesn't offer this provision.
Finally, look at the profit split. Does it change after a certain IRR is reached? If so, this could incentivize the sponsor to maximize the property's value.
Making the Most of Multifamily Investing

Understanding multifamily investing and the waterfall structure is key to making informed investment decisions and maximizing your returns. As you navigate through the multifamily investment landscape, remember that knowledge is your most valuable asset. So, keep exploring, keep learning, and let the cascading profits of the waterfall be your guide to financial growth!
With this comprehensive exploration of multifamily investing and waterfall structures, you're now equipped to dive headfirst into the world of multifamily investing. Just remember, the real estate landscape, much like the ocean, is vast and deep. Equip yourself with the right knowledge, approach each investment opportunity with an analytical mind, and you're well on your way to achieving your financial goals. Let the journey to wealth generation begin!
If you'd like to learn more about waterfalls and profits shared when multifamily investing, feel free to schedule a complementary exploratory call with us here!
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