This article is part of our passive investors guide on real estate syndications, available here.
The promote interest is a great incentive to motivate real estate sponsors to keep creating, executing and managing real estate deals on behalf of passive investors.
This article will cover the promote interest, carried interest, and how these terms align interest. By understanding these concepts, investors can better understand the inner workings of a private real estate investment and make more informed decisions about their investments.
Key Takeaways
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Promote interest, also known as “promoter’s interest,” refers to the share of profits that are allocated to the individual or entity responsible for sourcing, structuring, and negotiating the real estate investment.
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Carried interest, also known as “carry,” refers to the share of profits or return on investment allocated to the real estate sponsor/general partner in a real estate investment.
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Alignment of interest refers to the extent to which the interests of the investment real estate sponsor/general partner and the limited partner/passive investors are aligned.
Promote Interest Definition
Promote interest, also known as “promoter’s interest,” refers to the share of profits that are allocated to the individual or entity responsible for sourcing, structuring, and negotiating the real estate investment.
This can include finding and evaluating potential investment properties, arranging financing, and negotiating terms with various parties involved in the transaction. In real estate investing, the promote interest also includes a share of profits from the sale of the property.
Promote interest is typically paid in addition to any other returns or profits that an investor may receive from the investment. It is meant to compensate the real estate sponsor/general partner for the time, effort, and expertise they contribute to the real estate project.
Carried Interest Definition
Carried interest, also known as “carry,” refers to the share of profits or return on investment allocated to the real estate sponsor/general partner in a real estate investment. This is typically a percentage of the profits generated by the investment. It is meant to compensate the investment manager for their work to manage the asset and generate returns for equity investors.
Carried interest is often structured as a performance fee, meaning it is only paid out if the investment generates a certain level of returns. This aligns the interests of the real estate sponsor/general partner with those of the investors, as the manager only receives carry if the investment performs well.
Carried interest and the promote interest are interchangeable terms. In traditional private equity, it’s often referred to as the promote, and in private real estate investing, it’s often referred to as the “carry”.
How the Management Promotes Ensures Alignment of Interest
Alignment of interest refers to the extent to which the interests of the investment real estate sponsor/general partner and the limited partner/passive investors are aligned. In other words, it refers to the degree to which the sponsor’s interests are aligned to maximize returns for the investors.
Real estate investment managers can ensure alignment of interest by structuring carried interest as a performance fee, as mentioned above. This ensures that the manager only receives carry if the investment performs well and generates returns for the investors.
Another way to ensure alignment of interest is through “waterfall” structures, in which the real estate sponsor/general partner only receives carried interest after the investors have received a specific pre-determined return hurdle. This helps to ensure that the manager’s interests are aligned with those of the investors, as the sponsor only receives carry once the investors have received a certain level of return on their investment.
Promote Interest Example
To better understand the real estate sponsor promote interest and how it works, let’s consider the following example:
Imagine that a real estate sponsor is looking to acquire a multifamily apartment building in a desirable location. The sponsor sources the property, negotiates the purchase price, and arranges financing for the acquisition.
Once the acquisition is complete, the sponsor manages the property and works to increase its value through various means, such as making significant physical improvements to the units’ interiors and exteriors. They also created operational efficiency and employed other ways to lower operating costs and increase occupancy rates.
In this scenario, the sponsor would be entitled to a share of the profits generated by the investment, known as the promote interest or the carried interest. Let’s say the sponsor promote was 30%, which means that the sponsor gets to share 30% of the upside in the value they created in the property.
Frequently Asked Questions About The Promoted Interest
Yes, the promote and carried interest are the same. The promote is often used in traditional private equity, while carried interest is more commonly used in private real estate investing.
The promote in a waterfall structure is the cash flow splits and the additional share of profits a real estate sponsor is entitled to over and above a specific pre-determined return hurdle rate.
Promote Interest - Conclusion
The promote interest or carried interest is a necessary way of fairly compensating and incentivizing real estate sponsors in a syndication or investment fund to create the opportunity for investors to invest passively.
The alignment of interest is there for both general partners and limited partners to share each of their resources. For limited partners, that’s their capital, and for general partners, that’s their expertise, relationships, and time.
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