Take a look at the waterfall in action for a hypothetical restaurant.
- All right, want to show you what's different about this version of the model now. There's a few extra worksheets, okay. There is the investor assumptions worksheet. Now, this should look very familiar to you because, well, it's exactly the same structure as the waterfall framework examples that we did in the earlier lectures here. And what's additional is there's some charts now that charts out the returns for the investors, kind of their investment out and their cash flow in, and then also the numbers as a P&L format and then the actual waterfall calculation here, which is the same as the examples that we've seen, except now it is done on a month to month basis.
For fix and flips, we want to go on a month to month because, well, the timeline for fix and flips is in terms of month to month. That's why the year to year wouldn't work in this case, all right. So let's go back to the investor assumptions worksheet now. How do we use it in this model? And this assumes that all of your other assumptions about the project itself is done. Okay, so you've done your cost estimates for the fix and flip. You have made your assumptions about your purchase price, timing of your construction projects, whether you're taking on debt and how much, how long you're holding it for and what you're selling it at.
So all of the project-level returns are here. Okay, project level information. In this case, the default settings here shows a profitable fix and flip that's done in three months. Okay, so with that out of the way, let's look at this waterfall framework here now. You'll see that this looks like the four-tier waterfall structure, and it is. It has four tiers here. We have the preferred return. We have the secondary hurdles. And then we've got the catch up.
And then we have the final split. All right, now, I put four tiers here because you have the choice or the option to go up to four tiers but you don't have to use it. If we look at the numbers here carefully right now, what we see is that here the second tier, I have set it for default at a hundred percent to the managers, so and at zero IRR and zero gross multiple. So basically I just kind of made this second tier here irrelevant, 'cause all of it's going back to the investor anyways and there's no hurdle to meet or to pass.
So then it goes immediately to the next part, which is the catch up. And I gave it a 0% catch up to the managers, which makes it effectively not part of this tier now. So by putting a zero in the catch up, you're basically taking the catch up out of the waterfall. So effectively what I did here is to make it into a two-tier rate. There's the preferred return. And once it's past this preferred return, it goes straight to the split, the final split here, which in this case is 60/40.
So what you have with this model then is the normal model, you have all your assumptions, you get to see what the project does at the project level in terms of the return. Then with the investor assumptions, you get to see how it does with the different investors that are involved. So if you're not doing this project on your own and you have some other folks who are doing this, you can model that out here now. And you don't have to use all five investors, right? If you only have two investors, you can clear out these, clear out these numbers, and you can ignore the rest and just look at the numbers for the two folks that are involved.
So you can do that as well. But if you want to use, say, a three-tier, you can do that now, right? So you just adjust this to what your second tier might be. Put in your assumptions. Put in your assumptions around the multiples. And we see that with the multiples with the tiers, now it adjusts it so this kicks in before the final split. So it lowers the return of the project manager, Albert, a little bit and then brings it back, okay.
All right, so that is the fix and flip investment model with the waterfall framework. And you can essentially use this model now to evaluate any fix and flip opportunity that you have and look at how it would look like if you were to make this investment with other people and whether somebody's serving as a project manager or not and how you structure your waterfall framework with the other investors involved for that investment.
So you can get a sense of what it would look like based on everything and what it would look like for each investor, what they're expected to invest versus what their profits are going to be. So use this for your own investments, for your fix and flips. In the next lecture, we're going to go over the rental income investment model but with the waterfall framework included so you see what that looks like and how you can use it. (hypnotic music)
- Risks of real estate investing with partners
- Waterfall examples: 2, 3, and 4 tiers
- Choosing a waterfall model
- Accounting for losses
- Tracking rental income using the waterfall framework
- Analyzing fix and flips using the waterfall framework