Return of capital strikes again

Don't budge on return of capital, 2.0

Happy Sunday!

Don't budge on return of capital was one of the first articles I wrote on this newsletter - September 2023, back when the subscriber count was far less than 10,000! Thank you for being a part of my journey.

After nearly 2 years of advising LPs full time since then, I felt the need to revisit the topic for a few reasons. It’s a good idea to read the last article before you continue, particularly if you’re new to the topic, its terms, or importance.

Today we’ll cover:

1. updated list of articles related to this very important principle

2. how my views on the importance of return of capital has changed in 2 years

3. cash flow vs capital event splits and implications to return of capital

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Announcements (article continued below):

1. 🆕GP-LP Match has a new website, Twitter and LinkedIn page - I will be posting a lot more there for content related to the platform so please consider following along and sharing!

2. Latest article: Why multiple IRR hurdles is an overkill - why simple alignment beats fancy structures

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1) Updated list of articles related to this very important principle:

• Return of capital is a legal clause that forces the first “profit” dollars to be sent to the LP rather than being split between the GP and LP. A typical waterfall upon a sale of a property looks like this:

  • first 8% preferred return (typically accrued as opposed to cash) to LP

  • then full return of capital to LP (i.e. if you invested $100,000 you have to get it back prior to hitting the next step of the waterfall)

  • lastly, a split between the GP (typically ~20%) and LP (~80%)

    • note that some waterfalls have multiple hurdles, which I actually wrote about last week

• Return of capital is part of a waterfall, which I consider to be a single variable (of 3) within the Alignment of Interests pillar of LP investments. Here are the 3 Pillars of LP investments:

  • Execution - track record and counterparty risk

  • Alignment of Interests - coinvest, waterfall, and fees

  • Property - valuation and business plan

• The reason why return of capital is important is that nobody should be investing in real estate deals for vc-like returns, and therefore downside protection is really important

  • More on why I like to think of real estate returns as being capped in probability, thereby making real estate investment diligence particularly important to limit downside

  • More on the long term impact of losing capital here (hint: it takes way longer than you think to recoup losses)

  • More on the easiest ways to lose money in real estate

With that out of the way, let’s get into so updated thoughts:

2) How my views on the importance of return of capital has changed in 2 years