Private mortgage fund managers run recurring questions on the quarterly waterfall framework. This article answers the questions on the tier framework, the reserve framework, the K-1 framework, and the corrective framework against the waterfall execution cycle.

What is a waterfall distribution?

A waterfall distribution runs the priority framework against the fund’s distributable cash on a defined tiered allocation framework. The framework runs the cash through preferred return, return of capital, catch-up, promote, and residual split — each tier runs in priority against the next tier on the operating-agreement framework.

What is the preferred return rate?

The preferred return rate runs the operating-agreement’s defined annualized rate against the investor’s unreturned capital base. The standard runs a single-digit annualized rate on the cash-on-cash framework or the accrued framework. The rate runs against the fund’s asset framework, the fund’s investor-base framework, and the fund’s performance discipline framework.

What is the catch-up?

The catch-up framework runs the manager’s pro-rata share against the cumulative preferred-return distribution. The framework runs the manager to the economic-split target before the residual tier runs. The catch-up framework runs the manager’s incentive framework against the fund’s performance discipline.

What is the promote (carried interest)?

The promote framework runs the manager’s carried-interest share against the distribution cycle. The framework runs the manager’s defined percentage of profits above the preferred-return hurdle against the residual-tier framework. The promote runs the manager’s economic-incentive framework against the fund’s upside.

What runs the reserve framework?

The reserve framework runs against four categories — loss reserves, liquidity reserves, recapture reserves, and opportunity reserves. The framework runs the fund’s distributable cash on a reserve-net framework before the waterfall runs. The framework runs against the operating-agreement discipline and runs the manager’s good-faith framework against the lender-investor base.

How does the K-1 framework run?

The K-1 framework runs the partnership taxation framework under IRC Subchapter K against the fund’s pass-through entity classification. The framework runs the income-and-deduction allocation framework against the investor’s capital account on a separate framework from the distribution. The fund issues the K-1 against each lender-investor on the annual cycle.

What is a preferred-return arrearage?

A preferred-return arrearage runs on the accrued framework when the fund runs a partial or zero preferred-return distribution against the lender-investor base on a quarter. The unpaid preferred runs to the subsequent quarter on the cumulative framework. The fund runs the arrearage framework against the investor-reporting cycle and runs the arrearage paydown against the subsequent distribution cycles.

How does the fund report the waterfall?

The fund runs the investor-reporting framework against the waterfall calculation on each quarter. The framework runs the tier-by-tier disclosure against the lender-investor base — preferred return on the unreturned capital base, return of capital, catch-up, promote, and residual split. The framework runs the cumulative-distribution framework against the investor on the annual cycle.

Related Topics

This article is educational and does not constitute legal, tax, or investment advice. The waterfall framework runs under the fund’s operating agreement, the partnership-tax framework under IRC Subchapter K, and the Investment Company Act framework against the fund. Consult qualified legal, tax, and SEC counsel on the specific waterfall framework against any private mortgage fund.

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