What is a Catch-up in Real Estate Financial Modeling?

Catch-up Clause Overview

A catch-up is a provision in a waterfall structure that allows the sponsor (GP) to receive a larger share of profits after the investors (LPs) have received their preferred return, ensuring the GP is fully compensated for their promote (carried interest) before standard profit splits begin.

How a Catch-up Works

1. Investor First (Preferred Return)
   • Investors (LPs) receive all distributions until they achieve a hurdle rate (e.g., an 8% preferred return on their invested capital).
2. Catch-up Phase
   • After LPs receive their preferred return, the sponsor (GP) receives 100% of profits (or a high percentage, such as 80%-100%) until they "catch up" to their intended promote share of total profits.
   • This ensures the sponsor is fully rewarded before profits are split according to the final waterfall tiers.
3. Final Profit Split (Standard Promote Kicks In)
   • Once the GP has caught up, profits are split according to the agreed-upon promote structure (e.g., 80/20 or 70/30 split between LPs and GP).

Example of a Catch-up in a Waterfall

• LPs receive an 8% preferred return first.
• GP receives 100% of profits next until they receive 20% of total profits (if the promote is 20%).
• After the catch-up is complete, remaining profits are split 80% to LPs, 20% to GP (or another agreed-upon ratio).

Why It Matters

• Aligns incentives by ensuring the GP gets their full share once investors are paid.
• Encourages strong performance, as the GP benefits from exceeding investor return hurdles.
• Common in private equity real estate funds and joint venture agreements.