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Have you ever heard the phrase preferred return?

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What is a preferred return for investors?

Many syndicators use what's called a preferred return or pref as part of their payout structures. To be a smart passive investor, it’s key to understand these payment structures, what they are and how they incentivize people.

A preferred return is the minimum return that investors must get before the syndicators – the people who put together the deal – get money. This is expressed as a percentage.

If you hear someone talking about an eight prop, it means that the investors themselves would get 8% before the people who put together the deal would get any money on the deal from the operational cash flows.

Are these preferred returns always considered a good thing?

LPs, or limited partners, may see prefs as a good thing because they are put at the front of the line. So, yes, people tend to like prefs.

But at Nighthawk, we want to be aligned with our investors. From that perspective, prefs might be a bad thing.

For instance, let's say there's a property you've given out in eight pref and it consistently over the first three or four years is returning 5, 6, 7 percent to the investors. Not only does it not meet that 8% hurdle, it's actually creating a deficit. It's creating an IOU, and in that world, it's very possible and it’s very common for the syndicators to become unmotivated by the asset and not work as hard on executing their business plan.

As a result, they don't make that property the best it can be. It not only never meets the pref of 8%, but the syndicators aren't working as hard on making it super valuable, and for that reason, we have historically stayed away from prefs.

We want to stay aligned with our investors. When they do well, we do well. When that happens, everyone wins.

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