Deal Structuring and SPV

Deal Structuring in Real Estate

Effective deal structuring is a critical element of success in real estate investments. The right structure optimizes the tax burden, allocates risk among the parties, determines decision-making mechanisms, and creates appropriate incentives for all participants.

SPV/SPE: Why Special Structures Are Needed

Definition

An SPV (Special Purpose Vehicle) or SPE (Special Purpose Entity) is a legal entity created specifically to own one or several real estate assets.

Main Purposes of an SPV

Limiting liability (Ring-fencing) — isolating assets and liabilities from other investments
Non-recourse financing — the loan is secured only by the assets of the SPV, not affecting other property
Bankruptcy remoteness — protection of the asset from sponsor bankruptcy
Tax efficiency — optimal structure for a specific jurisdiction
JV structure — a convenient platform for joint investments
Simplified exit — sale of shares in the SPV instead of the real estate itself

Typical SPV Forms

Jurisdiction	Form	Characteristics
USA	LLC (Limited Liability Company)	Pass-through taxation, flexibility
USA	LP (Limited Partnership)	GP/LP split, pass-through
Delaware	Delaware Statutory Trust (DST)	For 1031 exchanges
Cayman	Exempted Limited Partnership	Tax neutral, for international investors
Luxembourg	SCSp, SCA, SICAV-SIF	European real estate funds
UAE (DIFC)	LLP, Limited Partnership	Regional structures

Structuring Debt Financing

Capital Stack: The Capital Hierarchy

Typical capital structure of a real estate project:

Layer	LTV	Yield	Risk	Rights
Senior Debt	0-60%	SOFR + 200-350 bps	Low	First lien, full recourse upon default
Mezzanine	60-75%	10-14%	Moderate	Second mortgage or pledge of equity
Preferred Equity	75-85%	12-18%	High	Equity position with priority over common
Common Equity	85-100%	15-25%+ IRR	Highest	Last money in, first money out in case of loss

Senior Debt: Key Terms

LTV (Loan-to-Value): Typically 50-65% for stabilized assets
LTC (Loan-to-Cost): 60-70% for development
DSCR (Debt Service Coverage Ratio): NOI / Debt Service, minimum 1.25-1.40x
Debt Yield: NOI / Loan Amount, minimum 8-10%
Interest-only period: 1-5 years for value-add projects
Amortization: 25-30 years for permanent loans
Prepayment: Yield maintenance, defeasance, or declining penalties

Mezzanine Debt

Structure: Loan secured by shares in the SPV (not directly by the real estate)
Rights: UCC foreclosure (faster than mortgage foreclosure)
Intercreditor agreement: Agreement with senior lender on rights
Standstill provisions: Restrictions on actions in case of default
Use: Bridge financing, boosting equity returns

Preferred Equity

Difference from mezz: Equity position, not debt (important for covenant compliance)
Preferred return: Fixed or PIK (Payment-in-Kind)
Redemption rights: Put/call mechanisms
Participation: Sometimes upside participation above the preferred return
Control triggers: Right to take control upon certain events

JV Waterfall Structures

Waterfall Concept

Waterfall is a mechanism for the distribution of cash flows and profits among JV participants. The structure defines the order (priority) of payments and the “steps” (hurdles) for changing distribution proportions.

Typical LP/GP Waterfall Structure

Return of Capital — return of invested capital (100% LP/GP pro-rata)
Preferred Return — priority yield to LP (typically 8-10% IRR)
GP Catch-up — equalizing GP’s return to the level of the preferred return
Profit Split Tier 1 — up to first hurdle (e.g., 15% IRR): 80/20 LP/GP
Profit Split Tier 2 — up to second hurdle (e.g., 20% IRR): 70/30 LP/GP
Profit Split Tier 3 — above second hurdle: 60/40 or 50/50 LP/GP

Example of Waterfall Calculation

Suppose: LP invested $9 million, GP invested $1 million (90/10). Project sold with a $10 million profit.

Step	Distribution	LP receives	GP receives
Return of Capital	$10M pro-rata	$9M	$1M
8% Preferred to LP	$720,000 (8% × $9M × 1 year)	$720,000	$0
GP Catch-up	$80,000 (up to 8% on GP capital)	$0	$80,000
Remaining Profit (80/20)	$9.2M remaining profit	$7.36M	$1.84M
Total	$17.08M	$2.92M

LP IRR: ~25%, GP IRR: ~100%+ (promote effect)

Promote and Carried Interest

What is Promote?

Promote (Carried Interest) is an additional share of profit received by the GP above their proportional share of capital. This is the main mechanism for rewarding the GP for creating value.

Types of Promote Structures

Lookback (True-up) — recalculate promote at final liquidation
Deal-by-deal — promote calculated separately for each project
Whole fund — promote calculated at the fund level
Clawback — GP’s obligation to return excess promote received

Typical Levels of Promote

Deal Type	Preferred Return	First Hurdle	Promote after hurdles
Core	6-7%	8-9% IRR	20-25% of profits
Value-Add	8-9%	12-15% IRR	25-35% of profits
Opportunistic	10-12%	15-20% IRR	30-40% of profits
Development	10-12%	18-22% IRR	35-50% of profits

Tax Aspects

Depreciation

Straight-line: 39 years for commercial, 27.5 years for residential (US)
Bonus depreciation: Accelerated depreciation (100% in the first year for qualifying property)
Cost segregation: Allocating components with shorter depreciation terms
Depreciation recapture: Tax at sale on previously taken depreciation

1031 Exchange (USA)

A mechanism for deferral of capital gains tax when exchanging “like-kind” real estate:

Timing: 45 days to identify, 180 days to close
Like-kind: Any investment real estate for another
Boot: Cash or non-qualifying property is subject to tax
DST: Delaware Statutory Trust as replacement property

REIT Tax Status

Distribute 90%+ of taxable income as dividends
No corporate tax on distributed income
Restrictions on types of assets and income

Key Transaction Documents

SPV and JV Documentation

Operating Agreement (LLC) or LPA (LP) — primary governance document
Subscription Agreement — investors’ funding commitments
Side Letters — individual terms for large investors
Management Agreement — property management terms

Key Provisions in the Operating Agreement

Capital Contributions: Schedule and conditions for contributions
Distributions: Waterfall and timing
Major Decisions: What requires LP consent (sale, refinancing, budget)
Removal Rights: Conditions for replacing GP
Transfer Restrictions: ROFR, tag-along, drag-along
Default Remedies: Consequences of non-performance
Reporting: Frequency and contents of reporting

Loan Documentation

Loan Agreement: Main credit terms
Promissory Note: Borrower’s obligation
Mortgage/Deed of Trust: Lien on real estate
Environmental Indemnity: Environmental indemnification
Guaranty (Carve-out): Personal guarantees for “bad boy” carve-outs
Assignment of Leases and Rents: Assignment of lease payments
UCC-1: Pledge of personal property

Recommendations for LP Investors

Understand the waterfall: The promote model significantly affects net returns
GP co-investment: Minimum 5-10% “skin in the game”
Clawback protection: Mechanism for returning excess promote
Major decision rights: Control over key decisions
Reporting standards: Quarterly financial statements, annual audits
Fee transparency: Understanding all fees (acquisition, asset management, disposition)
Alignment check: How the structure affects GP behavior