Preferred Return
AdvancedA preferred return is the minimum annual rate of return that investors in a private fund or investment must receive before the manager can share in the profits through carried interest.
Private equity, real estate and other private investment funds commonly set a preferred return, also called a hurdle rate, often around 8% a year. It ensures that managers are rewarded with a share of profits only if investors first earn a reasonable return.
For example, if investors contribute 100,000,000 and the fund has an 8% compounding preferred return, investors must receive about 146,900,000 after five years, their capital plus the preferred return, before the manager earns carried interest on that period's profits.
Once the preferred return is met, many funds include a catch-up, which gives the manager a larger share of further profits until it has received its agreed percentage, often 20%, of total profits. After that, profits are split according to the agreed ratio.
The preferred return is set out in the fund's partnership agreement and forms part of the distribution waterfall. In real estate deals, preferred returns may also be paid to certain classes of investors before others.
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