Covenants, Waterfalls & Distribution Priorities
Every real estate deal is a structured financial agreement where covenants protect investors, waterfalls control how cash flows are distributed, and distribution priorities determine who gets paid first, shaping both risk and returns.
Introduction
Every real estate deal is more than just bricks and mortar, it is also a carefully structured financial agreement that dictates who gets paid, how much, and when. At the heart of this structure are three critical elements: covenants, which impose rules and restrictions to protect investors; waterfalls, which govern the sequence of cash flow distribution; and distribution priorities, which establish who stands first in line for repayment. Together, these mechanisms shape both the level of investor protection and the potential return profile.
Covenants: Guardrails for Investors
Covenants are legally binding clauses embedded in financing and investment agreements. They serve as protective guardrails that limit risk by setting both financial and operational conditions. Financial covenants typically include requirements such as maintaining a loan-to-value ratio below a certain threshold or ensuring that the property generates enough income to cover debt payments comfortably, measured by the debt service coverage ratio (DSCR). Operational covenants can restrict additional borrowing, set minimum property standards, or impose requirements to maintain occupancy levels. Reporting covenants, meanwhile, oblige sponsors to provide regular financial statements and project updates.
For investors, strong covenants are a double-edged sword: they safeguard capital but may restrict flexibility for the sponsor, influencing how aggressively a project can be managed.
Waterfalls: The Sequence of Cash Flow
If covenants act as rules of the road, waterfalls are the roadmap for how profits and cash flows are divided. A waterfall outlines the precise sequence in which money is distributed from project operations, refinancing, or sale. In a typical structure, investors first receive a return of their capital, followed by a preferred return, often expressed as a fixed annual percentage. After this, many deals include a “catch-up” provision that allows the sponsor to claim a share of profits until they reach a predefined threshold. Only then are the remaining profits split between investors and the sponsor, commonly in ratios like 80/20.
To illustrate, consider an investor who contributes S$1 million to a project with an 8 percent preferred return and an 80/20 profit split. That investor first recoups their capital, then earns the 8 percent return. Once satisfied, any additional profits are divided, 80 percent flowing to the investor and 20 percent to the sponsor.
Distribution Priorities: Who Gets Paid First
While the waterfall describes the order of distribution within a deal, distribution priorities establish who is entitled to cash flow at each level of the capital stack. Senior debt is always paid first, followed by mezzanine lenders, then preferred equity holders. Only after these claims are satisfied do common equity investors receive what remains.
The position an investor occupies in this hierarchy fundamentally affects both risk and reward. Those lower in the stack, such as senior lenders, enjoy greater protection but lower returns, while those at the top, such as common equity holders, face more uncertainty but capture the upside if a project performs well.
How RealVantage Structures Deals
At RealVantage, our approach to deal structuring emphasises both protection and fairness. Conservative covenants are embedded into agreements to guard investor capital, while waterfall provisions are carefully designed to align the incentives of investors and sponsors. Distribution priorities are made explicit so that investors always know where they stand in the repayment order. Transparency is central to this process, our investment memos clearly outline the covenants, waterfalls, and priorities in plain language so that there are no hidden surprises.
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About RealVantage
RealVantage (operating as RV SG Pte. Ltd. in Singapore) is a leading real estate co-investment platform, licensed and regulated by the Monetary Authority of Singapore (MAS), that allows our investors to diversify across markets, overseas properties, sectors and investment strategies.
The RealVantage team comprises professionals across real estate, corporate finance, technology, venture capital, and startup growth. The platform combines institutional deal sourcing with structured underwriting and portfolio diversification capabilities. The team is led by a distinguished Board of Advisors and advisory committee who provide cross-functional and multi-disciplinary expertise to the RealVantage team.
The company's philosophy, core values, and technological edge help clients build a diversified and high-performing real estate investment portfolio.
Get in touch with RealVantage today to see how they can help you in your real estate investment journey.
Disclaimer: The information and/or documents contained in this article do not constitute financial advice and are meant for educational purposes. Please consult your financial advisor, accountant, and/or attorney before proceeding with any financial/real estate investments.