What is a Preferred Return?

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What is a Preferred Rate of Return?

A preferred return is a minimum rate of return that investors receive before a general partner or sponsor can earn a performance fee or participate in an investment's profits. It's also known as a hurdle rate. 

Preferred returns are commonly used in real estate and private equity investing. They can be expressed as a percentage or equity multiple. For example, an 8% cumulative return on the initial investment is a preferred return. 

Preferred returns are important because they:

  • Reward early investors

  • Show confidence in profitability

  • Align the interests of investors and operators

  • Shape investor risks, rewards, and partnerships 

In real estate investing, preferred returns are typically between 6% and 9% depending on the investment's risk. They are calculated by the sponsor on a compounding or simple interest basis. 

The exact mechanics of preferred returns can vary based on the operating agreement and subscription documents signed by investors.