A preferred return (also called a hurdle rate) is the minimum rate of return that limited partners must receive on their invested capital before the general partner is entitled to any carried interest. The standard preferred return in private equity and real estate funds is 6-8% annually, though it varies by strategy, market conditions, and LP negotiation.
How Preferred Returns Work
In a typical waterfall structure: first, LPs receive return of their contributed capital. Then, LPs receive their preferred return (e.g., 8% annually, compounded). Only after these thresholds are met does the GP begin earning carried interest — usually through a catch-up provision that brings the GP's total share to the agreed carry percentage (e.g., 20%), followed by an ongoing profit split.
Compounding and Calculation Methods
Preferred returns can be structured as simple interest or compound interest, and may be calculated on contributed capital, committed capital, or invested capital — each producing different outcomes. The compounding method and calculation basis significantly affect LP returns and GP carry timing. Automated waterfall engines handle these variations accurately across investor classes, including side letter modifications that may grant different preferred return rates to different LPs.