The term Preferred Return is not exclusive to the Qualified Opportunity Fund (QOF) industry but is a concept used in various investment contexts, including private equity, real estate, and venture capital. In the context of a QOF or other investment vehicles, a preferred return refers to the minimum return that investors are promised before the general partners or fund managers start sharing in the profits.
Here’s a basic breakdown:
- Preferred Return: This is the initial rate of return on an investment that limited partners (or investors) are promised. It’s typically expressed as an annual percentage.
- Hurdle Rate: This is another term that is sometimes used interchangeably with preferred return. It indicates the minimum rate of return on an investment required by an investor.
- Distribution of Profits: Once the preferred return is achieved and distributed to the investors, any additional profits are usually split between the limited partners (investors) and the general partners (fund managers). The specific split is determined by the fund’s agreement but could be something like 80/20, where 80% of the profits above the preferred return go to the investors and 20% to the fund managers.
In the context of the QOF industry, the preferred return can be an attractive feature for investors. QOFs were established by the Tax Cuts and Jobs Act of 2017 to incentivize long-term investments in economically distressed communities designated as Opportunity Zones. Given the potential risks associated with investing in these areas, a preferred return can offer some assurance to investors about a base level of return on their investment.
However, it’s essential to note that a preferred return is not a guarantee. If the fund doesn’t perform well enough to achieve the preferred return, investors might not receive that return. The specifics would be detailed in the fund’s operating agreement or the subscription documents.