The preferred return is the threshold return (annually) that the limited partners are offered before the sponsor receives any payment. After all the operating expenses and debt service has been paid, the cash flow remains. This is where the distributions come from, and you can view this cash flow in the profit-and-loss statement available each month. What the limited partners receive is based on their original capital and the preferred return. For example, if a limited partner invests $100,000 and you offer an 8% preferred return, they receive $8,000 per year in distributions. Let’s say the sponsor has 10 limited partners in the deal who each invested $100,000 with an 8% preferred return, requiring the sponsor to distribute $80,000 annually. If cash flows are less than $80,000 each year, then the sponsor would first distribute whatever the amount of the cash flow is – say, $60,000 – to his limited partners. In this scenario the sponsor wouldn’t receive his split of the profits. This means that $20,000 would accrue to be paid at closing (this is a situation where you want to make sure there is a “catch-up” provision in the PPM). So if the actual returns are less than the preferred return, the preferred return will accumulate until it can be paid retroactively with the cash gains at sale.