Preferred Equity

Preferred Equity investments in a junior position behind senior debt, but senior to the Sponsor’s investment and Joint venture equity. Preferred equity investors are typically structured with two forms of return. There is an annual payback, the “preferred return”, a return paid by the sponsor at a negotiated rate. There is also typically a payback from the profits after a sale or refinance at the end of the project term. Both the preferred return and the “kicker” at the capital event are typically capped at a certain return percentage, leaving the majority of the upside to the Sponsor and common equity partners, but offering the security of predictable annual returns and less downside risk by comparison.

Situation Suited to Preferred Equity:

  • A Sponsor is seeking a $2 million preferred equity investment for a value-add multifamily project. The sponsor plans to acquire the occupied property, and over a period of 5 years make capital improvements and increase rents. At the end of the 5-year period, the sponsor will refinance the property with a new loan at the increased value, paying back investors a portion of the profit. The sponsor will remain holding the asset, but the preferred equity investor will have the opportunity to exit the deal at the refinance. The sponsor offers preferred equity investors an annual 8% return on their investment, the “preferred return”, as well as 15% of the upside at the refinance. The preferred equity investor is able to exit the deal after 5 years, averaging a 12% annual return on their initial investment.