Preferred equity in real estate is a financing solution that is common among commercial real estate investments or individual equity funds. In the world of commercial real estate, preferred equity systems are much alike as preferred stock does in corporate society.
It plays a supporting role in all forms of debts but still holds a place in common equity. Owners of preferred equity begin to receive their respective related payments when lenders are repaid. Check out for more details on preferred equity real estate financing.
In simple terms, there are two types of capital usually applied in any real estate transaction; debt and equity. “Debt” implies borrowing money to be repaid with interest and raising money by selling interests in the company is “equity”.
Basically, you will have to choose whether you want to pay back a loan or give shareholders stock in your company. Debt is something that requires to be paid off after a certain period but raised money by issuing shares to general people which is kept for a long period is known as Equity.
Preferred equity is more like a hybrid product, it offers a share of upside and the priority of payment is over common positions. It can be attractive at all platforms of the market cycle but specifically near or at the top of the market. This system also resembles mezzanine debt in the procedure system, but with a slightly different approach.
Mezzanine debt functions represent bridge financing rather than being stable by the underlying property, but Preferred equity is normally entitled to force sale of property in non-payment method. It also includes an “equity kicker”, an additional entitlement that profits if the project performs well but the mezzanine does not.
To put it simply, both mezzanine debt and preferred equity deliver gap funding but carry some unique differences. Let’s not also forget, preferred equity provides developers and sponsors a much larger degree of leverage at a cheaper cost than common equity. It allows grabbing a fixed rate return with the priority of payment and some upside to the real estate investors.
In any case, if the property is restrained by senior mortgage debt, the investor or preferred equity investor must ensure that the investment and remedies don’t violate the terms and conditions of the loan documents. The preferred equity investor must make privity with the senior lender through a recognition agreement.
With having no “standard” form of recognition agreements, these agreements are becoming quite corresponding with senior loan-mezzanine loan inter-creditor agreements, as preferred investments are highly turning more debt-like.
Though the preferred equity has some of its own advantages and disadvantages. Investors who are with preferred stock receive the first gratuity and some stock also delivers cumulative shares. It provides the investors with a good claim on any company’s assets.
The individual might have to choose to take in preferred shares for common stock. The rising capital cost for share allocation is pretty much lower. There might be some tax advantages to consider when it comes to preferred stock and can receive gradings from rating agencies.
Just like mentioned earlier, it does not always come up with advantages. The individual loses his / her voting rights. Some companies do not use their share of profit in dividend payments and also the time to maturity can be problematic for some investors. Sometimes even guaranteed dividends do not get paid.
It also creates limited upside capacity. Industry diversification is not much for preferred stock nowadays. The lower level tradeoff of market risk against common shares is there’s only a little activity in the equity value of the investment. So there are many important things and issues to consider when it comes to preferred equity.
The bottom line is, in today’s real estate market situation where prices have continued to climb even greater, it is not infrequent for preferred equity to obtain double-digit returns. This results in preferred equity to have a highly attractive opportunity for investors to get into the market of commercial real estate.