Exploring Preferred Equity: A Strategic Capital Solution for Multi-Family Assets

In the complex world of commercial real estate finance, preferred equity stands out as a powerful tool for experienced sponsors seeking to optimize their capital stack. This blog post delves into the specifics of a preferred equity program, focusing on its application in lease-up/stabilized multi-family assets with Freddie Mac, Fannie Mae, and Life Company senior mortgages.

What is Preferred Equity?

Preferred equity occupies a unique position in the capital stack, sitting between senior debt and common equity. It offers investors a preferred return on their investment, typically in the form of a current pay and accrued return, while also providing borrowers with additional capital without diluting their ownership.

Key Features of This Preferred Equity Program:

• Target Assets: The program focuses on lease-up/stabilized multi-family assets, indicating a preference for properties with established cash flow and reduced risk.
• Senior Debt: The requirement for Freddie Mac, Fannie Mae, and Life Company senior mortgages highlights the program’s focus on high-quality, agency-backed debt.
• Borrowers: The program targets experienced sponsors with a demonstrated track record and strong reputation, particularly those who are repeat agency borrowers. This emphasis on borrower quality underscores the importance of risk mitigation.
• Geography: Investments are focused on primary and secondary U.S. markets, offering a broad geographic scope.
• Size: The minimum investment of $5MM suggests a focus on larger, institutional-grade transactions.
• Investment Term: The investment term is coterminous with the senior loan, aligning the preferred equity investment with the existing debt structure.
• Pricing: The total rate ranges from 12.00% to 14.00%, with a minimum 4.00% current pay, providing investors with a predictable income stream.
• Minimum Multiple: The minimum multiple of 1.25x-1.35x indicates the expected return on the preferred equity investment.
• Sizing: The program offers maximum 85% LTV/LTPP, with a minimum 6.00% debt yield and 1.05% DSCR (Freddie Mac hard pay), ensuring a conservative approach to leverage.
• Fees: The program includes a 1.00% origination fee, 1.00% exit fee, and 12.5bps servicing fee, reflecting standard market practices.
• Recourse: The investment is generally non-recourse with typical non-recourse carve-outs for bankruptcy, fraud, and environmental, providing borrowers with limited liability.

Benefits of Preferred Equity:

For borrowers, preferred equity offers several benefits:

• Increased Leverage: It allows borrowers to increase their leverage beyond traditional senior debt limits.
• Reduced Equity Requirements: It reduces the amount of common equity required for a project.
• Flexibility: It offers more flexibility than traditional debt financing.

For investors, preferred equity offers:

• Preferred Return: It provides a predictable and preferred return on investment.
• Senior Position: It sits in a senior position to common equity, offering greater downside protection.
• Attractive Risk-Adjusted Returns: It offers a compelling risk-adjusted return profile compared to other investment options.

Conclusion:

Preferred equity is a valuable capital solution for experienced sponsors seeking to optimize their capital stack for lease-up/stabilized multi-family assets. By partnering with experienced sponsors and focusing on high-quality assets with agency-backed debt, this preferred equity program offers a compelling opportunity for both borrowers and investors.

Disclaimer: This blog post is for informational purposes only and should not be considered investment advice. Investors should conduct their own due diligence before making any investment decisions.