217 preferred equity real estate lenders. At last count, that’s the number that Lev Capital tracks. These funds stand ready to fill the “financing gap” between senior debt and common equity.
Lev Capital is a tech-enabled real estate finance brokerage. As such, we incorporate every aspect of innovation into our advisory process. At the data level, we have invested tens of thousands of hours to track data points on lenders. Preferred equity financing can be complex. We understand the patterns of movement and available structures within the segment. Below are questions we fielded on the subject from sponsors and developers over the last year.
What is preferred equity?
It’s a form of subordinated debt with debt-like and equity-like features. It is subordinate to the senior debt but has priority over common equity — that’s why they’re “preferred.” Given its position in the capital stack, the cost is more than senior debt but less than common equity.
Is it Debt or Equity?
It’s a hybrid product with elements of each. It’s unsecured like equity, but has priority over equity, limited upside, and fixed returns like debt.
Like debt, preferred equity requires control rights in the event of default and there is a fixed maturity date.
Like equity, the developer and the preferred equity investor are joint venture partners. Their relationship is documented in a partnership agreement and is often subject to the preferred equity’s approval of certain major decisions.
Pricing generally ranges from high single digits to low double digits, it all depends. As leverage climbs to mid or high 80’s Loan to Cost, rates will rise into the low or mid double digits. Property type, market, business plan risk, and sponsor experience also impact pricing.
Average Check Size?
Generally, loan sizes start at $7M and can reach $100 million-plus. Some providers specialize in small balance loans in the $3M to $7M range.
Generally, preferred equity reaches into the low to mid 80’s LTC. As leverage approaches 90%, the likelihood of a required equity participation increases. The share of upside in the form of an equity kicker will vary, typically 15% to 30% depending on the coupon and other factors.
Is preferred equity available for all asset types and risk profiles?
Multifamily sponsors are the most common users and value add and ground-up construction are the most common transaction types. That said, most other property types with strong fundamentals, such as hospitality, office, built-to-rent, and others can find a home. Also, there are lenders with a lower cost of capital that can efficiently finance lower return core and core-plus deals.
Control Rights — What are those?
Among the key default rights that providers typically ask for are the rights to:
- Remove the developer and take over the decision-making
- Force a sale of the underlying property
- Terminate the management agreement
Scenario: Developer Seeking Flexibility to Adapt to Market Conditions
As an example, preferred equity can be a good fit for an owner taking apartment units off-line to complete renovations. The lender might quote a 12% preferred with 6% current pay, and 6% accrued. The current pay may shift higher over time in line with the projected increase in cash flows.
Scenario: Under Hard Contract with 30 Days to Close
Preferred equity lenders can move quickly. They can provide feedback on sizing and terms in a matter of days when time is of the essence. An accelerated closing schedule of less than a month from the signing of a term sheet is also possible. In addition, because there is no need for an intercreditor agreement, transactions are simplified and delays are avoided.
Scenario: Sponsor Seeking More Favorable Sponsor Economics
Preferred equity can boost returns to investors by replacing incrementally expensive common equity. This comes with a trade-off, increased levels of risk with the higher leverage.
Scenario: Limited Partners are in Need of Liquidity or Seeking Early Exit
A sponsor may wish to pull equity from an existing project and recapitalize it with preferred equity. The funds can be used to buy out LP partners or provide partial liquidity.
Lev continuously monitors the universe of preferred equity financing to know all the available options and players. Our goal is to identify the best lenders for each transaction. Then, we back it up with the work and relationships needed to get those deals done. If you’re working on a deal, reach out, experience Lev, and let us show you what we can do.