Preferred equity is a unique method of financing that is commonly used in large commercial real estate projects to increase leverage for sponsors or syndicators and create a great investment opportunity for individuals looking to earn consistent returns at a significantly lower risk.
Preferred equity can provide a significant advantage to both sponsors and investors. Let’s go through how preferred equity works and the need for preferred equity lenders.
What Exactly Is Preferred Equity?
Preferred equity provides active investors with additional funds to complete a real-estate deal. This sort of equity is superior to ordinary stock and ranks second only to senior debt in the capital stack. When profit is realized or default occurs, the senior debt holder receives payments first, followed by preferred equity, and, finally, common stock.
Why Do Investors And Sponsors Prefer This Sort of Equity?
Investors’ preferred equity
Preferred equity has a few advantages for investors. It’s a safer, more reliable investment with a guaranteed rate of return. So, if you have $100,000 ready to invest and are content with an average return of 7-12 percent, preferred equity may be the way to go.
One disadvantage of preferred stock investment is the absence of upside potential. If a real-estate project does well, preferred equity investors will continue to earn a predetermined rate of return on their capital with no portion of the upside.
Sponsors’ preferred equity
Preferred equity can be a more accessible means for sponsors to obtain funds than taking on additional debt or seeking new limited partners. Senior lenders and mezzanine loans are legitimate financial products in which the lender has a property lien. As a result, the majority of these Mezz debt rates are made by financial institutions.
Preferred equity, on the other hand, can be acquired by anybody. Preferred equity can be purchased by a family office, hedge fund, real estate syndication firm, venture capital fund, or even a private individual. This opens up a whole new universe of possible investors that you would not have reached with debt and common investors alone, and it’s usually less expensive than senior debt or carving out another sponsor or manager role.
Preferred equity has the potential to benefit both investors and sponsors.
Finally, preferred stock may be a major benefit in a real-estate syndicate since it gives an additional, more flexible route to raising capital. Real-estate syndication, rather than being confined to limited partners and lenders, might open up a whole new universe of possible investors searching for preferred equity investments.
Many of these investors do not want to bear all of the risks associated with a project, nor do they want to make a loan secured by some asset. Instead, preferred equity is ideal in this sense since investors receive a consistent return, have no participation once the check is written, and have greater security than ordinary equity owners.
Take a look at this sort of equity investment and assess whether it can help you reach your financial and real-estate goals in 2022, whether you’re investing in a commercial deal or raising cash.