Preferred Equity is a hybrid debt and equity product where the investor is in a senior position to the common or GP equity, but more junior than the 1st lien and mezzanine debt.
The advantage is, Preferred Shares generally have a dividend that must be paid out before dividends to common shareholders and from a risk perspective they are lower in the capital stack.
• Pref Equity Investors will generally receive a set coupon payment although some of the payments may be accrued, at times they will also retain a residual ownership in the property.
• In a Mezzanine loan, the lender has a lien on the equity stake, in Pref equity the lender actually receives an equity stake. This allows it to be used in circumstances where lenders do not allow Mez as here there is only one lien and everything else is equity.
• Pref is also useful when the Sponsor and equity investor do not have the same vision of the upside, as long as the asset does not fall in value below the total debt and pref. equity, the equity investor will not lose money.
• The sponsor only has to pay the investor the original amount to pay him off and then regains full equity, similar to debt (Although sometimes the investor will get some sort of participation in the upside)
• Generally, you can get up to 85% LTC with preferred equity
• Pref equity gets you higher up in the capital stack than just your senior debt alone and often because the investor is in a “preferred” position the Sponsor gets more of the upside upon hitting predetermined targets.
• Disadvantages are that they get their money before anyone else (hence preferred) and if it’s a hard pay pref then it behaves like a loan and the predetermined return must be paid monthly as opposed to accruing and being paid upon an exit...