What is Preferred Equity?
Preferred equity serves as a source of secondary debt financing, which sits in second priority behind the senior loan on the subject collateral property. This type of financing can provide investors and developers with some relief in terms of the size of their equity raise – but at a cost as preferred equity return hurdles (interest rates) typically start in the low double digits and higher.
Preferred equity is often utilized on heavy value-add and/or construction projects that expect higher returns and can support the cost of those higher interest rates on a component of the capital stack.
Advantages of Preferred Equity for Borrowers:
• Improve levered returns for investors and developers
• Typically more flexibility in the structure of interest payments, with a current pay component and accrued pay component
• Lower the equity raise amount
What to consider when using Preferred Equity:
• Higher cost of capital
• Impact on project delays – potential need to replenish interest reserves
• Allowance for secondary financing by senior lender, and associated legal cost