Preferred Equity typically comes from family offices, insurance companies, hedge funds, other funds, and even certain institutional investors that will take a fixed return or equity position in your real estate deal. We have assisted many clients with their Preferred Equity transactions.
If you are considering using Preferred Equity in your deal, read this article first so you understand what you are getting into. You will need experienced attorneys to represent you in the transaction, and we recommend you hire us as soon as you get a draft Term Sheet from the Preferred Equity company. We can help you negotiate the Term Sheet and the Operating Agreement(s) detailing the terms between you and the Preferred Equity partner. Your Preferred Equity partner will have expert legal representation and you should, too.
Before you pursue Preferred Equity for your real estate transactions, you should do the following analysis to see if it even makes sense:
- The first question is, why do you want to take Preferred Equity in your deal? You need to make sure you are clear on your objectives to determine whether it makes sense. What is your reason?
- The primary reason to accept Preferred Equity is that you can’t raise all of the money yourself. If this is true, go for it! It’s better to own part of something than nothing of nothing.
- Another reason to do it is that the Preferred Equity partner wants a lower return than you would have to pay your own private investors. If it saves you money or results in a higher return for you or your investors, that’s a great reason to do it.
- If none of those reasons applies, is there something else you are trying to achieve?
- If so, will it help you purchase this property or further your syndication business in the long run?
Most of our clients who use Preferred Equity do so with the idea that they will get rid of it as quickly as possible, because the Preferred Equity partner will likely place restrictions or additional burdens on you that you would not otherwise have with private investors.
Based on our clients’ experience, here are some typical risks and burdens associated with accepting Preferred Equity in your real estate transactions:
- Most Preferred Equity companies will require that you produce a list of periodic reports (some may be monthly, others may be quarterly or annual), which is more reporting than you would typically do with private investors. This will cost you time and money, as you may have to hire someone to keep up with their demands. Additionally, they will usually want a lot of upfront paperwork that you will need an experienced attorney to draft for you.
- Most Preferred Equity companies will require that you meet certain performance parameters, in addition to the payments you owe them, for things such as minimum occupancy levels, DSCR, reserves in the bank, etc., and if you don’t meet these parameters, they may consider it a “default” and begin the takeover process or force a sale at an inopportune time. If you also have your own investors in the deal, they are at risk, as the Preferred Equity firm will only care about making themselves whole and may completely disregard your investors by selling the property at a price that doesn’t yield enough to pay your investors — often selling it to an affiliate of theirs at the price they are owed so they can strip your investors’ equity.
- Some Preferred Equity companies are actually predatory and will try to force you into a technical “default” so they can own the property themselves. We have seen six-figure litigation over this issue, which was initiated by the Preferred Equity partner even after the technical default had been cured.
- Some Preferred Equity companies may string you along and then pull out at the last minute, leaving you stuck with all of the pre-closing expenses and no investors to close the deal.
- Most Preferred Equity companies will require that you pay their legal fees in addition to your own, which could double or triple your upfront legal expenses.
If you still want to do a deal with a Preferred Equity partner, we are here to help. We have assisted many clients with their Preferred Equity transactions. Please schedule an appointment today for your free consultation by clicking here.