Have you been following our discussions on preferred equity? This has produced some questions on deal structure, terminology, and a desire to see some examples. I’ve discussed the case for preferred equity and why there’s a limited time window here. In addition, I overviewed a recent preferred equity deal in my last article.
I’ve covered a lot, but I haven’t provided all the basic terminology investors need to comprehend all these deals.
BiggerPockets has long been an educational site. As such, we may sometimes get nerdy on details that are of little to no interest to the general real estate investor. This is one of those occasions.
So, we’re going to take some time in this post to break down the definitions for commercial real estate preferred equity investments. But I’m not just going to bore you with definitions. I’m going to explain the term and then tell you how it worked in a real-life preferred equity investment.
The Terms and the Investment
This opportunity was a $3.5 million preferred equity investment in the acquisition of a value-add multifamily project with an experienced sponsor in the Virginia Beach area. I’ll state our definition and then, in italics, explain how that term would work in this investment.
Current pay rate
The portion of the coupon rate that is paid from operations.
Current pay rate of 9%. This current pay is actually reserved in advance for one year, and the reserved capital could be invested in Treasuries, which are currently paying about 5%. This could enhance potential returns for this investment.
Accrual
The accrued portion of the coupon rate that is paid at a capital event.
Annual accrual of 8% compounded. (The current pay plus accrual totals a 17% coupon rate.)
Personal guarantee
A contractual guarantee by the sponsor or key principal to cover the preferred equity in the event of a default. This is similar to a full-recourse personal guarantee on a loan.
A…