Co-Founder and Managing Partner of Disrupt Equity. Find out more about investment opportunities by visiting our website.
Given the volatility of today’s business climate, many investors are looking for stable, consistent returns with low risk. Preferred equity is a special financing structure that offers investors the opportunity to achieve constant returns with significantly reduced risk.
What is preferred equity for apartment buildings?
Preferred equity is a capital financing structure that is often used in large commercial real estate investment opportunities. The purpose of preferred equity in multi-family homes is to reduce the capital requirements for the deal sponsor by raising funds from preferred equity investors to make a deal sponsor’s equity raising process much more manageable. Preferred equity investments are generally offered by private equity groups working with real estate syndicators / deal sponsors who need additional funding for their projects. There are several companies an investor can work with, such as EquityMultiple, Yeildstreet, and Disrupt Equity, a company I co-founded. Access to these offerings, similar to common equity investment opportunities, requires a relationship with the company that can be built through networking and building relationships with others in the multi-family industry.
The preferred equity funding is placed in addition to debt within the capital stack. A capital stack refers to the layers of funding capital, and each layer has priority positions for receiving returns. When it comes to preferred equity in apartment buildings, preferred equity investors are given priority in repaying the profit generated or any cash flow from the property. Preferred stock investors are paid right behind the bank, and prior to the deal, sponsors and limited partners, also known as common investors, can get any profit from the property.
Suppose there is a case where the apartment building does not work. In this case, preferred equity investors are also above the common equity investors and owners to get their money back in full. This priority position in the capital stack reduces risk for preferred stock investors.
How is preferred stock different from share capital?
A common equity investor buys the shares in the property and generates returns based on the property’s performance. While common equity investments are generally riskier, if the property performs well, they can also generate a much higher return than preferred stock investors.
Preferred equity investors are always paid after the bank and before common equity investors, which is why common equity investors may not always receive cash flow income while the property is being held.
Example of multi-family preference shares
For example, suppose an apartment building syndication firm wants to purchase a sizable multi-family asset costing $ 18 million. The syndication firm received a $ 12 million loan from the bank, leaving $ 6 million to purchase the deal. This $ 6 million increase is too big for the syndication firm to raise from its pool of investors. Hence, the funding needs provide an opportunity to partner with a preferred equity fund to participate in the multi-family project. If the preferred stock fund agrees to raise $ 3 million, the syndication firm has only $ 3 million left for its investors to raise.
Advantages and disadvantages
As with any investment vehicle, investors need to weigh the pros and cons of an investment opportunity to determine whether it is suitable based on their risk tolerance and financial goals. Benefits include consistent returns for investors over shorter periods of time, lower risk and, depending on the terms of the contract, preferred stock investors can take ownership of the asset in the event of a default, ultimately reducing risk for investors. On the flip side, however, if the transaction performs very well, preferred stock investors can achieve lower returns than common stock investors.
For investors looking for constant returns with reduced risk, investing in preferred stocks in apartment buildings is an option worth exploring.
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