Preferred Vs JV Equity
Wanted to see if anyone had current terms on preferred equity quotes?
Looking at a value add (via lease up) office play in a secondary submarket in Greater Los Angeles. Roughly $15M equity required at closing. Typical JV guys are saying they like the strategy and return metrics, but given the location is just outside of the core, they can't get their committees to approve it.
Thinking that maybe preferred equity would be a solution. I have never used it on a deal. I wasn't sure if the pushback regarding location would be the same as with a typical 90% JV partner. Or would it be more "lender" like in the sense that if the returns worked, it's much smoother a process?
Would equity contribution be similar to 90/10 JV structure? Would sponsor be on the hook for larger portion of equity? Is it a straight IRR and then sponsor takes anything left above it? Or would preferred want some form of a split over the IRR?
From my recollection, pref is more "gap" equity, akin to mezz but with a higher place in the cap stack. You are still clipping coupons as an investor and not seeing the upside of a JV who typically fronts 80-95% of the equity check. Maybe someone at a fund can elaborate more. But, yes more sponsor equity in pref.
I've always understood it to fall under two scenarios:
1) Exactly like mezz except in name to avoid the hassle of having the senior lender approve the use of mezz
2) Kind of like mezz but with some limited upside participation
Pref is usually 40-60% of the equity requirement assuming a 70% LTV loan. There are a few options out there that can be higher in the equity stack. I would be glad to discuss this with you as I am heavily involved with a lot of funds that do pref and JV.Pm me
My understanding is there are two ends of the equity spectrum: straight JV and Senior Sub (Pref). I typically find on value add deals that pref equity will get you a higher split, since there is less risk for the LP (senior on cash flows). For example, I was looking at a deal where we (the LP) were OK with two options:
Pref Equity (Senior on all cash flow): 85/15 split. 9% pref return, 10% promote after that to a 12, then 25% promote after that.
JV Equity (Pari Passu on all cash flow): 80/20 split. 12% pref return, 20% promote after that
I have also seen hybrid structures where the LP is senior on all opperational cash flows but pari passu on capital event cash flow
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