Preferred Equity Structure? Most Common?
So I am here varying things about Pref equity. The way we were looking at it was as was whatever the pref % was would be paid annually and any if that year is a negative balance and does not fully cover pref, then it would accrue to the next year.
So if a LP invest $100k at 8%, we owe them $8k each year. If in one year we only have $6k for distribution to them, then that $2k carries forward and the next year we owe them $10k. However, I just spoke to a GP that said all cash flows are allocated as return of capital and then the promote begins to happen once the LP has all their capital returned. Did he mean the pref % is allocated or are they allocating all of the cash flows to the LP as return of capital. A bit confused on this.
Wait is this pref equity or a preferred return
That GP might be explaining it from an accounting perspective. In the Equity Method of Accounting all cash flows paid to the equity partner are recorded as paying down the equity balance or return of equity. From an investment return perspective though you should still be making your 8% on the full balance. In your example, if the $8,000 technically pays down the equity balance the 8% return still accrues and capitalizes next year so the LP should make the same amount in the end.
Ok thanks. That might be the case. Let me ask you this then:
Let say $100k LP equity, so if its an 8% pref.
Lets say in year 1, the cash flow is $10k, does that mean there will be a promote split on the $2k, or will the split only happen upon a full return of capital.
This is going to be in the JV agreement, I've seen both, Full return of capital before any disproportional split is typical.
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