My firm has historically relied on LP equity for all of their acquisitions (primarily value-add office). Seems like LP equity is more cautious these days (compared to years prior), certainly more concerned about market cycles and how much longer we have in the current cycle.
We have had to blow out of a few deals that we had in contract, completed DD, etc specifically because we were unable to secure an LP partner prior to going hard on our deposit.
I have never used preferred equity on a deal I have worked through. I'm curious just how high up the stack you could get on straight pref equity. The current deal I am working through had a good return profile in 2-3 years, the challenge with LP equity is the location is a bit of a tweener/suburban office, and because of the shorter term hold, the equity multiple isn't high enough for them (they love the IRR but want more net dollars coming out of the deal).
Thinking pref equity might be a good solution, but my firm is historically has done 95/5 JV deals where they syndicate out a portion of their 5%, so I'd assume they are sensitive to how much total equity they would need to contribute.
Any thoughts on an Accretive structure?
Thanks
Great question. But how were you able to lock deals up long enough to execute DD without an LP? I feel like brokers would hate you and not bring you anything...
Not sure about office. But in multifamily, we usually contribute more to the stack if doing pref equity. at 95/5, there's not much higher you can go. Obviously our pref is lower (usually 3-4%) than it would be on a JV deal.
I've used a pref equity structure on some retail development deals. The construction loan went up to 55% LTC and our pref equity covered up to 90% LTC. We charged 18% for a variety of factors (location, credit of the tenant, sponsor experience). Min 18 months yield maintenance and after 24 months we could take them out. They had every incentive in the world to take us out at exactly 18 months and that is exactly what they did. We recycled the same deal a few other times with this group.
For the sponsor it was cheaper than a 90/10 JV, and the LP has confidence the sponsor will do everything they can to execute in a timely manner.
Could return principle plus 8% pref return to LPs then 20% full catch for GP followed by whatever equity split you want (80/20) between LP/GP? Keeps it simple for investors.
On a side note, that's crazy that the deal fell through because you didn't have LP funds ready to go. Set up an escrow account that accrues interest while your looking for properties so that once you find the right buy you're set.
Not sure I follow?
Unless the GP has programmatic LP partners locked and loaded, each deal gets syndicated on the fly. And generally, a GP won't go hard on the deposit if they haven't ID'ed a capital partner willing to pro rata contribute to that hard deposit.
^This is how it works in the real world, for the most part.
We typically allow investors to hold a slot with a portion of their determined investment until we hold the final capital call. All the while we're sourcing deals, but if we don't win any bids then we'll keep looking until we identify properties that fit what we're looking for. Could be months until we actually close and all the while we have investors money ready to go once DD is complete. Could be that our funds are
Isn't pref equity the same as LPs? Am I missing something?
Pref equity can take many different forms depending on the collateral, rights, and remedies and is not the same as JV Equity. Pref is a form of sub debt like mezz, which in most cases doesn't get to participate in the upside of the deal. While there is participating pref (if you go high up in the stack usually >80-85%+) that can get some of the ups, most pref is structured like a fixed instrument such as mezz that pays a fixed rate. The rate can be part accrued / part current. Pref usually requires a minimum multiple that essentially functions as the minimum interest for the deal. On the qualitative side, pref is usually just as hands-off as debt, unlike a JV partner which would be a lot more closely involved in the deal including strategy, major decisions etc.
Wouldn't the OP run into the same issue as with the LPs? Getting pref capital is never a sure thing either. It might have the same level of risk of backing out as LPs, right? Or are there companies that will straight up give you pref?
Good post with correct info summarized nicely. +1
Spot on. I work for a REPE firm that typically does 90/10+/- type structures but we'll do the occasional pref or mezz structured deal in situations we otherwise couldn't get comfortable with some aspect of a transaction.
In my experience or ability to go higher leverage has been more concerned with what we perceive the underlying cost basis of the asset to be rather than how much equity is being put in. But the structures have typically shaken out in the 85%+/- range. We typically have a current interest portion 6-8% with the outstanding balance accruing to a 12-16% depending on the risk profile. For a value-add deal in our fund we would have a 1.5X equity hurdle if the property was sold in the first 2 years. Asset Management on our end is pretty hands off operationally, basically keeping up on monthly performance and watching for any red flags.
Voluptatem voluptatem corporis qui repudiandae quia. Ea earum non temporibus autem aut harum quas. Quo ab omnis facilis eaque corporis. Ipsum optio aut culpa sed quo. Incidunt dicta rerum consequuntur et omnis.
Perspiciatis qui expedita qui est totam exercitationem ut. Aliquam harum ut quia ab est tempore ratione. Et illum pariatur sit magni earum. Ut deleniti cum error quis ut. Maxime velit perferendis voluptatem ut. Labore sequi ut eos non explicabo odio eveniet.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...