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What is Preferred Equity in Real Estate?

Investing in preferred equity in real estate involves receiving certain privileges in exchange for the investment. Investors can benefit from these privileges by earning greater returns or receiving priority capital returns.

A preferred equity holder's claim to its equity is also generally privileged over that of a common equity holder in the event of a sale or liquidation. 

Preferred Equity in Real Estate: Overview

There is a high cost associated with institutional-grade commercial real estate. Purchasing property can require an amalgam of capital from several sources, but preferred equity may be an option you can consider.  

Investors in this type of investment receive special privileges or preferences in exchange for their money. As a result of the higher return on investment (ROI) and higher risks, alternative investments are often more profitable than traditional equity investments.

In commercial real estate, preferred equity is a unique method of financing that is often used to increase sponsors' leverage and create great investment opportunities. Similar to real estate funds, this is great for individuals looking to earn consistent returns at a significantly reduced risk.

Sponsors or syndicators are groups of investors who pool together their funds for real estate investments.

How Does it Work?

Equity investments in commercial real estate are generally payments made to property owners for ownership stakes. Investing in common equity and preferred equity are the two most common equity types. Compared to other types of investors, preferred equity owners have special privileges or preferences available to them.

Preferred equity can be structured in a number of ways, but a mezzanine loan is one of the most common. A mezzanine loan is subordinate to a senior loan, usually a first mortgage. Therefore, mezzanine lenders would receive payments after senior lenders, but before equity holders in the event of foreclosure.

Preferred Equity vs. Common Equity: What Is the Difference?

It is primarily the level of risk that distinguishes preferred equity from common equity. Due to its higher position in the capital stack, preferred equity pays off more quickly and enjoys more elevated rates of return than common equity. Preferred equity investors also have control rights and participate in decisions that are highly significant.

Preferred equity in real estate investment usually has a fixed term, like debt. The duration is usually between two and three years. If the sponsor fails to perform at the end of the term or if certain triggering events occur as a result of the nonperformance, the sponsor usually redeems the preferred equity interest for a price equal to the unreturned capital plus any accrued but undistributed interest earnings.

A common equity loan, however, is more than just a loan. These investment projects are rewarded with a percentage interest. As a result, they benefit from any increase in the value of the project. They may also receive a portion of the rental income and in some instances, it could be either.

Similar to buying stock from a broker, this is a pretty straightforward process. There is a portion of the company that the investor owns. However, if the investment fails, they could also lose money.

What are the Pros and Cons of Investing in Preferred Equity?

Before investing in preferred equity real estate, you should consider both the advantages and the disadvantages. You should keep the following in mind when weighing the pros and cons:

Pros

  • It generally has higher returns than common equity investments.
  • It may protect against downside risks during liquidations or sales.
  • It provides investors with priority over common equity holders in liquidations.

Cons

  • It involves greater risk than in common equity investments.
  • It may not have as much control over the property as other investors.
  • It has less liquidity compared with common equity investments.

Why Invest in Preferred Equity Real Estate?

Preferred equity is a hybrid of debt and equity offered by sponsors as a way for investors to align their risk and return tolerances with the project. As with commercial real estate funds, investors need to determine what preferred equity structure is right for them.

However, it is a popular strategy for investors of every size and experience level to gain exposure to the real estate market.

We can provide you with more information about real estate investing when you work with our team of financial experts. We look forward to hearing from you. Contact us at 949-881-7128 at Saint Investment Group today!

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* Information in this message, including information regarding targeted returns and investment performance, is provided by the sponsor of the investment opportunity and is subject to change. Forward-looking statements, hypothetical information or calculations, financial estimates and targeted returns are inherently uncertain. Such information should not be used as a primary basis for an investor’s decision to invest. Investment opportunities on the Saint Platform are speculative and involve substantial risk. You should not invest unless you can sustain the risk of loss of capital, including the risk of total loss of capital. Please see additional disclosures here.
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