{"id":161458,"date":"2023-10-31T14:09:31","date_gmt":"2023-10-31T20:09:31","guid":{"rendered":"https:\/\/www.biggerpockets.com\/blog\/?p=161458"},"modified":"2023-10-31T14:09:36","modified_gmt":"2023-10-31T20:09:36","slug":"why-preferred-equity-is-so-compelling-right-now","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/why-preferred-equity-is-so-compelling-right-now","title":{"rendered":"Why is Preferred Equity So Compelling Right Now? And Why It Will Be Gone Fast"},"content":{"rendered":"\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">\u201cWhat is your least favorite aspect of real estate investing?\u201d<\/span><em><span data-preserver-spaces=\"true\">&nbsp;<\/span><\/em><\/p>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">Thanks for asking. I sold my company to a public firm over 25 years ago, and I\u2019ve been a full-time investor since. There\u2019s so much to love\u2014and so many frustrations.&nbsp;<\/span><\/p>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">One thing I hate is missing the top (or bottom) of the market or not catching a trend until it\u2019s too late.&nbsp;<\/span><\/p>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">For example, I wrote a&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/store.biggerpockets.com\/products\/storing-up-profits?utm_campaign=storage&amp;utm_source=podcast\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">BiggerPockets-published book on self-storage<\/span><\/a><span data-preserver-spaces=\"true\">. And I am so glad our firm has invested in self-storage for quite a few years. But I wish we would have started much earlier. I feel the same way about&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/blog\/should-you-add-manufactured-homes-to-your-portfolio\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">mobile home parks<\/span><\/a><span data-preserver-spaces=\"true\">.&nbsp;<\/span><\/p>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">I authored a recent BiggerPockets article&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/blog\/preferred-equity-can-improve-your-returns-in-this-environment\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">making a case for investing in preferred equity<\/span><\/a><span data-preserver-spaces=\"true\">. This article covers another vital question:&nbsp;<\/span><em><span data-preserver-spaces=\"true\">\u201cWhy are we in a limited-opportunity window for top preferred equity deals right now?\u201d&nbsp;<\/span><\/em><\/p>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">As a reminder, preferred equity sits in the middle of the\u00a0<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/blog\/multifamily-capital-stack\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">capital stack<\/span><\/a><span data-preserver-spaces=\"true\">. It can provide debt-like repayments independent of the property\u2019s performance, with additional upside to investors. It generally carries less risk than common equity, but it has limited upside.\u00a0 \u00a0<\/span><\/p>\n\n\n\n<figure class=\"wp-block-image size-full\"><img loading=\"lazy\" decoding=\"async\" width=\"620\" height=\"601\" src=\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2023\/10\/image1-1.jpeg\" alt=\"graph of the capital stack\" class=\"wp-image-160838\" title=\"\" srcset=\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2023\/10\/image1-1.jpeg 620w, https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2023\/10\/image1-1-300x291.jpeg 300w\" sizes=\"auto, (max-width: 620px) 100vw, 620px\" \/><\/figure>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">As mentioned, we are in a unique window of opportunity to invest in preferred equity right now. Preferred equity is&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.multihousingnews.com\/preferred-equity-is-pouring-into-multifamily\/?utm_source=newsletter.credaily.com&amp;utm_medium=newsletter&amp;utm_campaign=is-preferred-equity-multifamily-s-savior\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">in the press<\/span><\/a><span data-preserver-spaces=\"true\">. More deals are available than usual, and with this supply-and-demand imbalance comes theoretically better terms and returns for investors.&nbsp;<\/span><\/p>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">At a high level, here are some reasons we like preferred equity:<\/span><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><span data-preserver-spaces=\"true\">Immediate cash flow, future upside, and shorter hold time.<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Payment priority ahead of common equity.<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Lower downside risk exposure than common equity.<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Preferred equity still receives depreciation tax benefits.<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Can negotiate control rights in case something goes wrong.<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Can negotiate a MOIC (multiple on invested capital) floor to juice returns if taken out early.<\/span><\/li>\n<\/ul>\n\n\n\n\n\n\n  <div class=\"lg:block\" x-data=\"{ ad_block_block_65415ea8321a5: popAds(1) }\">\n      <template x-for=\"ad in ad_block_block_65415ea8321a5\">\n        <a\n          :href=\"ad.linkURL\"\n          class=\"no-underline text-black\"\n          x-on:click=\"adClicked('https:\/\/www.biggerpockets.com\/blog\/why-preferred-equity-is-so-compelling-right-now', ad.sponsor, ad.title, ad.id, 'blockAdClicked', 'blockAd', '')\"\n          target=\"_blank\">\n          <div\n            class=\"py-4 border-b flex flex-col flex-nowrap text-sm border-t px-0 rounded-none\"\n            x-init=\"\n              analytics.track('blockAdLoaded', {\n                referrer: 'https:\/\/www.biggerpockets.com\/blog\/why-preferred-equity-is-so-compelling-right-now',\n                sponsor: ad.sponsor,\n                ad_title: ad.title,\n                ad_page_location: ''\n              })\n            \"\n            x-intersect:enter.once=\"adViewed('https:\/\/www.biggerpockets.com\/blog\/why-preferred-equity-is-so-compelling-right-now', ad.sponsor, ad.title, ad.id, 'blockAdViewed', 'blockAd', '')\">\n            <div><span class=\"text-xs text-slate-light block bg-slate-50 p-1 inline-block rounded-md\">Sponsored<\/span><\/div>\n            <div class=\"flex items-center text-sm space-x-4\">\n                <img :src=\"ad.imageURL\" :alt=\"ad.imageAlt\" class=\"h-10 w-10 object-cover rounded-full\">\n\n                <div clas=\"text-sm\">\n                    <span class=\"font-bold block\" x-text=\"ad.sponsor\"><\/span>\n                    <span class=\"text-slate\/80\" x-text=\"ad.description\"><\/span>\n                <\/div>\n            <\/div>\n\n            <div>\n                <span class=\"font-bold\" x-text=\"ad.title\"><\/span>\n                <p class=\"mt-2 text-slate\/80\" x-text=\"ad.body\"><\/p>\n                <span class=\"mt-2 text-themeBlue block mt-2 underline\" x-text=\"ad.linkTitle\"><\/span>\n            <\/div>\n          <\/div>\n        <\/a>\n      <\/template>\n  <\/div>\n\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">So Why is Preferred Equity a Robust Investment Opportunity&nbsp;<\/span><em><span data-preserver-spaces=\"true\">Right Now<\/span><\/em><span data-preserver-spaces=\"true\">?&nbsp;<\/span><\/h2>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">You may be wondering why preferred equity is having such a moment in the sun. Here are four reasons why.<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Many lenders are pulling back compared to 12 to 18 months ago, drastically increasing demand for preferred equity.<\/span><\/h3>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">We have all heard stories about lenders refusing to lend on deals. Many that are funded close with lower loan-to-cost ratios and stricter terms. This has created a gap, which won\u2019t necessarily last forever, whereby sponsors scramble to close deals by employing preferred equity.&nbsp;<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Shortfalls in common equity create gap-funding opportunities.&nbsp;<\/span><\/h3>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">This is a double whammy for sponsors already coming up short on debt. With both equity and debt capital in limited supply, preferred equity or mezzanine debt is often the remedy.&nbsp;<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Coupon rates\/current pay are much higher than in the past.&nbsp;<\/span><\/h3>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">We\u2019re typically seeing 16% to 18% coupon rates instead of 12% to 14% for $1 million to $5 million check sizes. This capital crunch has hit smaller deals particularly hard. It is not worth most preferred equity providers\u2019 time to evaluate these smaller deals (especially in light of the current deal volume). But these under-the-radar deals can often provide superior safety and upside.&nbsp;<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Sponsors with excellent assets are often caught with an unfortunate capital stack and need rescue capital.<\/span><\/h3>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">Many excellent projects with upcoming refinance deadlines will not get funded as planned. Sometimes, this has nothing to do with the sponsor or project. Injecting preferred equity is often the only way forward. Though my firm isn\u2019t investing in rescue capital, the increasing demand for it is placing additional demand on a limited supply of capital.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">But Why is This Such a Limited Window of Opportunity?&nbsp;<\/span><\/h2>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">Now is clearly the time for preferred equity deals, but here are four reasons the window may close when current market conditions shift.&nbsp;<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">When interest rates drop, banks will start lending at higher leverage and relaxed terms again.&nbsp;<\/span><\/h3>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">As the credit cycle ebbs and flows, lenders will predictably change their underwriting standards and terms. High interest rates and tighter terms are creating an excellent opportunity for us right now, but this won\u2019t last forever.&nbsp;<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">When interest rates drop, sponsors with floating-rate debt won\u2019t need to recapitalize as much as they do now.<\/span><\/h3>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">The current conditions have wreaked havoc on sponsors with floating-rate debt. Though we won\u2019t typically invest in these deals, their ubiquity has created tremendous demand on a limited pool of preferred equity dollars. When interest rates drop, the pressure and demand will decrease significantly.&nbsp;<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Institutional investment activity and common equity investments will increase when market uncertainty recedes.<\/span><\/h3>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">The issue here is not just the lower availability of debt. It also hinges on constrained equity availability. Part of the issue is in regard to spooked institutional investors cashing in their shares. The issue is not a lack of investible cash, and at some point, the spigots will open again.&nbsp;&nbsp;<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">More competition potentially coming for $1 million to $5 million check sizes could drive down the current pay and coupon rates that we\u2019re seeing now.&nbsp;<\/span><\/h3>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">We\u2019re not alone in spotting this opportunity, especially with the premium returns generated from small check sizes. We believe preferred equity competition in this sector will increase soon; hence, our desire to place more preferred equity as soon as possible.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">What About Us?&nbsp;<\/span><\/h2>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">Our firm believes in broad diversification. We are not raising preferred equity for one-off deals, and we have not established a separate fund for preferred equity. Other fund managers are setting up specific preferred equity funds, and we think that\u2019s a great plan, too.&nbsp;<\/span><\/p>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">If you\u2019re interested in investing in a theoretically safer place in the capital stack during this time of uncertainty, preferred equity could be a good option. One of our most sophisticated investors, the founder of a multibillion-dollar hedge fund, agrees. His comments to me on the limited window for this opportunity spurred this post.&nbsp;<\/span><\/p>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">If you decide to invest in preferred equity, I don\u2019t believe it\u2019s a viable option for most individual investors. I don\u2019t mean to sound self-serving. But after watching our investment director and his team spend countless hundreds of hours over months to get a handful of deals across the finish line, I can tell you there are a&nbsp;<\/span><em><span data-preserver-spaces=\"true\">lot&nbsp;<\/span><\/em><span data-preserver-spaces=\"true\">of effort and complications. It\u2019s not for the faint of heart.&nbsp;&nbsp;<\/span><\/p>\n\n\n\n<p class=\"wp-block-paragraph\"><span data-preserver-spaces=\"true\">Many investors are investing in assets with lower projected returns\u00a0<\/span><em><span data-preserver-spaces=\"true\">and<\/span><\/em><span data-preserver-spaces=\"true\"> with the highest risk borne by common equity investors. We are pleased to share this alternative with BiggerPockets readers.<\/span><\/p>\n\n\n\n    \n  <div id=\"visibility-group-block_ffc41e7ef11a6e43883a303672ee4681\" class=\"visibility-group alignwide  hidden\">\n        \n\n<div id=\"hero-block_8102683e356838c7e0cc0994850ab8c8\" class=\"first:mt-0 hero-block py-4  alignwide   has-background has-slate-200-background-color has-text-color has-theme-gold-color\">\n    <div\n        class=\"gap-10 lg:gap-20 flex flex-wrap lg:flex-nowrap max-w-screen-xl mx-auto px-4 relative lg:items-center \">\n\n        <div class=\"relative z-30 lg:w-1\/2 \">\n            <main class=\"py-4\">\n                \n\n<p class=\"has-slate-800-color has-text-color has-large-font-size wp-block-paragraph\" style=\"font-style:normal;font-weight:800\">Find the Right Agent, Close the Best Deal<\/p>\n\n\n\n<p class=\"my-3 md:my-5 lg:my-8 has-slate-900-color has-text-color wp-block-paragraph\" style=\"font-size:18px\">Step #1: Use Agent Finder to match with top <em><strong>investor-friendly<\/strong><\/em> real estate agents to help you find, analyze, and close your next deal.<\/p>\n\n\n\n<div id=button-custom-event-block_c89e01f0cc2493c56da0e3b5f55b461b class='button-custom-event'>\n      <a href=\"https:\/\/www.biggerpockets.com\/agent\/match\" x-on:click=\"window.analytics.track(&#039;Blog Block | B2C Marketplace Agent Finder&#039;, {\n      referrer: &#039;https:\/\/www.biggerpockets.com\/blog\/why-preferred-equity-is-so-compelling-right-now&#039;,\n    });\" class=\" btn-shape inline-block no-underline has-background has-theme-blue-background-color has-text-color has-white-color\" target=\"_blank\">Find an Agent<\/a>\n  <\/div>\n\n            <\/main>\n        <\/div>\n\n                <div class=\"lg:w-1\/2 first:mt-0 relative h-full lg:flex lg:items-center\">\n            <img decoding=\"async\" class=\"object-cover w-full relative z-20 my-0  rounded-md hidden lg:block\" src=\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2021\/08\/Marketplace-Blog-Blocks-Agent-v3.png\" alt=\"investor friendly real estate agent\" title=\"\">\n        <\/div>\n            <\/div>\n<\/div>\n\n  <\/div>\n  \n\n\n<div class=\"wp-block-group\"><div class=\"wp-block-group__inner-container is-layout-constrained wp-block-group-is-layout-constrained\">\n    \n  <div id=\"visibility-group-block_64dd31c79f00f\" class=\"visibility-group  \">\n        \n\n<div style=\"height:10px\" aria-hidden=\"true\" class=\"wp-block-spacer\"><\/div>\n\n\n\n<div id=\"hero-block_64dd2875dba9d\" class=\"first:mt-0 hero-block py-4    has-background has-slate-100-background-color has-text-color has-theme-slate-color\">\n    <div\n        class=\" flex flex-wrap lg:flex-nowrap max-w-screen-xl mx-auto px-4 relative lg:items-center \">\n\n        <div class=\"relative z-30 w-full \">\n            <main class=\"py-4\">\n                \n\n<h3 class=\"wp-block-heading my-0 tracking-tight font-extrabold has-theme-slate-dark-color has-text-color has-large-font-size\">Join the community<\/h3>\n\n\n\n<p class=\"my-3 md:my-5 lg:my-8 has-theme-slate-color has-text-color wp-block-paragraph\" style=\"font-size:16px;font-style:normal;font-weight:400\">Ready to succeed in real estate investing? Create a free BiggerPockets account to learn about investment strategies; ask questions and get answers from our community of +2 million members; connect with investor-friendly agents; and so much more. <\/p>\n\n\n\n<div id=button-custom-event-block_64dd2888dba9e class='button-custom-event'>\n      <a href=\"https:\/\/www.biggerpockets.com\/signup\" x-on:click=\"window.analytics.track(&#039;Blog Block | Acquisition | Free Membership Signup&#039;, {\n      referrer: &#039;https:\/\/www.biggerpockets.com\/blog\/why-preferred-equity-is-so-compelling-right-now&#039;,\n    });\" class=\" btn-shape inline-block no-underline has-background has-theme-blue-background-color has-text-color has-white-color\" target=\"_blank\">Sign Up<\/a>\n  <\/div>\n\n            <\/main>\n        <\/div>\n\n            <\/div>\n<\/div>\n\n\n<div style=\"height:10px\" aria-hidden=\"true\" class=\"wp-block-spacer\"><\/div>\n\n\n  <\/div>\n  <\/div><\/div>\n","protected":false},"excerpt":{"rendered":"<p>These investments are gaining steam in the market, and they&#8217;ll be gone before you blink. Here&#8217;s why you need to get started.<\/p>\n","protected":false},"author":214608,"featured_media":161461,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[4433,5527],"tags":[],"class_list":["post-161458","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-opinion","category-commercial-real-estate-investing"],"acf":[],"comment_count":0,"_links":{"self":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/161458","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/users\/214608"}],"replies":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/comments?post=161458"}],"version-history":[{"count":0,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/161458\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media\/161461"}],"wp:attachment":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media?parent=161458"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/categories?post=161458"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/tags?post=161458"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}