Preferred Return

11 Replies

I met with a developer yesterday and during our meeting he stated a 40% “preferred” return to partners. That got my attention, and although I do not want to talk numbers here, the point is that he is looking for a loan to fund his deal. This morning I read his detailed proposal and see that the 40% return is over a two year period. That sounds misleading and I’m wondering if anyone in the world of development would present proposals that way.

@JScott, I would take title to the property in second lien position.  Can't I make a loan and have an equity position?

That is quite a hurdle to get over on the preferred return side for the developer.  The preferred nature puts priority on specific equity for returns.  I would be instantly skeptical just based on the age old adage of "if it sounds too good to be true then it probably is" and would look very closely at the deal.  It's more typical to have a preferred return at 7-10% & then projections on cash flow splits or gains at sale in the double digits.  Also is the 40% return over two years with the return being 20% annually?  Or 40% averaged out over two years?  

If you don't have a good feeling about the developer there are plenty of other private placements to invest in.  I wouldn't necessarily walk away right now but carefully do your due diligence and make your decision from there.  Good luck! 

@Stephen Weber  

Given your most recent comment about taking an equity position & holding a 2nd on the property I would give more deal specifics including property type, deal size, structure including debt/equity financing, basic financials etc.  It's definitely something you want to go through with an experienced SEC/Blue Sky attorney.  If it's a 1-4 residential product it probably wouldn't conform with Dodd Frank (I'm not the expert on 1-4 or Dodd Frank).  

@Stephen Weber  something seems off. Pref returns is what it sounds like you have a preferred return before others get a shot to get their return. 40% sounds very high for that. 

Originally posted by @Stephen Weber :

@JScott, I would take title to the property in second lien position.  Can't I make a loan and have an equity position?

I think you're confusing some things here...

If you take title to the property, you are owner (or part owner).  If you hold second lien position, you have a security interest in the property, but no ownership.  Which one is it (I don't imagine it's both)?

If you really have both an equity and a debt (loan) position in the property, you should be receiving two separate returns -- stated return for the debt position and a to-be-determined return for the equity position (dependent on the success of the deal).

You will get better deal doing 4 flips in 2 years, the second half of year 2, maybe you can double your flip totalling 5 houses. 40% in 2 years as developer is not that interesting on me. If I was the lender, if it is 1MM or bigger, I would do factoring on government contractors' account receivables, they are covered by payment bonds from surety company and you could collect directly from government agencies and give them (contractors) the balance. But of course, this is a whole new realm not covered by RE Investing. Just my experience.

I agree with @Chris Winterhalter  when he asks: "Also is the 40% return over two years with the return being 20% annually? Or 40% averaged out over two years?". In my mind it is NEVER OK to suggest possible 40% net returns if it is alluding to a longer period than 1 year - unless it is specifically stated there and then and so is clear. But if they ARE expecting an 80% return over 2 years, OK, worth a listen - then look for other loopholes that might affect you!  Cheers...

Sorry I wasn't clear. The return in the proposal states a 40% return in 2 years (thus, 20% annual return).  But before I was presented with that information in writing, I was told verbally that the return would be 40%.  It sounded misleading.  If I am quoted a percent I assume it is an annualized return.  That was a bad assumption on my part, in this case.

I appreciate all the answers, but I was simply trying to figure out who quotes returns in 2 year periods, and it looks like that was just a little marketing on my "partner's" part. The Preferred reference is new to me, so I asked the community.

I would take on a loan position in this project to build duplexes.  So not an equity position @J Scott 

Thanks for your input @Chris Winterhalter  and @Brent Coombs  

 and @Bryan Hancock  I am absolutely skeptical, that's why I brought up my concern.

@Manolo D.  - I might "get a better deal flipping houses" but that's beyond the scope of my question. And I have no knowledge of government contractors and surety bonds. 

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