The MF Deal is refinancing after some value added. They provided a buy out option to return the full initial capital back, however there will be no more interest in the deal. Is this a common practice, I thought typically deals returns portion of capital to the LP after refi, but LP still retains the same percentage share. Am I missing something ?
Depends on the deal, much of the time there is return of capital but the LP retains ownership. It should all be lined out in the disclosure documents provided before the deal was closed.
Generally a refinance and return of capital wouldn't change the investor's ownership percentage, even if all capital was returned. But you'd have to read the operating agreement to be sure. Some sponsors slip in provisions that give them the ability to do differently.
What you might be missing is the sponsor is seeking to add value to the property using your money, then reap the reward of that effort for themselves by getting you out, and not fully sharing that value with you.
Originally posted by @Mike Zhou :
The MF Deal is refinancing after some value added. They provided a buy out option to return the full initial capital back, however there will be no more interest in the deal.
Are they really just providing all your funds back and no return for the use of your funds so that you end up having given them an interest free loan and they get all the rewards from the value added, which would not have been possible without the use of your funds? I cannot help thinking there must be something more since you call it a "buy out option". And is this an option in the sense you have the option to decline and keep your interest in the deal or are they exercising some kind of buyout option in the documents? If so, can you share the relevant provisions in the PPM or operating agreement?
@Mike Zhou All depends on the PPM that was signed. It can be structured in multiple ways. It does sound like the group is returning capital and effectively buying out the investor equity. Nothing wrong with this per se if it is part of the agreement signed. As long as you are getting the promised return over X years of the hold and it is stated in the documents this would or could occur, it shouldn't be too much of difference. Effectively you are getting your capital + return much quicker and can go reinvest into another deal thus accelerating your return on equity.
You can then value other deals that do not have this option whereby, you maintain your position of ownership regardless of a refinance or not. That would then be your choice.
I would say, however, if you are not getting the return promised but only say 1-2 years of cashflow returns or preferred returns and not sharing in the total IRR return promised, well that's a bit hard to swallow. This is more like a private lender loan rather than a typical syndication. Most of the return comes from a refinance or profit from sale, so you the investor would be missing out effectively and the group profits on the investor capital to a great degree.
This seems like a good example of making sure you know your sponsor and how they operate. Typically on a refinance the sponsor will return your capital and reduce the preferred return, interest payment on that capital going forward. Typically your equity (ownership percentage) in the deal should stay the same until sale of the property.
It is fairly common to return capital upon a refinance. The original debt is being restructured and you are effectively reducing the amount of capital that you have in the deal by replacing it with typically structured bank or other debt. Refinances are hard to model in a pro forma as well as hard to determine exactly when they happen. But they are a great tool in some cases. Next time, just be clear on how your sponsor will handle a future refinance.
They paid 8% preferred for the holding period (3yrs). Yes, it is an option to decline. I choose to decline since the underlying MF has appreciated quite a bit and it makes no sense to accept that buy out agreement.