For many real estate investors and developers eyeing larger commercial projects—be they multifamily, office towers, mixed-use developments, or specialized properties like hospitality—securing enough capital can feel like a balancing act. Even with a senior loan in place, you may still face gaps in your capital stack that prevent you from getting deals to the finish line.
That’s where preferred equity comes into play. By working with partners who specialize in providing this unique form of financing, you can reduce your out-of-pocket equity requirement and secure the capital you need to move forward. In this post, we’ll break down what preferred equity is, how it differs from other financing solutions, and how our extensive lender network can help you tap into it.
1. What Is Preferred Equity?
In commercial real estate, preferred equity is an investment that typically sits between the senior loan and the common equity (the developer’s or sponsor’s standard ownership stake). It can also be viewed as an alternative to, or a hybrid of, mezzanine debt. The primary goal is to bridge the gap between the main loan and the total project cost, so the sponsor doesn’t need to contribute as much capital.
Key Characteristics of Preferred Equity
- Higher Priority Than Common Equity: Preferred equity holders generally receive distributions (like dividends or a preferred return) before common equity owners.
- No Claim on Collateral: Unlike mezzanine debt, which may take a pledge of ownership interest or have foreclosure rights, preferred equity typically relies on a priority return or specific covenants in the operating agreement but doesn’t usually hold a direct lien on the property.
- Flexible Terms: Depending on the deal, returns might be structured as a fixed preferred return, a share in profits above a certain threshold, or both.
2. Why Preferred Equity Can Be Crucial for Large Deals
When funding major projects, sponsors often discover that senior lenders limit their loan-to-cost (LTC) ratio to a level below what the project truly needs (e.g., 60-70%). Traditional equity can fill the gap, but that may require a substantial outlay of sponsor capital or bringing on multiple co-investors—potentially diluting ownership and complicating decision-making.
Enter Preferred Equity:
- Less Sponsor Equity Needed
By offering a higher LTC effectively, sponsors can reduce their personal capital commitment. This is invaluable for those with multiple deals in the pipeline or who want to maintain liquidity.
- Simplified Ownership & Control
Compared to bringing in multiple small equity partners (common equity), a single preferred equity partner can often be more straightforward. The sponsor typically retains control, provided they meet performance and return covenants.
- Project Feasibility
If the project is on a tight timeline or the sponsor’s capital is tied up elsewhere, preferred equity provides a crucial capital injection without the rigors of another full underwriting akin to a second lien or mezzanine loan.
3. Preferred Equity vs. Mezzanine Financing
While mezzanine financing is also used to fill the gap between senior debt and sponsor equity, there are notable distinctions:
- Collateral & Security
- Mezzanine Debt typically includes a pledge of ownership interest as collateral. If the borrower defaults, the mezz lender can foreclose on those shares.
- Preferred Equity doesn’t usually rely on collateral but rather on ownership provisions like specific covenants or priority distribution rights.
- Remedies in Default
- Mezzanine Lenders may step into ownership more easily upon a default.
- Preferred Equity Investors often negotiate terms in the operating agreement allowing them to exert more control or influence if the sponsor fails to pay the preferred return—but they don’t hold a lien against the property.
- Position in the Capital Stack
- Both sit behind the senior lender but in front of the common equity. However, mezzanine debt is more “loan-like,” while preferred equity is more “ownership-like,” albeit with enhanced rights over common equity.
4. How LoanFunders.com Network Facilitates Preferred Equity
LoanFunders.com partners with specialized lenders and investors across a broad spectrum of capital solutions, including preferred equity. Here’s what that means for your larger deals:
- Extensive Network
With a reach of thousands of lenders and equity providers, we can identify who focuses on preferred equity investments in specific asset types—be it multifamily, office, assisted living, or hospitality.
- Flexible Structures
Our network’s breadth means we can help structure deals with terms fitting your project timeline, risk profile, and exit strategy. Some preferred equity providers may offer fixed monthly returns, others might prefer a share of upside beyond a certain IRR.
- Strategic Guidance
Preferred equity can be complex. Our experienced team helps you evaluate whether it’s the right fit, explaining how it aligns with the senior lender’s terms and your operational plan.
- Reduced Equity Outlay
You can focus on assembling high-level deals, confident that the capital stack is within reach. By tapping our relationships, sponsors often reduce their personal cash requirement while still retaining control.
5. Scenarios Where Preferred Equity Shines
- Large Multifamily Development
A sponsor has partial equity but needs another 10-15% of project cost to meet the senior loan’s LTC requirements. A preferred equity partner covers that slice, enabling the sponsor to commence construction.
- Office/Industrial Conversion
The sponsor is acquiring an underutilized property to repurpose. They have the experience but limited liquidity. Preferred equity helps them secure a senior loan by supplementing the capital gap.
- Expansion in Hospitality
Projects like hotels demand high upfront costs. Adding preferred equity ensures the sponsor retains majority ownership while not draining their personal reserves.
- Rapid Portfolio Growth
Investors seeking to acquire multiple assets quickly can use preferred equity repeatedly—spreading out their equity contributions across several deals.
6. Key Considerations Before Opting for Preferred Equity
- Return Expectations
Preferred equity holders may want a target IRR or a specific periodic distribution. Ensure this aligns with your pro forma projections.
- Operating Agreement Provisions
Review terms about control triggers or decision-making rights if distributions fall behind.
- Senior Lender Approval
Some senior lenders require consent or have guidelines regarding subordinate capital in the transaction. Verify they permit preferred equity as part of the structure.
- Exit Strategy
Preferred equity is often short- to mid-term. Plan whether you’ll refinance the partner out after stabilization or exit via property sale.
Conclusion: Powering Up Large Deals With Preferred Equity
Preferred equity stands as an invaluable tool for bridging capital gaps in major commercial real estate deals. By sitting behind senior debt yet in front of common equity, it offers a streamlined way to reduce the sponsor’s equity burden, accelerate timelines, and secure more ambitious properties. And, because it doesn’t involve a collateral pledge typical of mezzanine debt, it can be less restrictive.
Ready to Explore a Preferred Equity Solution?
At LoanFunders.com, our expansive lender network includes seasoned equity investors eager to finance large-scale projects when the economics and sponsorship align. Whether you’re breaking ground on a 200-unit multifamily or repurposing an industrial facility, preferred equity might be the missing piece that closes your deal.
- Contact Us at 718-878-3131 or fill out our form to discuss your goals.
- We’ll walk you through the structuring process and match you with the right preferred equity providers.
- Close on your dream project with fewer roadblocks, more efficiency, and a capital stack that truly makes sense.
Make Your Next Big Project a Reality—with preferred equity solutions fueling your progress from start to finish.