By Matt Zisler, Head of Greystone Equity
Borrowers across the country are discussing the rise in preferred equity and how to prudently add it to their deals. The run on interest rates has created a need for borrowers to look to the investment product for additional proceeds behind their senior loan for the next acquisition or refinance. With preferred equity behind Agency loans on multifamily properties, borrowers are able to obtain the proceeds they need and have an equity partner whose return is fixed but senior to their return. Assuming the preferred equity investor’s return is fixed at a lower rate than the overall equity return, the result should be positive leverage to the borrower. Preferred equity investors should be seen as an equity partner and useful tool to prudently increase proceeds.
Institutional equity investors, reluctant to deploy traditional joint venture equity, are focused on preferred equity and better risk-adjusted returns. Preferred equity behind Agency loans typically detaches at 75-80% of total cost or value. The preferred equity investor is willing to take a fixed return, comprised of current and accrued portions of the total rate, in exchange for having 20-25% of the capital stack behind them. The borrower is satisfied because they pay a lower return than they would to a limited equity partner, and the equity investor is happy to protect return with additional equity behind them in case of further volatility and potential declines in values.
Compared to senior loan interest rates borrowers were able to obtain prior to 2022, preferred equity may at first seem expensive. However, the cost of preferred equity has not changed meaningfully over the last year, while senior interest rates have continued to rise. In the case of Agency loans, the borrower has the choice between preferred equity behind a Freddie Mac or Fannie Mae loan. Freddie Mac preferred equity includes a hard current pay, which allows the pref investor additional rights and remedies in the case of missing a hard current payment. Fannie Mae preferred equity is mostly soft current pay, meaning that any missed portion of the current pay is capitalized and accrues without penalizing the borrower. There are fewer Fannie Mae preferred equity investors, since many are focused on the rights and remedies that come with a hard current pay structure. However, there are still plenty of Fannie Mae preferred equity options and there is little differentiation between Fannie Mae and Freddie Mac preferred equity at the margin.
A borrower should consider the blended rate between the senior loan and total rate of the preferred equity when evaluating the capitalization of the transaction and the preferred equity investor. Capital advisors and brokers can do little for their borrowers when it comes to the specific index rate on their loan (they can affect the spread), but they can use preferred equity to create a capitalization structure which, when combined with the senior loan, provides adequate proceeds and positive leverage to the borrower.
Greystone Equity places preferred equity behind new Agency loans for Greystone borrowers. The types of deals supported include acquisitions and refinancings on new and old suburban and urban multifamily, student housing, Build-to-Rent and seniors housing. The preferred equity investments in Greystone’s pipeline range from $2 million to $130 million in size, providing Greystone with a unique view of the market, key players and pricing overall.