If you’ve been reading our articles over the past year or so, you’ll know that we’re bullish preferred stock. We believe the window of opportunity to realize this asymmetric risk/reward opportunity is short.
Investors are asking a lot of questions about preferred stocks, so we thought you might be interested in some details about the latest preferred stock opportunities in which our funds have invested.
As a reminder, preferred stocks are in the middle Capital stacking. In theory, it has lower risk than stocks and higher returns than debt, although it has characteristics of both.
Our recent preferred equity transactions
In December, after months of due diligence, we closed a $4 million preferred equity investment in the Atlanta area Multifamily Project. You may have heard of Atlanta Recently rated One of the strongest multifamily markets in the U.S..
But there are many more important reasons why we like this investment. The workforce housing multifamily project was acquired by an operator with many years of experience owning and operating multifamily assets in the area. The senior loan was obtained through Fannie Mae and carries an interest-only interest rate of 6.61% over a three-year term.
Transaction Overview
Below is an overview of our preferred equity investments:
- 9% current payment cash flow
- 8% monthly upward accumulation and compounding (total coupon 17%)
- Our fund maintains a current payroll reserve of $355,122 and a capital improvements reserve of $2.55 million.
- All reserves are held in a cash flow account currently earning an additional 4.5% or more.
- all internal rate of return Forecast is 19.4% (including cash sweep interest)
- MOIC is expected to be 1.62x in 36 months, which can be improved through early refinancing.
Here are some other important considerations:
- Current compensation takes precedence over all other equity in terms of post-debt cash flow distributions.
- Capital is fully returned to preferred stock before common stock receives distributions from a capital event.
- All compound accruals must be paid in full to the preferred stock before the common stock receives distributions from a capital event, including a return of capital.
- Same depreciation as normal.
- Forced sale rights to protect senior capital and returns prior to potential senior loan foreclosure.
- All common shares will be forfeited before preferred capital and full returns are affected.
- Subject to our unilateral approval, the capital improvements budget will be withheld pending completion of the work.
- Annual budget review authority.
- Although we technically have no control due to FNMA requirements, the budget approval process gives our fund “power of the wallet.”
The operator plans to get a supplemental loan within three years to take us out. Our negotiated MOIC floor is 1.50x, which means we can get a higher annual return if we exit early (but there’s no guarantee).
final thoughts
As we mentioned, this type of transaction is virtually unavailable to individual investors unless you are a family office with significant legal and negotiating power. There are currently some outstanding players providing preferred equity investment opportunities. But that window may close when interest rates fall and lender restrictions ease.
If you have questions, I’d love to hear from you.
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Mr. Moore is a partner in Wellings Capital Management, LLC, the investment adviser to Wellings Real Estate Income Fund (WREIF), which is open to accredited investors. Investors should consider the investment objectives, risks, charges and expenses before investing. For the Private Placement Memorandum (“PPM”) and information about Wellings Real Estate Income Fund and other information, please call 800-844-2188, visit wellingscapital.com or email [email protected]. Please read the PPM carefully before investing. Past performance is no guarantee of future results. The information contained in this communication is for information purposes only and does not constitute advice and should not be construed as an offer to sell or a solicitation of an offer to buy any securities in any jurisdiction where such offer or solicitation would be contrary to any local law. All investing involves risk of loss, including loss of principal. We do not provide tax, accounting or legal advice and all investors are advised to consult their tax, accounting or legal advisor before investing.
Notes on BiggerPockets: These are the opinions written by the author and do not necessarily represent the views of BiggerPockets.
