“You’re investing in preferred stocks? No, thank you – I’m not investing in rescue funds!
I’ve heard this comment many times and in one form or another from potential investors over the past 18 months. My firm, Wellings Capital, added preferred stock to our income fund in 2023.
Here I will try tidy There is some confusion regarding the types of preferred stock available. My goal is to help investors understand this investment for Make an informed decision about whether to invest.
I’ve written a lot of articles on this topic, if you’re new to preferred stocks you can check out these articles:
What is preferred stock no
An investor said: “My CRE investment includes preferred stocks. I get priority returns before profits.” divided With the Syndicate.
The preferred return is great. almost every Multifamily and others commercial estate One of the investment offers. But this is not the same as investing in preferred stocks.
Preferred return method That Common Equity LP investors receive priority cash flow and a certain level of appreciation before receiving these benefits being shared with Syndicate.
For example, the operator/syndicate may offer the first 8% to LP investors of Split the additional cash flow and profit 80/20 against the previous operating cash flow. If cash flow falls below the 8% level in this example, investors would typically accumulate deferred returns, Which yes paid in full reached pre-split levels.
To reiterate: That’s not what I want to discuss.
What is preferred stock
preferred stock Be positioned between senior debt and common equity Capital stacking. It has some common characteristics and disadvantages Both Debt and equity, sometimes called gap financing, because it can fill gaps in the capital stack during turbulent (and other) times.
Preferred stock typically consists of a current payment component (such as debt) plus an accrued and compounding rising component (such as equity). This is quite It’s very expensive now, often Syndicates cost in the teens and up. this can provide unusually strong Generating returns for investors with limited risk. us yes often funds Preferred shares and internal rate of return It’s currently in the 16% to 18% range.
Ironically, interest rates are higher today That is compression Common In addition to providing preferred stock investors with higher returns, return on equity also provides demand and context for more preferred stocks.
Four types of preferred shares
As I mentioned, our team has been seeking preferred equity investments It’s been over a year now. We have developed a small but effective network of debt and equity brokers who bring us trades every week. (We turn down almost all opportunities.) this Provides us with a broad window into various situations The transaction type is It’s happening in this space now.
Let’s take a closer look at four common types of transactions.
1. rescue capital
this yes perhaps The most widely known type of preferred stock Now on the market Now. Rescue preferred equity is used to rescue A tough deal. Unfortunately, There are many CRE deals Now there’s trouble, especially in the multifamily space.
Many of today’s troubled deals yes at first funded Use floating rate debt. These loans are more affordable than fixed-rate debt and often do not come with foreclosures (prepayment penalties). This gives Syndicates are a much-needed advantage when acquiring deals that are often overpriced.
Floating-rate debt was extremely popular during the bubble years before the Fed’s rate-raising spree starting in spring 2022. This debt is often acquired Has a protective rate cap, which guarantees That rate Cannot rise above a certain level. Unfortunately, these caps have a limited time frame and must Updated at some point.
A substantial interest rate hike, plus cooling rental and growing operating costs, This has caused huge distress to businesses that bear such debts. Rate caps cost tens or hundreds of thousands of dollars to start and can cost millions to renew.
Many have suspended distribution and some are facing foreclosure. Their options include investors injecting capital or injecting preferred shares. Some people do both.
These syndicates are raising preferred shares that will have priority over existing common shares. The source of this rescue funding is usually third parties, although some operators invite current investors to provide preferred equity in this rescue first.
i believe this Probably the riskiest type of preferred stock. The deal has run into trouble. There There is no guarantee that variable rates will fall this year or next. A variety of factors could cause these deals to fail, and investors need to realize this.
Although preferred shares Located in a safer location In capital stacks, foreclosure transactions can still drain investors of their principal. Thankfully, preferred shares often come with forced sale rights and management control, providing investors with a chance to salvage a troubled deal.
My company considers the rescue funds to be a legitimate use of preferred stock. But our risk tolerance is quite conservative and we have not seriously considered such a transaction.
(Note: While I’m not aware of any current examples of this happening, a rescue preferred stock might provide a A bit Providing predatory opportunities to its funders. By rescuing troubled deals and negotiating receiverships, preferred providers may try to acquire assets in the event of operator default. through elimination Common and general partner equity, The acquirer may get the deal at a bargain price.
2. Development funds
Real estate developers often use preferred shares to provide part of the capital for underlying development projects. The development process often results in a significant increase in asset value, which can provide the operator with the high value needed to refinance debt and repay expensive preferred equity In progress.
This strategic move can quite It has a value-added effect on developers, will have to Share ownership of smaller portions with Common Equity investors. this should also be increased (thus reducing the quantity) Common Equity investors, who will individually own a larger percentage of the shares in the deal.
Our firm likes developers to use preferred stock successfully. But like rescue capitalat least for usthe risk is beyond our tolerance.
3. Acquisition funds
Real estate syndicates are increasingly using preferred shares to acquire existing commercial real estate assets. As with development transactions, The preferred shares may use arrive Fill the gap between debt and common equity.
The high cost of preferred stock makes most stable “coupon” trades untenable. However, it might be ideal bonus transaction has Huge potential upside. The higher appraised value resulting from the appreciation should allow the syndicate to refinance go out Preferred stock, which gives common and common stock investors a higher stake in a successful project.
Our company believes in many bonus Acquisitions offer investors an ideal risk-reward ratio. we have done it Some and is eagerly pursuing more.
4. Recapitalization
I mentioned that preferred stocks are generally not suitable for acquiring stable assets. However, owners sometimes use preferred stock to recapitalize existing Stabilize assets to provide funding for other uses. These uses may include making improvements to increase revenue, acquiring other assets, or only Profits are withdrawn for owners without the need to refinance senior debt.
this Can a special Using preferred stock is less risky because the asset should have existing cash flows to support the preferred stock payments. All things being equal, our company believes this is the best use of preferred stock and we have funded a number these investments.
Are preferred stocks an investment opportunity for you?
Why Consider Preferred Stock? There are several potential reasons:
1. You have invested in common stocks but are concerned about returns and safety in this uncertain environment.
2. You invest in debt, and you Recognize that preferred stocks offer higher potential returns.
3. You are looking for an equity investment with management control, forced sale provisions and (usually) a personal guarantee from the sponsor.
4. You want higher initial cash flow than most common equity offerings Now.
5.you searching Hold time shorter than many Common Equity investment.
6. You considered diversified funds but chose Clarity Provided by the Invest in a single asset.
Interested in learning more? Let’s start the conversation here. Or feel free to contact me directly.
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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. To request a Private Placement Memorandum (“PPM”) containing this and other information about Wellings Real Estate Income Fund, please call 800-844-2188 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.
