Preferred Equity Loans
We'll Add Our Capital to Your Buyer's Down Payment
If you're a commercial broker, this article is super-important to you. You lose a lot of commercial brokerage commissions because the bank won't give your buyer a large enough commercial loan.
For example, your client is trying to buy a $1 million office building, and he has $250,000 to put down. You apply to the bank for a $750,000 conventional commercial loan, but the bank only agrees to make a $600,000 commercial loan. To make matter worse, few commercial banks will allow the seller to carry back a second mortgage.
Of course, if your buyer intends to move his business into the subject property, he can get an SBA loan. What we are talking about today, however, is the purchase of commercial real estate - like multi-tenant office buildings or strip centers - by investors. Since the Great Recession, commercial banks have gotten very, very conservative about such loans.
In fact, banks today will make few conventional commercial real estate loans in excess of 58% to 63% loan-to-value. Not many investors are willing to put down 38% to 42% of the purchase price in cash.
A preferred equity "loan" from Blackburne & Sons will quickly and easily solve your leverage problem. We add our capital to your buyer's down payment to create a down payment large enough to satisfy the bank. In return, we take a preferred equity position in the property.
Technically, preferred equity is NOT a loan, although for convenience's sake, we will sometimes use the expression, "preferred equity loan". Your buyer does not promise to repay Blackburne & Sons. Your buyer does not guarantee our investment. Whether we earn any return, or even get back our original investment, depends entirely on the success of the real estate venture.
Our investment is called "preferred equity" because we enjoy a repayment preference in the case where the profit is very small. An example will make this more clear:
Let's suppose your buyer and Blackburne & Sons buy together a multi-tenant office building for $1 million. Your buyer puts down $250,000. The bank makes a $630,000 new first mortgage, and Blackburne & Sons makes a $120,000 preferred equity investment.
Unfortunately, after we buy the property, two of the seven tenants move out. Therefore the property is not bringing in the kind of income that we projected. Fortunately the property is making enough money to service the first mortgage, plus there is enough to pay Blackburne & Sons a 5% preferred return, but not the agreed 16% preferred return. What happens?
Can Blackburne & Sons sue your buyer? No! Remember, your buyer never promised Blackburne & Sons any sort of return. In fact, your buyer did not even promise a return of its $120,000 principal investment.
All Blackburne & Sons can do legally is fire your buyer as Property Manager and Managing Member of the joint venture and then bring in a more competent property manager, if we believe your buyer is doing a poor job. In this example, we do NOT blame your buyer, but rather just bad luck. What happens to the unpaid preferred return? It accrues, defers, and compounds at 16%.
Five years later, this disappointing property investment (remember, we intentionally chose a so-so outcome here as an example) sells for $1,225,000. The joint venture nets $1,139,000 after real estate commissions and closing costs. Who gets what out the proceeds? The profit distribution plan of a real estate joint venture is called a waterfall.
From the proceeds, Blackburne & Sons' gets repaid its original investment first because we own the preferred equity. If there is any money left over, your buyer gets back his original $250,000 downpayment. Next, Blackburne & Sons gets back some profit, up to a maximum of our 16% preferred return.
In this case, because the property only generated enough monthly cash flow to pay a 5% annual preferred return to Blackburne & Sons, an 11% preferred return went unpaid annually. This unpaid preferred return accrued, deferred, and compounded.
There were enough proceeds from the sale of the property, together with the small amount of monthly net rental income, to pay Blackburne & Sons a total preferred return of 9%. We did NOT earn our anticipated 16% preferred return, but we have no recourse against your buyer. Remember, your buyer did NOT borrow this money from us. Instead, we invested alongside of him as a fellow equity investor.
Since there are no more profits to be disbursed, your buyer does not earn a return on his $250,000 down payment. He did, however, enjoy a healthy property management fee every month for five years, and he does not owe Blackburne & Sons a penny, even though he was unable to find a replacement tenant for two of the seven offices for five years. Had he found replacement tenants, the investment might have generated a 23% annual return on his downpayment for him.
In conclusion, if you are buying a commercial property with at least 25% down, but the bank won't give you a purchase money commercial loan of 75% loan-to-value, Blackburne & Sons will top off your capital stack. In other words, we will add our capital to your down payment to make your down payment large enough to satisfy the bank.
Blackburne & Sons is actively looking for preferred equity opportunities, from $100,000 to $1,000,000, nationwide. We might consider larger deals, up to $1.5 million, in California and the booming areas of Texas. Got a potential deal? Please call Angela Vannucci, Vice President and Equity Division Manager, at 916-338-3232.
Return to C-Loans
Home Page | Return to Blackburne.com Home Page