What were the terms on the original preferred equity? This deal would make me suspicious as F.
Assuming the rate only increased 300 basis points, we're looking at approximately 3% * 7 years equals 21% of the loan value. So in this transaction we would ballpark that the borrower is forfeiting the net present value similar to 21% of 65 million.
Given that 65 million is such a large portion of the financed amount losing 21% of it would be an enormous loss. That's 13.65 million on an original total property value of 100 million.
Given cap rates today and the cost of that new loan (just approximating), the new loan interest rate probably exceeds the cap rate. So the preferred equity coverage is awful. The common appears to be trying to withdraw all of their original investment, even at the cost of crippling future cash flows by sticking it with a high rate of debt.
If this was a real deal or the terms were very similar to a real deal on a proportional basis, then I would be inclined to think the manager was screwing the investors long term (by losing the value of the fixed rate loan) to churn that money faster or leverage it harder to bring in more management fees.
What do you think?
Also, this is probably the best real estate Substack. There are good ones for REITs, but your work on the underlying real estate is my favorite.
Unfortunately, I don't have the original deck from when this deal was syndicated in 2022, so no detail on what the terms of pref were. I can make an educated guess (based on hundreds such deals I saw in '21-22) that Class A (preferred) was making something like 10-12% at the time.
We don't really know how much pref they raised in '22- I'm making a guess based on the payoff amount (which is higher than the loan balance on the deed of trust recorded at purchase, I looked up county records)
My hypothesis: the pref from 2022 is forcing GP's hand. I agree with your math on the impact, it's really not accretive to the common equity (which is staying in the deal). I can't wrap my head around it, but the deal this is loosely based on did successfully raise money.
Wooof...this is a "hell no" for me. The general feeling at last week's Old Capital MF session is that "extend & pretend" is coming to an end and distressed operators have no place to turn, other than maybe suckering in investors chasing yield with financially engineered schemes such as your case study above.
Thanks, Leyla. It seems similar to me in the public REIT space (and some other sectors). The preferreds are so often a tiny slice in the overall capital stack, so they are not well protected in bankruptcy. Plus, despite seemingly protective "change of control" language, there are a few ways an acquirer can benefit by screwing the preferred holders. But try telling that to a retail investor with stars in their eyes about the high yield. Sigh.
I just heard of a deal where preferred equity was getting $.40 on each dollar invested after the short sale. It's really mind-boggling how semantics convince people this position is somehow "safe"..
What were the terms on the original preferred equity? This deal would make me suspicious as F.
Assuming the rate only increased 300 basis points, we're looking at approximately 3% * 7 years equals 21% of the loan value. So in this transaction we would ballpark that the borrower is forfeiting the net present value similar to 21% of 65 million.
Given that 65 million is such a large portion of the financed amount losing 21% of it would be an enormous loss. That's 13.65 million on an original total property value of 100 million.
Given cap rates today and the cost of that new loan (just approximating), the new loan interest rate probably exceeds the cap rate. So the preferred equity coverage is awful. The common appears to be trying to withdraw all of their original investment, even at the cost of crippling future cash flows by sticking it with a high rate of debt.
If this was a real deal or the terms were very similar to a real deal on a proportional basis, then I would be inclined to think the manager was screwing the investors long term (by losing the value of the fixed rate loan) to churn that money faster or leverage it harder to bring in more management fees.
What do you think?
Also, this is probably the best real estate Substack. There are good ones for REITs, but your work on the underlying real estate is my favorite.
Thank you for your kind words!
Unfortunately, I don't have the original deck from when this deal was syndicated in 2022, so no detail on what the terms of pref were. I can make an educated guess (based on hundreds such deals I saw in '21-22) that Class A (preferred) was making something like 10-12% at the time.
We don't really know how much pref they raised in '22- I'm making a guess based on the payoff amount (which is higher than the loan balance on the deed of trust recorded at purchase, I looked up county records)
My hypothesis: the pref from 2022 is forcing GP's hand. I agree with your math on the impact, it's really not accretive to the common equity (which is staying in the deal). I can't wrap my head around it, but the deal this is loosely based on did successfully raise money.
Wooof...this is a "hell no" for me. The general feeling at last week's Old Capital MF session is that "extend & pretend" is coming to an end and distressed operators have no place to turn, other than maybe suckering in investors chasing yield with financially engineered schemes such as your case study above.
There is a never-ending stream of preferred equity deals in my inbox now. And so few make any sense..
Thanks, Leyla. It seems similar to me in the public REIT space (and some other sectors). The preferreds are so often a tiny slice in the overall capital stack, so they are not well protected in bankruptcy. Plus, despite seemingly protective "change of control" language, there are a few ways an acquirer can benefit by screwing the preferred holders. But try telling that to a retail investor with stars in their eyes about the high yield. Sigh.
I just heard of a deal where preferred equity was getting $.40 on each dollar invested after the short sale. It's really mind-boggling how semantics convince people this position is somehow "safe"..