Preferred Equity
FinancingPreferred equity is a hybrid layer in the capital stack that sits above common equity (sponsor and LPs) but below all debt — senior and mezzanine. A preferred equity investor receives their agreed return (a “pref”) before the common equity holders see a dollar of distributions. In exchange for that priority, the preferred return is typically lower than mezzanine debt but higher than what common equity expects over a hold period.
How it works. Preferred equity is structured through a separate class of LLC membership interests — Class A (preferred) and Class B (common). The preferred member contributes capital in exchange for a defined preferred return (often 8–12%, cumulative) and may or may not participate in upside beyond that return. The operating agreement spells out the waterfall: operating cashflow first pays the preferred return; then remaining cashflow goes to common equity. At a capital event (refinance or sale), the preferred member gets its unreturned capital back before common equity is paid.
Preferred equity is not debt. The preferred investor is a member of the LLC and shares in the tax benefits (depreciation pass-through). This makes it attractive for tax-sensitive investors. It also means the preferred investor’s remedy in a default is taking over the entity — not foreclosing on the property — which can be simpler and faster than a UCC foreclosure on mezzanine debt.
Example. A sponsor raises $1,000,000 to acquire a self-storage facility. The capital stack is $600,000 in common equity from LPs and the GP, and $400,000 in preferred equity at a 10% cumulative preferred return. In year one, the property generates $70,000 in distributable cashflow. The preferred investor receives $40,000 (their 10% on $400,000). The remaining $30,000 goes to common equity. At sale, the preferred investor gets $400,000 back before common equity receives anything.
Preferred equity is a flexible gap-filler in the capital stack. For the senior debt it supplements, see DSCR and agency financing.