Real estate offerings aren’t all structured the same way, and the structure behind a deal can have a real impact on the kind of return you can expect, how much risk you’re taking on, and when you get paid relative to other investors in the deal.
Two of the most common structures you’ll encounter are preferred equity and common equity. Here’s a simple breakdown of how they differ, and what each means for you as an investor.
The Capital Stack: Where Your Investment Sits
Every real estate deal has a capital stack — the layered sources of financing that go into acquiring and operating a property. From the bottom up, it typically looks like this:
- Senior debt — the loan from a bank or lender, first in line for repayment
- Preferred equity — investor capital that sits above the senior loan but ahead of common equity
- Common equity — investor capital that sits at the top of the stack, with the most upside and the most risk
Where your investment sits in this stack determines both your priority for getting paid and the nature of the return you’re targeting.
Common Equity: Growth-Oriented, Ownership-Style Returns
When you invest in common equity, you’re taking an ownership stake in the property alongside the sponsor. Your returns are tied to the property’s overall performance — cash flow during the hold period, plus (often more significantly) any appreciation realized at sale or refinance.
This is typically expressed as a target IRR (internal rate of return) and a target equity multiple, blending income and appreciation into one overall return expectation across a multi-year hold, often 5-7 years.
Common equity investors are last in line to get paid, after debt service and any preferred equity distributions are covered, which means more upside potential, but also more exposure if the deal underperforms.
Preferred Equity: Income-Oriented, Priority Returns
Preferred equity, by contrast, is structured more like a fixed-income investment layered into a real estate deal. Instead of targeting a blended return realized primarily at sale, preferred equity typically targets a defined annual preferred return, often paid out monthly or quarterly as current income.
Because preferred equity sits ahead of common equity in the capital stack, preferred equity holders are generally entitled to receive their distributions before common equity investors see any return at all. This priority position is designed to provide a layer of downside protection that common equity doesn’t offer.
The tradeoff: preferred equity typically has a capped return. If the property dramatically outperforms projections, that additional upside generally flows to the common equity holders, not to preferred equity.
Leverage and Loan-to-Value (LTV)
One additional factor worth understanding: many preferred equity offerings are evaluated in part by their loan-to-value (LTV) ratio, which is the combined balance of the senior loan and the preferred equity contribution, divided by the purchase price. A lower LTV means there’s more asset value sitting beneath the preferred equity position, which can provide additional cushion if the property’s value were to decline.
Which Structure Is Right for You?
Neither structure is inherently “better"; they serve different goals. If you’re looking for a blended return with growth potential and are comfortable with a longer hold and being last in line for distributions, common equity may align with your goals. If you’re prioritizing current income, a defined return target, and a priority position in the capital stack, often with a shorter hold period, preferred equity may be a better fit.
As with any investment, review the full set of offering documents before investing, including the specific terms, risk factors, and capital structure of the deal in question. Past performance is not indicative of future results, and target returns are hypothetical projections, not guarantees.
This article is for informational purposes only, and is not a recommendation or offer to buy or sell securities. Information herein may include forward looking statements and is for informational purposes only. Forward-looking statements, hypothetical information, or calculations, financial estimates and targeted returns are inherently uncertain. Past performance is never indicative of future performance. None of the opinions expressed are the opinions of RealtyMogul. Advice from a securities professional is strongly advised, and we recommend that you consult with a financial advisor, attorney, accountant, and any other professional that can help you to understand and assess the risks and tax consequences associated with any real estate investment. All real estate investments are speculative and involve substantial risk and there can be no assurance that any investor will not suffer significant losses. A loss of part or all of the principal value of a real estate investment may occur. All prospective investors should not invest unless such prospective investor can readily bear the consequences of such loss.
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