Preferred Equity Takes Center Stage

LOS ANGELES—”Preferred equity has become the primary focus of our daily tracking. Many have ceased traditional purchases, reminiscent of the debt funds from a decade ago. Fortunately, most of my client base can adapt to this shift, which is encouraging,” said Laurie Morfin, Senior Managing Director at NewPoint Real Estate Capital during the recent GlobeSt. Multifamily Fall Conference held here in Los Angeles.

Discussing the challenges of managing cash in refinancing, Bryan Shaffer, Principal and Managing Director of Slatt Capital, said, “Lenders have displayed a level of patience, allowing borrowers to continue the fight.”

Moderator Malcolm Davies, founder and senior managing partner of WAY Capital, noted that he’s witnessing stress among borrowers who can’t consistently inject cash into their deals.

Jeff Salladin, Managing Director of Real Estate at Revere Capital, shared that “The common theme for everyone is survival until 2025, banking on the macroeconomic factors. It’s about making it from here to there.”

In terms of asset management, Salladin said that “Maintaining a strong relationship with our borrowers has proven crucial, especially when projects encounter challenges.”

However, panelists stressed that pressure in the commercial real estate industry isn’t solely due to fluctuating interest rates. Davies asked: “When you’re underwriting on a permanent basis today, how much pressure are you facing?” Morfin pointed out that insurance has long been a contentious issue, affecting loan viability and adding to the woes of rising interest rates. “The situation is challenging, and it feels like trudging through deep mud every day.”

Jeff Burns, Senior Managing Director of Walker & Dunlop LLC, added, “It’s very submarket-dependent, but rents are what they are. We need to invest more time upfront to address these concerns. Fortunately, it’s not as challenging as if we were speaking at a multifamily conference in Florida or Louisiana, when it comes to insurance. When you’re arranging a permanent loan and modeling the exit strategy, you’re factoring in modest rent growth, and there’s stress on how to adjust the interest-only periods on these loans.”

Shaffer added, “The insurance component is essential; the debt won’t function without it.”

Regarding solutions for refinancing floating rate debt issues, panelists agreed that “preferred equity is the go-to strategy.” Burns highlighted that Freddie Mac is more accommodating when it comes to preferred equity, whereas Fannie Mae’s sizing requirements can be cumbersome. 

“They [Fannie] seem to be realizing that this approach is hindering deal flow. We don’t know the outcome, but they’re recognizing it’s an issue and are investigating,” said Burns. “You can secure substantial preferred equity investments. However, there are many elements to consider, and it’s crucial to choose a provider with expertise in structuring. Avoid those with a ‘hard pay’ concept.”

Shaffer warned about the need for caution in today’s market. “Many groups initially formed funds to acquire distressed assets but ended up purchasing mezzanine financing instead. It’s crucial to understand your lender’s motivations because they have evolved significantly.”

For Salladin, being a floating rate shop means facing different challenges. “When considering a new deal and relying on an agency takeout, sponsors must have prior experience. We can’t hinge our exit strategy on an entrepreneurial opportunity.”