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Preferential Equity

Finance options requiring less capital investment from developers

Preferential Equity to obtain construction finance

Are you facing any of the following problems with your property development projects?

  • Reduced “As Is” Land Values and “On Completion Value “
  • Commitment to a high level of pre-sales in order to obtain construction finance?
  • Pressure to sell development sites at heavily discounted prices in order to reduce debt and fund working capital.
  • Having to commit to an unacceptable amount of upfront capital before you can obtain finance required for construction?
  • Need to bring your project to market sooner?

What is Preferential Equity and how does it work?

Preferential Equity (Pref Equity) is a hybrid of debt and equity financing filling the gap between what the Bank will fund and what the developer needs to contribute towards the Total Developments Costs (TDC) of a project.

Pref Equity financing is debt capital that gives the Pref Equity provider the rights to convert to an ownership and control position in the development company if the loan is not being paid back in time and in full or there being a prolonged un-remedied event of default relative to any loan documentation including he senior lender or the Pref Equity facility itself.

How is it different to Mezzanine finance?

The main of Pref Equity vs Mezzanine Debt is that Pref Equity does not require a registered 2nd mortgage or a deed of subordination debt to be negotiated by senior lenders such as banks.

Pref Equiry can also be used to “Sell Down” equity and or pay down and restructure existing debts secured by existing income producing commercial properties.

With Pref Equity lending the capital and return is secured in priority to the developer and obviously behind the Bank. The pricing of the Pref Equity return is generally calculated upon a risk adjusted return on capital basis and must achieve a minimum or floor Internal Rate of Return (IRR).

What is The Cost of Preferential Equity?

The cost of Pref Equity is similar to that of Mezzanine finance and is priced on the basis of risk which is largely driven by how far the overall gearing is extended to, however in most cases Development Finance Partners settles loans priced between 15% to 30% per annum.

The Benefits of Preferential Equity 

  • Generate a higher return on equity as your cash contribution is significantly reduced.
  • Bring the commencement and completion of your project forward.
  • Banks are more willing to provide senior debt with Pref Equity as they are reluctant to consent to second mortgages for construction projects.
  • Immediate access to equity lying dormant in brick and mortar assets.
  • Ability to restructure debts and rectify potential or existing loan covenant defaults without suffering significant losses due to the forced sale of the asset.
  • Ability to restructure ownership/equity/partners within existing property portfolios.
  • The Pref Equity participant provides additional experience, capability and strong management support to help manage risk and profitably complete the development
  • The reduced cash equity required by the borrower may allow them to take advantage of other opportunities which would not otherwise be possible
  • The Pref Equity’s underwriter’s returns are usually fixed, reducing the potential for conflict with respect to calculating the “Project Profit”. This gives the Property Developer the opportunity and the incentive to make additional profit if the project achieves profits beyond those originally forecasted.
  • The borrower is able to bring the project to market faster and reduce holding costs.
  • The Property Developer realises development profits sooner.
  • Pref equity provides the bank and Property Developer with an additional source of cash in the event of cost overruns beyond the existing contingency budget.
  • If structured correctly the addition of the Pref Equity participant can make the project more Bankable from a senior lenders perspective.

What are the risks?

  • Pref Equity is more expensive then traditional debt and as such it needs to be used wisely.
  • In the event of serious unremediated event/s of default the Pref Equity lender can enforce step in and control the development company to ensure the project is completed and their capital and return is preserved.

If you would like to discuss Preferential Equity funding for your development or portfolio please contact us.

How can we help you? Get in touch!

We will get back to you as soon as possible.